Why We Should Care About Oil Prices
When people talk about oil shocks, they worry mainly about consumers. Television serves up pictures of Mr. Frazzled Householder filling up his SUV; the slumped shoulders supposedly foretell a slump in the economy. Of course, this image has its place: One of the questions posed by costly oil is whether U.S. households, whose saving rate turned negative in July, might suddenly panic and set money aside, slowing growth alarmingly. But the scariest thing about expensive oil is not that it is going to shock people into saving. It's actually the opposite.
Despite all the jitters about oil, consumers are not massively exposed to its gyrations. Gasoline makes up 3.9 percent of the basket of goods in the consumer price index for American cities; if the gas price jumps by a quarter, average city dwellers will experience a 1 percent hit to their living standard. By contrast, medical goods and services, which grow more and more expensive by the year, make up 6.1 percent of the basket; rent and mortgage payments account for 29.3 percent. If people cared desperately about the price of gas, they wouldn't buy mega-trucks in the first place.
So the sticker shock may matter less than another consequence of costly oil: a bubble in global saving. Oil producers tend to save a good part of their windfall. Saudi Arabia and Russia are each on track to export about $100 billion worth of surplus capital this year, roughly double what they exported last year, when oil prices were lower. Most of these petrodollars find their way, directly or indirectly, to the United States. Other regions of the world are not importing more savings than they were a year ago, but the United States is set to boost capital imports from $668 billion last year to perhaps $800 billion this year.
Does this matter? In one sense, it's welcome: The influx of foreign savings keeps interest rates low, which means that mortgages stay cheap and home prices stay buoyant. This is another reason you shouldn't grieve for Mr. Frazzled Householder: The oil shock has pushed pump prices up, but it's also kept the payments on his mega-truck affordable. And yet, however seductive, these petrodollars are a curse. They are fueling an American debt crisis much as they fueled a Latin American one two decades ago.
After the 1973 oil shock, the Latins should have adjusted to the new reality. An essential import was now going to cost more; they should have cut spending in order to afford it. Instead, they and other developing regions borrowed low-interest petrodollars to pay for oil imports. By 1981, Argentina was borrowing the equivalent of 3.4 percent of gross domestic product, Mexico was borrowing 6.2 percent and Brazil was borrowing 6.9 percent. The following year Mexico's default unleashed the Third World debt crisis.
This time around, Latin America isn't borrowing to pay for oil. But the United States is borrowing the equivalent of 6.1 percent of GDP this year -- roughly in line with Mexico's rate just before it defaulted. Of course, the United States is not going to default, too, because the special status of the dollar allows it to borrow in its own currency. If the debt burden grows onerous it can allow the dollar to slide, cutting the value of the debt relative to export earnings. Still, the comparison shows that the United States has been seduced by low interest rates into borrowing truly staggering amounts. Paying off the debt is not going to be fun, either for households or for the federal government.
This is the real danger in the oil shock. The longer energy prices stay high, the greater will be the temptation to continue reckless borrowing. The oil shock creates an incentive to borrow -- suddenly we can't afford what we could afford before -- and it simultaneously creates a chance to borrow at beguilingly cheap interest rates. Yet the longer Americans carry on borrowing, the more they build their lives on foundations that can't last. Easy money has fueled a housing boom that's allowed families to grow richer even while saving pretty much nothing. But if house prices fall or even level off, families' sense of financial security will crumble. The scramble to save might set off a recession.
In a rational world, the nation's leaders would be on to this. The Fed is doing its part: Alan Greenspan has warned that house prices may be headed for a fall, and last week the Fed yet again raised short-term interest rates. But the Bush administration and Congress seem determined to make the oil shock worse than it need be. By embarking on a post-hurricane spending splurge, they are piling debt upon debt. They should pause a moment to recall the lesson of the 1970s.