Economic Suicide
March 13, 2001
For every fundamental reason, the softening U.S. economy should only be flirting with recession. However, for the single reason of energy prices the question is not whether there will be a recession, but, rather, how bad will the recession be? Sadly, the political leadership and government of the U.S. have greatly contributed to the coming recession.
In the interests of non-partisanship, there is no one political administration, political party or elected official who is to blame. Pathetically, the U.S. economy is sliding into an unavoidable recession as a result of almost three decades of cumulative neglect by all administrations, both political parties and most elected officials.
The first “energy” wake-up call came in October 1973 with the Mideast Oil Crisis. The 1973 crisis was interpreted as a reactive strike by the Arab OPEC nations against a pro-Israel United States. Official U.S. response to the 1973 oil crisis was essentially ineffective. Market forces eventually overshadowed the government’s three-tiered approach of regulation, condemnation and conservation when OPEC’s self-interest dictated the necessity of increased production.
Fruitless regulation consisted of rationing consumption and capping prices. If there is a certain way to create rationing, it is definitely to cap the price of anything. Elementary supply and demand curve analysis will validate the argument that at artificially low prices (i.e. capped prices) demand stays elevated and supply remains depressed.
The condemnation of OPEC nations by the leadership and public of the U.S. might have felt good but it was totally without productive consequence and is unworthy of further discussion.
The final tier of the U.S. response to the 1973 oil crisis made the most sense and had the greatest long-term promise. Unfortunately, conservation and the development of alternative-energy sources rank second only to campaign finance reform on the low priority agenda of the body politick. Reduced consumption of fossil fuels should be a matter of national security not a pet project of tree-huggers.
Until the United States reduces it’s consumption of fossil fuels as a consequence of long-term policy and not short-term market forces, the U.S. economy will be held hostage by the supply and demand forces of the energy markets. When the economy booms, demand for oil increases and price increases follow. Inflationary energy price increases transfer spending from productive economic sectors to the energy market and choke economic growth. Recession results from the huge transfer of wealth from productive expenditure to inflationary energy price increases and as the economy cools, demand cools and energy prices decline.
The latest 2000 round of crude oil and natural gas price increases have once again placed the U.S. economy in jeopardy. The economy boomed for most of the 1990’s. Unfortunately, yet predictably, increased demand for energy products enabled energy price hikes. Inflationary pressures created by increased demand for both labor and goods prompted corrective action. In response, the Federal Reserve increased interest rates in an attempt to cool mounting demand and moderate inflationary pressures. The stage is now set for an economic “Catch 22”.
Energy’s impact on the U.S. economy is unique. Unlike a DVD player or even an automobile, whose purchase can be delayed or canceled, people need energy and it affects the cost of almost every other economic variable. Consequently, if the factory has to pay more for energy, this increased cost is passed through to the consumer in a price hike for the widget that is purchased. Energy is used in the production of every product we buy. Energy is also a key component of setting wage rates. If one has to drive to work and heat one’s home, one needs to either earn a greater income or transfer expenditures from purchasing DVD players and all other consumables to energy.
If one chooses to keep consuming on a pre-energy price increase level, then one needs a pay raise. A pay raise (increased cost of labor) enables consumption at current levels of growth and, when added to the price hikes for goods (almost everything we consume except labor), creates inflationary pressures that prompts a response from the Federal Reserve in the form of interest rate increases. The result is a slowing economy in the guise of decreased spending, declining stock markets, and higher unemployment.
If one chooses not to seek a pay raise (which is unlikely) then the reality is that the individual must then forego the purchase of the DVD player and all other widgets to pay the gasoline and home heating bills. There will be some decreased consumption of energy also which contributes to decreased overall consumption. This also will result in decreased spending, slowing economic growth, declining stock markets, and higher unemployment (a.k.a. a recession).
The insidiousness of energy price increases is two-fold. As mentioned above, energy is an input product of all that is consumed and therefore, rising energy costs put upward pressure on the cost of all other consumables, including food. The more sinister component of energy price increases is that they are inflationary. If you go into a department store and spend twice as much as you had planned, in simple terms it means that you just bought twice as much (more consumption = more jobs). If, as a result of an oil price hike, you spend twice as much at the gas pumps, you only get the same amount of fuel for which you just paid double. Nothing more is created. That is inflationary.
The problem that the U.S. faces today is that we have a prosperous economy, radically increased energy prices that are creating inflationary pressures, a Federal Reserve that is intent on fighting inflation and the knowledge that there is no sensible method of reducing energy prices other than reducing demand. With no comprehensive national energy policy, Americans cannot just keep having their cake and eating it too.
Even if the U.S. government and all the states eliminated all taxes on fossil fuels, this would only lead to propping-up demand and eventually further price increases. The more moderate action of reducing interest rates in an attempt to sustain growth would also lead to propping-up energy prices, further demand, further price increases and growing inflation whose end result would be to wreck the economy.
The unfortunate truth is that the only solution the U.S. has immediately at hand is to keep interest rates elevated, slow growth, increase unemployment, reduce demand and let the markets moderate energy prices as a result of supply and demand curve equilibrium. In simple terms, this equates to a recession that was fully avoidable if the U.S. had given serious action to a comprehensive national energy program.
If, during the boom of the 1980’s and 1990’s, while national wealth was increasing along with the stock markets the U.S. had been diligently implementing a program to conserve energy and transfer energy consumption from fossil fuel to alternative sources then today America would be much less fossil fuel dependent. If the buyers of the millions of new homes had just used solar heat and received tax credits for doing so, the demand curve for fossil fuels would look much flatter and our economy would not be held hostage to world energy prices (not to mention how the increased productive expenditures for alternative heating systems would be offset by the tax credits being applied to the gains in their stock portfolios).
The U.S. government and its elected officials sat on the sidelines while the population sat fat and happy in their new SUV’s. This country sacrificed the opportunity of two major economic growth cycles to invest in America’s energy future. Not to mention the billions of barrels of crude oil and cubic feet of natural gas wasted. The greatest sin is that the health of the U.S. economy is still mated to fossil fuel prices.
In simple terms, America needs a comprehensive national energy policy with teeth in it. It is a matter of national security that the U.S. no longer ties its monetary and fiscal policy to the vagaries of world energy markets. The growth of the U.S. economy can no longer be so directly tied to the fossil fuel market. We are living in the 21st century with a 20th century energy mentality. This is not rocket science and a comprehensive energy policy, perhaps with campaign finance reform, deserves priority attention by the U.S. government. Perhaps campaign finance reform and energy policy have more in common than those in Washington, D.C. wish to admit.
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