Lower Oil Prices–Not a Good Sign!

Are lower oil prices good news? Not really, if it means the world is sinking into recession.

We know from recent past experience and from common sense that higher oil prices are a drag on oil importing economies, since if more $$$ are spent on the same amount of oil, there is less to spend on discretionary goods and services. In addition, oil money sent to oil exporting countries is likely to be spent within those economies, rather than being reinvested in the oil importing country that the funds came from.

igure 1. A rough calculation of expenditure (in 2011$) associated with oil imports or exports, based on 2012 BP Statistical Review data, for three areas of the world: the Former Soviet Union (FSU), the sum of EU-27, United States, and Japan, and the Remainder of the World. (Negative values are revenue from exports.)

A rough calculation based on 2012 BP Statistical Review data indicates that the combination of the EU-27, the United States, and Japan spent a little over $1 trillion dollars in oil imports in 2011–roughly the same amount as in 2008. Governments have been running up huge deficits and have been keeping interest rates very low to cover up this damage, but it is hard to make this strategy work. The deficit soon becomes unmanageable, as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries in Europe have recently been recently been discovering. The US government is facing automatic spending cuts, as of January 2, 2013, because of its continuing deficits.

Furthermore, lower interest rates aren’t entirely beneficial. With low interest rates, pension funds need much larger employer contributions, if they are to make good on their promises. Retirees who depend on interest income to supplement their Social Security checks find themselves with less income. The lower interest rates don’t necessarily have a huge stimulatory impact on the economy, either, if buyers don’t have sufficient discretionary income to buy the additional services that new investment might provide.

Below the fold, we will discuss what is really happening with oil prices, and consider reasons why lower oil prices may be a signal that the world is again headed for deep recession. Continue reading