Commentary: Only a Glancing Blow to the U.S. Economy

Is the U.S. economy heading for another recession? The latest surge in energy prices has plenty of smart economists worried. And they have the weight of history on their side: Since the first Arab oil embargo in 1973, nearly every oil spike in the U.S. has been followed by a recession. Writes Stephen S. Roach, Morgan Stanley's chief economist: "Inasmuch as America has yet to withstand an oil shock without tumbling back into recession, I am hard-pressed to believe that this will be the sole exception."

The latest spike is a doozy -- the price of crude has doubled to about $37 a barrel. Natural gas has more than tripled. Gasoline at the pump is up 50 cents. And there's little doubt high energy prices are hampering the recovery of an economy that's already battered by slow business investment, a huge trade deficit, weak consumer confidence, and a depressed stock market.

Yet even with all the short-term pain the energy spike is causing, if the Iraq conflict doesn't boil over into a regionwide war, there's a good chance the effect of the oil shock won't be severe. The history of oil spikes is a poor guide, in part because the country is less dependent on oil than it used to be. The U.S. uses only about half as much oil per dollar of inflation-adjusted output as it did in the early 1970s. Even since the last Gulf War, the economy's energy dependence has shrunk.

For energy prices to do real damage, they must remain high. It's only since December that crude has been firmly above its long-term average of the mid-$20s. And the factors propping up prices are mostly temporary, from a cold winter in parts of the U.S. to a Venezuelan oil strike to war fears. Winter is almost over and Venezuela has partially restored production. If the conflict with Iraq is resolved within a few months -- a big if, to be sure -- oil prices are likely to drop below $30 a barrel by summer. Some experts even think an oil glut is possible. Oil-company analyst Frederick P. Leuffer of Bear, Stearns & Co. predicts oil will average $18 a barrel in the second half of 2003.

Traders in the futures markets aren't so sure, but even they predict price declines. Oil on the New York Mercantile Exchange for August delivery is going for $31 a barrel, vs. $37 for April delivery. August natural gas is $5.50 per million Btus, down from more than $10 for the recently expired March contract. Things look worse for summer gasoline prices because supplies will be tight. Analysts see retail prices averaging from $1.65 to $2 a gallon.

While none of that is good news, a recession looks unlikely. Leading forecasters such as Waltham (Mass.)-based Global Insight Inc. and St. Louis-based Macroeconomic Advisers LLC predict that costlier energy will knock roughly half a percentage point off the first-half growth rate, but cease to be a factor in the second half. That's if per-barrel oil prices get back to the mid-$20s. If they stick at current highs, growth could be suppressed by half a percentage point -- or a bit more -- for the entire year.

Those who warn of an oil-induced recession may be misreading history. Merrill Lynch & Co. calculates that when oil prices have moved up 60% over a yearlong period in the postwar era, in all but one instance, 1987, the economy has fallen into a recession. But triggering most past recessions was the Federal Reserve's efforts to stop inflation by raising rates, says James Glassman, an economist at J.P. Morgan Chase & Co. This time, inflation is tame: Consumer prices rose only 2.6% in the year ended in January.

Of course, much will depend on how consumers, who buy two-thirds of total output, react to costlier energy. Certainly, higher prices add to the tentativeness many already feel in the face of a sluggish economy and high joblessness. The growth rate of consumer spending slowed sharply in the fourth quarter of last year to 1.5%, from 4.2% in the third quarter. And in January, spending actually fell by 0.3%, according to Macroeconomics Advisers. Global Insight forecasters believe that higher energy costs will notch consumer spending growth in the first quarter down to 1.5%, vs. the 2.2% it would have hit had oil prices remained stable.

Still, presuming energy prices do head down quickly, the hit to consumers should be short-lived. A recent Gallup poll found that 62% of people thought today's high prices were a "temporary fluctuation." So, they may save less or borrow more to preserve their spending patterns. Says Oscar Rivera, 30, an inventory manager at a Texas trucking company: "What are you going to do? Not go out? Not heat your home?"

None of which is to say that some sectors aren't getting whacked. Because of high natural-gas prices, 45% of the nation's production of ammonia, a fertilizer ingredient, is shut down. Behlen Manufacturing Co. of Columbus, Neb., says its energy costs have risen 30% recently, but it can't pass them along because retailers won't pay more for its fabricated steel products. Expensive jet fuel is further weakening the airlines.

Yet the economy as a whole remains resilient. Although Fed Chairman Alan Greenspan has warned that economists often underestimate the effects of oil shocks, he thinks the economy can withstand this one. As he once said, "forecasts of crises...more often than not fail to develop, or at least not with the frequency and intensity proclaimed by headline writers." Let's hope the headlines are wrong again.

By Peter Coy

With Stephanie Anderson Forest in Dallas, Michael Arndt in Chicago, Christine Tierney in Detroit, and bureau reports

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