It is far from clear whether the recent plunge in international commodity prices in general, and in oil prices in particular, will provide a boost to the US economic recovery. While those price declines would certainly providee the equivalent of a sizable tax cut for US consumers, they will deliver a major blow to the increasingly important US oil industry, as well as to commodity producing emerging market economies.
In so doing, they could cause serious strains in the US and global financial system.
Drivers wait in line to fill their vehicles at a petrol station in Bahrain, January 11, 2016. Bahrain has approved raising domestic gasoline prices, part of efforts to boost revenues hit by slumping oil prices. REUTERS/Hamad I Mohammed.
Over the past year, the earlier super-international commodity boom has turned into a spectacular bust. International oil prices — which a little over a year ago had exceeded US$100 a barrel — have declined by 70% to their present level of around US$30 a barrel. Similar out-sized price declines have been recorded in a wide range of other industrial commodity prices like iron ore and copper. It is not expected that these price declines will be reversed anytime soon, especially given the marked slowing underway in Chinese economic growth.
Lower international oil prices soon translate into significantly lower gasoline prices at the pump, the equivalent of a tax cut for US consumers. That in turn may boost the US economic recovery. Indeed, various macro-economic estimates would suggest that the consumption boost to US GDP growth from a 70% decline in oil prices could be anywhere between 0.75% and 1.5%.
Sadly, there are two major offsets of this benefit for the US economic recovery. The first is that the US economy itself now again has a large oil sector. Over the past five years, as a result of the shale oil revolution, US oil production has increased by 50% from around 6 million barrels a day to its present level of 9 million barrels a day.
However, at US$30 a barrel, the shale oil industry is no longer profitable. This is already causing major investment and employment cutbacks in the oil and gas industry, which is estimated to employ around 2% of the US workforce. It is also raising the risk of major defaults on the US$200 billion in loans that have been extended to the domestic shale oil industry.
The second major downside to the bust in international commodity prices is that it plunges into recession major emerging market economies like Brazil, Russia, and South Africa. This could have important consequences for the US and global economic recoveries. According to World Bank estimates, a 1 percentage point decline in the growth of the BRICS economies (Brazil, Russia, India, China, and South Africa) could shave off as much as 0.4% from global economic growth. More serious still, the sharp reversal of the emerging market economies’ fortunes could put into question their corporate sector’s ability to service its US$ 5 trillion in US dollar denominated debt. That in turn could add to the stresses already appearing in the global financial system.
Hopefully the Fed is paying close attention to the negative fall-out from the international commodity prices on the emerging market economies. For then it might not be in quite as much of a hurry to raise US interest rates three to four times in 2016, as it presently seems to be contemplating.
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