It must be the noxious fumes or the stratospheric prices because crude oil crossing the $100 (R692) threshold makes normally thoughtful individuals funny in the head.
The early symptoms of high oil price syndrome can easily be masked or confused with a more generalised form of lazy economic thinking.
For example, those afflicted with high oil price syndrome start making assertions that higher oil prices are inflationary, as if relative price changes can morph into an economy-wide rise in prices without help from the central bank.
High oil price syndrome sufferers aren’t beyond doing a quick 180, pronouncing higher oil prices to be deflationary because they sap consumer demand. Which is it?
When oil prices aren’t standing in for the central bank, the ultimate arbiter of all things monetary, they’re doubling as the tax man. High oil price syndrome sufferers claim oil prices are a tax on the consumer, even though the effect is nothing like a tax, which drives a wedge between consumers and producers.
Finally, higher oil prices devastate the economy and destroy jobs. What happens to producers’ profits?
I find myself getting light in the head from all this nonsense. For my own peace of mind, I need to set the record straight. Here goes.
n Sometimes a cigar is just a cigar
For folks who use the term “inflation” interchangeably with higher prices – as in wage inflation or commodity inflation – they are not the same thing.
A higher price for oil and/or other commodities is a higher relative price until ratified by the central bank. What does the central bank have to do with it?
Inflation is a monetary phenomenon: too much money chasing too few goods and services. Where does the money come from? In the US, it comes from Ben Bernanke, the chairman of the Federal Reserve, and his trusted band of governors and district bank presidents.
To be more accurate, it comes from the New York Fed’s Open Market Desk, which buys Treasury securities (generally) from a group of primary dealers at the direction of the Fed’s policy committee.
Higher oil prices don’t cause inflation. They aren’t synonymous with inflation. Higher oil prices represent a relative price increase until proven differently.
Higher oil prices are always viewed as a negative because they crimp consumer purchasing power. It’s not a one way street. Wealth is transferred from consumers to producers and recycled.
Higher prices act as an incentive for oil exploration. Exxon Mobil buys new drilling equipment and hires more workers. Those dollars go back into the economy, they don’t suck life out of it.
What do they do with them? They spend them on US goods and services. They buy US stocks, bonds, trophy property and F-16 fighter jets. This doesn’t happen simultaneously, of course. But to portray every dollar of oil profit as a net drain on the economy is inaccurate.
When oil prices rise, consumers have to allocate more of their household budget to filling the tank and heating the house, leaving less for discretionary purchases. The composition of their spending may change, but nominal spending shouldn’t be affected. There will be some effect on real gross domestic product (GDP), but that depends on the Fed.
n Taxing thought
The claim that oil is a tax on the consumer is one of the most common talking points during every oil price spike. It also happens to be dead wrong. An excise tax raises the price to the consumer, who will demand less, and lowers the price received by the producer, who will supply less. The result is deadweight loss.
The recent increase in oil prices qualifies as a supply shock – a decline in Libyan oil production and expectations of further disruptions in Middle East supply – on top of what was already a demand-driven rise as the world economy recovered.