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Trading Lessons

The Myth of Lower Oil Prices Will Hit Consumers

Commodities / Crude Oil Dec 04, 2014 - 02:07 PM GMT

By: Money_Morning

Commodities

Michael E. Lewitt writes: Media elites and Wall Street cheerleaders are greeting lower oil prices with open arms.

Investors should beware these self-appointed experts bearing gifts.

Oil prices are falling for reasons that should be surprising to nobody: supply has been rising and demand has been falling. If prolonged, which it is likely to be, the drop in oil prices is going to be destabilizing geopolitically and damaging economically.


For those who want to believe in a magical economic rebirth as the price of oil falls, well, good luck with that.

My view is distinctly different, and it demands we look at the whole economic picture as it is, not as others want it to be. It's time for some hard truths…

"Extra Money" in Our Pockets Is a Delusion

Global oil supply has been rising due to the explosion of fracking in the United States as well as rising output from Libya, Iraq, and Iran. Demand has been falling because the global economy is faltering.

With the exception of the United States and China, the rest of the world is in recession, and even Chinese growth is less than meets the eye and lower than in previous years. The simple fact is that demand for oil is weak at a time when supply has never been higher.

Furthermore, supply has been abetted by the availability of cheap capital to fund new projects in the shale regions not only in the United States but in other parts of the world as well. These conditions have led to a more than a 40% drop in prices since the summer that virtually nobody expected.

The argument that consumers will wake up and find extra money sitting in their checking accounts because gas is cheaper is an intellectual affectation of a media and Wall Street elite that is completely out of touch with reality.

It is an argument promulgated by those elites about the experience of the disenfranchised. The people who make these arguments are generally highly compensated media and financial industry types who are least affected by changes in the prices of everyday products and services.

Those realities include wage growth, which remains sluggish. There may be signs that wage pressures are building, but they have yet to arrive in a meaningful way. More important, the cost of every other product or service that people need to live – food, insurance, tuition, etc. – is much higher than it was five or ten years ago.

As The Wall Street Journal reported in a December 2 front page article "Basic Costs Squeeze Families": "The American middle class has absorbed a steep increase in the cost of health care and other necessities as incomes have stagnated over the past half-decade, a squeeze that has forced families to cut back spending on everything from clothing to restaurants."

Spending on healthcare, for example, has increased by 21% between 2007 and 2013 (and is no longer optional thanks to the Affordable Care Act).

Further, other expenses that have increased since 2007 include home Internet (+81.9%), cellular phones (+49.1%), rent (+26%), education (22.2%), and food at home (12.5%), none of which would be considered truly discretionary anymore.

Those fortunate enough to save money at the gas pump will have plenty of uses for that money; it won't be burning a hole in their pockets.

Furthermore, lower gas prices aren't creating money but merely shifting money from one category of spending to another. The idea that this will increase economic activity is nonsensical.

Here's Where the Logic Fails

The fallacy of consensus thinking on this point was fully evident in a recent speech by New York Fed President William Dudley (God forbid our central bankers shouldn't number themselves among the deluded!).

In a December 1 speech he said, "Since energy expenditures represent a higher proportion of outlays for lower income households, falling energy prices disproportionately raise their real incomes. Also, because such households are more liquidity constrained, with budgets that often bind paycheck to paycheck, they have a higher tendency to spend any additional real income. As a result, much of the boost to real household income from falling energy prices is likely to be spent, not saved."

This is not only incredibly condescending but logically nonsensical. Mr. Dudley is saying that money that would have been spent on gas will now be spent on other things, but that does not mean that more money is being spent; as noted above, all it means is that money is being shifted from one expenditure to another.

The former Goldman Sachs partner simply ignores the fact that the only thing lower oil prices will enable lower income people to do is spend their energy savings on other necessities that are increasing in cost like health insurance, rent, education, and the like.

It also ignores the negative effect that lower oil prices will have on the business sector…

The Economic Reality: Lower Oil Prices Hurt

Bridgewater Associates, LP, a highly respected hedge fund that writes some of the best research on Wall Street, confirmed that lower oil prices will have a negative impact on the economy.

After an initial transitory positive impact on GDP (buying into the argument that consumer spending will receive an initial boost – see above), Bridgewater argues that lower oil investment and production will lead to a drag on real growth of 0.5% of GDP.

The firm notes that over the past few years, oil production and investment have been adding about 0.5% of GDP to nominal GDP growth but that if oil levels out at $75 per barrel, this would shift to something like -0.7% over the next year, creating a material hit to income growth of %1 to 1.5%.

Perhaps it is the holiday spirit that is confusing allegedly intelligent people like central bankers and Wall Street strategists into thinking that lower gasoline prices will magically create more money that will somehow boost overall spending in the economy.

Whatever the reason for their thinking, however, it is just plain wrong. Lower oil prices are a reflection of a slowing global economy and will further contribute to slower growth over the course of 2015.

Beware the opinions of experts when it comes to economic matters, especially around the holidays.

Source : http://moneymorning.com/2014/12/04/the-economic-fallacy-of-lower-oil-prices-will-hit-consumers-right-here/

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