Some oily economics

Sixty-one buck a barrel oil has got me reaching for the Maalox, though long-time readers know that last year I predicted in this column that oil would indeed settle over the $50 per barrel mark. To add insult to injury, the world is going to have to hear a lot of wrongheaded economic blather about oil prices, and on the radio I heard a real humdinger on the international news today.

Some commentator, who must have worked his way up from reading sports scores to reporting economic events, said that high oil prices are “inflationary,” and may therefore cause the U.S. Federal Reserve to “raise interest rates.” That logic is so doggone wrong that it gives me whiplash from shaking my head. I figure that since you’re paying $2.74 to $2.79 for self-serve regular gasoline today, you might as well get a dose of high-minded economic theory to go along with it. These economic factors will certainly affect Saipan’s residents and visitors.

Let’s look at inflation first. There are two types. One is “cost-push” inflation; the other is “demand-pull” inflation.

Demand-pull is a monster that springs to life when governments create too much money. This money floods consumers with purchasing power, which causes them to bid up the prices of goods and services. More money means more demand, and more demand pulls up higher prices. See? Demand-pull.

Which leads us to how this money was created in the first place. Money is basically created by banks; when they make a loan, they are creating money. Now interest rates take the stage. Since interest rates are the price of loans, the higher the interest rate, the less loans that are demanded. In other words, when interest rates go up, loans—and money creation—go down from where they would have been if the interest rates had not been raised.

Raising interest rates, then, puts downward pressure on price increases, since it reduces the demand-pull effect. And that, dear friends, is why economists and investors watch inflation reports, interest rates, and Federal Reserve Bank policy. In a demand-pull world, when inflation heats up, it makes sense to raise interest rates to put the brakes on money creation. We’re all used to thinking in those terms, especially since the terrifying, inflationary days of the Carter administration.

You still with me? Good.

Oil, however, isn’t part of the demand-pull world. It’s just more expensive because of global factors, not money-supply factors. So this is “cost-push” inflation. The higher cost of oil will (all else being equal) push up prices. That’s easy to see. If anything, this force would be a factor pulling the Fed to lower interest rates, so as to lower the cost of capital to businesses, sort of as a counter-balance to the higher oil prices. Otherwise, recessionary risks might start knocking on the door.

Got that? If so, you’re miles ahead of some pundits in the international news racket, who should have stuck to reading soccer scores and doing cutesy pieces on what Nelson Mandela had for lunch today.

You’re probably going to be hearing a lot about oil prices in the foreseeable future. This factor is going to run the realm from the price you pay at Mobil and Shell…to how much you pay CUC…to how much money tourists have to spend on their vacations…to how much your food costs…to what interest rates you have to pay on your credit cards and other debts. All this stuff is related.

Question: Is the CNMI vulnerable to high oil prices? Answer: Yes, big time. Our target market for tourism—industrial Asia—is addicted to oil, and if oil spins out of control, our tourists are going to spin into job losses and other financial bummers.

My professional undertakings have a very high exposure to oil prices, and there is no way for me to hedge against that risk. This situation, though predicable, is still costing me some sleep. I am terrified at the prospect of anything that looks remotely like an “oil crisis.”

Count your blessings that you can get gasoline for under three bucks a gallon, folks. Given the global situation, it looks to me like Saipan is getting a pretty good deal. If you want something to really complain about, then an oil shock, and a severe Asia-Pacific recession, may accommodate you.

I’m not predicting an immediate oil shock, but I am saying it’s possible in the near term, and, given China’s growth, likely in the long term.

I usually get a lot of e-mail from readers about oil and gasoline prices, so keep it coming, since this issue is probably heating up. The bigger this story gets, the worse it gets.

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Ed Stephens, Jr. is an economist and columnist for the Saipan Tribune. Comments? E-mail Stephens at Ed4Saipan@yahoo.com.