Falling oil prices not exactly good news

Crude oil fell for a third day in New York, Bloomberg reported, trading near $118 a barrel. Oil dropping to its lowest level since early May should be good news to all of us. But apparently, many economists are now worried than ever. Dropping oil prices are nothing to cheer about, The Economist headlined. It could even be a harbinger of worse things to come with the world economy.

That’s because the reason for the drop in oil prices is a fall in demand caused by economic slowdowns in the US and Europe. The services industries in the US and Europe shrank for a second straight month in July, Bloomberg reports. Now, there is also concern about an economic slowdown in China.

In people terms, this is how an economist puts it in an interview with the New York Times: “I think we’ll see a miserable job market and, consequently, an eroded standard of living for the vast majority of Americans for several years,” said Lawrence Mishel, president of the Economic Policy Institute, a liberal research organization in Washington.

“This is indistinguishable from a recession for a working family,” Mr. Mishel said. “They’re losing jobs, and they’re getting a double bite as wage growth slows down and inflation kicks up. People are losing out on both ends.”

Oil has lost more than $28 since touching a record of $147.27 a barrel in New York on July 11 as the unprecedented rise in fuel costs prompted US consumers to limit spending. According to The Economist, “it is that slowdown, echoed in the euro area, that surely underlies the fall in the price of oil in recent weeks.” Weak economies being reflected in the weakening of oil prices can’t be good news.

The Economist explains that “according to one recent study a 10 percent increase in the price of oil reduces American demand for the stuff by only about 0.3-0.8 percent. But a decline in American income has a bigger effect.” In other words, this decline in oil prices if caused by a decline in income can only mean bad news about near term economic prospects.

As a result of worsening economic conditions, The Economist reports “the United States will guzzle 430,000 fewer barrels a day this year, according to analysts at Lehman Brothers. And on July 28th, the Department of Transportation reported that Americans drove 9.6 billion fewer miles (15.5 billion km) in May than they had a year before.”

But declining oil prices will not make the job of Central Bankers easier. It was hoped that as oil prices fall, the rise in inflation will be checked and they need not raise the interest rate to deal with rising inflation. The Economist however pointed out, “rather than paving the way for lower interest rates, the oil price may have dropped in anticipation of higher ones.” But because the interest rate stayed as is, I guess current low oil prices may just as quickly reverse directions.

Current interest rates now fail to compensate savers for inflation. As a result, The Economist explains, the return to pumping a barrel of oil, selling it and investing the proceeds is often less than can be gained by leaving the oil in the ground and waiting for its price to rise further. That means, don’t expect current low oil prices to be around long enough to matter much.

“Although there is no sign that producers are actually sitting on their hands, the theory suggests that they might do so until the oil price is so high — so far above its long-run value — that they begin to suspect it might fall. Then, and only then, will they feel motivated to pump, preventing the price rising any further.”

Our exuberant reactions to bits of good news in recent days may be premature. For one thing, what the world is seeing in terms of rising inflation with slowing growth isn’t a good thing for the stock market, one analyst told the Wall Street Journal, but the market did jump anyway, on news that the Federal Reserve wasn’t raising interest rates as feared. She told the WSJ the market’s recent gains have had more to do with the sudden downturn in oil prices, which caught some traders by surprise. A reflex reaction? A dead cat bounce? Whatever… it definitely is not based just yet on positive economic fundamentals.

There are two views on what is going on, according to the WSJ. “The respite in commodity prices reflects the slowing of economic growth around the world, which has cooled demand for a broad range of commodities. The optimistic view is that lower gasoline prices will make it easier for consumers to spend money, and lower prices of industrial commodities will make it easier for companies to do business. All of that should ease the downward pressure on the world economy, making any recession shorter and shallower.

“Pessimists reply that, as soon as lower commodity prices start boosting economic growth, it will stimulate demand for commodities in places like China and India, which will send commodity prices higher again. In that view, the commodity-price pullback is only a temporary respite for the economy and for financial markets. Pessimists believe commodity prices, including oil prices, could soon be rising again, hurting growth and forcing central banks to boost interest rates in order to ease inflation. Higher interest rates, in turn, would further hobble growth and make stocks less attractive compared with cash and bonds.”

Bottom line is, it seems no one really knows what is happening or is about to happen next or how long before we can be sure things will be alright. Best thing to do is be as prudent as possible and hold the champagne until it is clear that we are over the hump. That may take a while yet.

CSR

I received this e-mail from a reader, Jun Umali of Parañaque City.

Hi Mr. Chanco, I am a regular reader of your column in The Philippine Star and I read one of your more insightful last July 23, 2008 entitled “CSR: More hype than heart”. I appreciate the eye-opener approach you used by way of revealing the real meaning and concept of CSR— that is the integration of business operations and values, whereby the interest of all stakeholders including investors, customers, employees, the community and the environment are reflected in the company’s policies and actions. 

I am an entrepreneur for the last 11 years and it is good to note that we can practice CSR in our company without the need of being a “corporate philanthropist.” Our business entails hiring mostly high school graduates who may not have the opportunity to go to college because of their financial situation. Treating them with respect and providing what is due them like on-time salary, SSS and Philhealth payments and imparting Christian values to them are our little way of practicing CSR in our company. 

Now I feel a little comfort in the fact that we don’t really need all the hype to be able to practice good CSR, I believe that we do this so that one day, when we face our Creator, He can say “welcome to my kingdom, my good and faithful servant!”

I am again exploring a venture that will greatly benefit the Bottom of the Pyramid. I have been eager to de something more for our fellow countrymen given the hard times we are experiencing now. I guess this eagerness comes with age as they say when you reach your 40s, you start thinking of contributing back to society. 

Thank you Mr. Chanco for listening and I just felt good about writing this email to you. I guess I just like to encourage you to continue writing your sensible articles and that there are people like me who are being touched and inspired by them.

Pinoy joke

Reader Mon Juan sent in this joke.

TANONG: Paano mo sasabihin sa isang babae na mataba siya nang hindi siya mababastos?

SAGOT: “Uhm, excuse me, miss...Mang Tomas ba ang lotion mo?”

Boo Chanco’s e-mail address is [email protected]