Freeman Cebu Business

Oil is so cheap: The possibilities

FULL DISCLOSURE - Fidel O. Abalos - The Freeman

While the Sinulog celebration heightened, the revelers presented different approaches or attitudes.  Some merrymakers turned wild and so engaging while watching the Sinulog Grand Parade, while the rest simply find joy in being more pious at the Basilica. 

Likewise, on the same day, the world economy was in a different mood.  With the global price of oil bottoming in the low US$30s and expected to go further down to US$20 per barrel, the bigger economies in the world are deeply pondering what shall happen next. 

For us, a very small economy and largely an oil importing country, this is a blessing, a valuable Christmas or Sinulog present.  However, for oil exporting countries, like Saudi Arabia this could mean bad.  Coupled with the recent developments of the bigger economies like China, things can even go worse.  

For one, respected economists believe that China is headed to deflation.  If it does happen, China’s manufacturing activities will slow down and their demand for oil will drastically fall, thus, pushing oil prices further to the bottom.   As USA’s major trading partner, some US economists, likewise, believe that the USA will be largely affected and will follow in the same direction. 

Generally, falling consumer prices could usher in bad times especially for stagnant economies because people speculate and will normally wait until prices will move further down for better deals, thus, resulting to weaker economic activity.  Obviously, the absence of demand could spell trouble.

So that, having cheaper oil is not worth rejoicing at all.  On the contrary, this is a very precarious economic condition.  The cheaper price, especially if brought about by the absence of demand, makes deflation not just possible but inevitable.  An economic condition that obtained during the 1930s.  Universally referred to as the Great Depression, this is the same situation that prevailed in Japan since 1990 until the middle of the last decade. 

Something new to this generation, dictionaries in economics define deflation as a “situation where there is a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.”  

While cheaper prices could be a happy development, its darker side is more catastrophic.  If these will persist, the decline in prices will generally create a vicious spiral of negatives such as falling in profits for businesses, to closing of more factories which will surely lead to unemployment, diminishing of incomes, and increasing defaults on loans by companies and individuals. 

To most of us, struggling Filipinos, who have been so bitter about high cost of oil and food might even think that the idea about deflation is so attractive.  However, economists generally agree that this is entirely not just bad news but could be worst to some extent. 

Why?  When deflation pervades in the USA, our economy will certainly suffer.  When prices start to fall because of lack of demand, prices will likewise drop.  It shall drop to a point where manufacturing companies in the USA might find their production costs higher than the selling prices.  Therefore, companies will have no other alternative but to cut back on production.  Once production targets are cut, some factories may have to close.  Consequently, USA’s unemployment rate rises.  As the list of unemployed individuals rise, even the demand for consumer products will certainly decline.

When deflation persists, as an exporting country to the USA, we shall also suffer.  We shall find no market at all for our products.  If there is, prices will be unprofitably low.  As the USA buys all over the globe, therefore the global economy suffers as well. Obviously, therefore, we can’t count on countries in Europe, like Germany, Great Britain, France and Russia.  Neither can we count on Australia and other affluent countries in Asia as potential customers.  Remember, the Middle East, a supposedly potential buying region, will also be severely affected by the drastic oil price drop. 

Finding no market for our exportable products, our manufacturers shall consequently cut production targets.  In doing so, they shall close factories and worst, fire employees.  With a growing list of unemployed and, therefore, penniless Filipinos, demand for local products will surely decline.  Thus, even companies that are just supplying the local market shall suffer as well.

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