Some months ago, petroleum prices became a favorable factor in the global economy in the midst of the worldwide recession. Prices fell from their historic height of about US$148 a barrel last July to US$34 this February. But crude has begun a new path upward, moving above US$65 a barrel just when some global organizations like the International Monetary Fund were beginning to talk about the first signs of a recovery of the world’s major economies.
Dominique Strauss Kahn, director general of the IMF, said on May 15 during a conference in Vienna that there are “green shoots” in the global economy and “glimmers of hope on all sides… [In] some ways, we have left the worst behind us.” He indicated that the IMF’s main worries continue to include the health of the banks, which must clean up their balance sheets in order to enable the broader economy to recover.
On May 29, Joaquín Almunia, European Commissioner for Economic and Monetary Affairs, told attendees at the Jornadas del Circulo de Economia, a business forum in Barcelona, that the economic recovery is near and will probably occur in 2010. “We are emerging from the recession,” he asserted. Almunia said that the economic free fall has become something more controlled. “We can look forward with more optimism, with more hope,” he noted, arguing that confidence indicators “are rising all over Europe.”
While echoes of those words of hope resounded around the world, markets for a barrel of West Texas crude, the benchmark in the United States, moved comfortably above US$65. This means that its price has risen by more than 40% this year. Since oil closed at its lowest price of US$33.98 on February 12, it has risen by more than 80%. Something similar is happening for [the benchmark of] Brent, which is followed in Europe. Since January, its price has risen by more than 35%, and it has risen about 55% since its low for the year.
According to Rafael Pampillón, professor of country analysis and economics at the IE Business School, three factors explain this rise in the price of crude. “Demand for petroleum in China, the second-largest consumer in the world; consistent speculation about buying now, given the prospects for future increases; and the depreciation of the dollar.” He adds that it is not by accident that the price of a barrel is rising while the dollar is moving lower. “Prices for crude have been rising for three months, reaching a higher level every day, while the dollar has been moving lower for three months. This is not a mere coincidence. Crude producers are trying to resist the lower buying power caused by the growing weakness of the dollar by pushing oil price levels higher. We are in a vicious cycle in which crude rises and the dollar depreciates considerably, and vice versa.”
Can the rise in crude prices spoil the first signs of recovery from the global economic crisis? According to Pampillón, “The increase in energy prices is going to freeze the global economy again. In this sense, the increase in the price of energy can now suffocate the few ‘green shoots’ that can be seen. Nevertheless, it seems that an important cause in the increase in the price of petroleum is [growing] demand for oil in China…. This is due to the fact that if there is one place where there are ‘green shoots,’ that is China. And if China grows, the rest of the world will wind up growing. China will pull the global economy.”
According to Pampillón, this rise in petroleum prices “is going to negatively affect developed countries that import oil, since the first and most serious negative consequence of a higher price of oil is going to be the increased cost of energy imports for those countries, companies and families.” Nevertheless, he adds, “since the price of petroleum is denominated in dollars, countries such as Brazil, Peru, Chile and the Euro zone can do a better job of avoiding the impact of the higher price of crude thanks to the greater strength of their currencies.”
Countries That Benefit
However, not everyone in the world is going to be hurt by higher prices for crude. Pampillón says, “It is clear that companies that have reserves of petroleum will see their revenues rise in a meteoric way, and also that state treasuries will increase their fiscal revenues from gasoline taxes. The rise in the price of crude is also going to directly benefit producing countries. Venezuela, Argentina, Brazil, Cuba, Ecuador and Mexico are going to see their revenues grow, which could improve their trade balances and fiscal balances.”
As a result, stock markets in the West could be influenced by the idea that emerging nations will grow more rapidly than developed countries, which would translate into higher earnings for shares of companies in emerging nations. The Gross Domestic Product of developing countries will probably grow by 1.6% this year. Forecasts call for Asia to lead the way with 4.8%, followed by the Middle East with 2.5%, and Africa, with 2%, according to an IMF report in April.
The IMF also asserts that Latin America is well prepared for dealing with the global economic crisis, although it forecasts that the economies of the region will contract by an average of 1.5% this year. “Latin America is not immune to the crisis, but its performance has been better than it would have been ten years ago in a situation like this one,” said Miguel Sabastano, Peruvian-born chief advisor in the IMF’s department for western hemisphere affairs, during a presentation in May in Costa Rica.
This data from emerging economies, which in many cases depend on petroleum exports, contrasts with the economic contraction forecast for advanced economies. According to the IMF, the GDP of the United States is expected to contract by 2.8%, and the Euro zone by 4.2%.
Goodbye Deflation, Hello Inflation
From a macroeconomic point of view, the rising price of petroleum also brings some good news. As Pampillón points out, “It will help put the phantom of deflation behind us.” Deflation is defined as a generalized fall in the level of prices for goods and services throughout the economy lasting at least two quarters. It is the opposite of inflation; it’s what happens when prices drop as a result of a fall in demand. Most economists consider deflation more malignant. Business executives are more fearful of deflation than they are of inflation.
Once the fear of deflation has been discarded, many analysts warn that the expansive economic policies that central banks are taking today could lead to great inflation. Marc Faber, the famous investor, believes that the United States is going to enter a period of hyperinflation because the Federal Reserve will be reluctant to raise interest rates. “I am 100% sure that the United States will go into hyperflation,” Faber told Bloomberg News on May 27. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”
“The rise of petroleum prices will enable us to leave behind the fear of deflation but, later on, it could generate inflation with stagnation (‘stagflation’), and central bankers would have to deal with a very difficult situation. On the one hand, they would have to raise interest rates and withdraw immense liquidity generated in recent times with the goal of avoiding inflation. But on the other hand, if they withdraw that liquidity and interest rates rise, then that would suffocate the slow growth those economies have. I would not like to be in that position,” says Pampillón.