International | Dec 19 2018
The president wants low interest rates, and a low oil price, believing that to be good good for the US economy. But history suggests cheap oil is not necessarily as beneficial as Trump might think.
-Low oil price boosts savings
-Oil states suffer dramatically
-Net negative impact on GDP
By Greg Peel
It is true, says CIBC Capital Markets, that the US consumer gets a big boost in spending power from lower gasoline prices. The fall in pump prices over the past couple of months would boost real disposable incomes by US$30bn or 0.25%. Solid retail sales numbers ahead of the holiday shopping season has raised expectations for consumer spending growth ahead.
But an ability to spend more does not always translate into a desire to do so.
When oil prices slumped in 2014-15, real US spending power was boosted by 0.75%. But during the same period, savings rose by 0.6%. suggesting much of the benefit of lower pump prices went into savings. This might simply imply a lag, as savings are eventually drawn upon to fund consumption, but a fall back in the US savings rate in 2016-17 can also be attributed to oil prices rising again.
Typically, oil prices have fallen at times of recession, CIBC notes, providing some offset to household budgets at a time of rising unemployment and allowing at least some to maintain spending levels. But prior to 2014, the previous sharp fall in oil prices during a non-recessionary period was in 1998, at which time savings grew by a level equivalent of 75% of the benefit of lower oil prices.
If we include oil under the general banner of “mining”, most of the swings in non-residential investment in the US since 2013 have been driven by the mining sector. Investment in mining structure and equipment investment made up 13% of overall business spending in 2014, falling to 5% in 2016. The hit to GDP growth from declining mining investment in that year was -0.3%.
But that figure underestimates the importance of the sector as an investor and contributor to overall GDP growth, CIBC points out. Companies do not exclusively invest in equipment specific to their own business, but more general equipment as well, such as computers for example. A broader survey of capital expenditure suggests mining accounted for 15% of all business investment in 2014, and the 2016 decline likely had a greater impact on GDP than quarterly numbers imply.
The consequences of lower US oil prices are more harshly felt in oil-rich US states. Oil states are over fourteen times more dependent on mining activity growth than other states, CIBC notes. Given the breadth of associated spending, from transportation to R&D, the impact is likely higher in employment terms.
Most notable in the 2014-15 oil price downturn was that as growth declined in the oil states, there was no offsetting pick-up in other states. The 2014 oil price downturn had a more pronounced impact on oil states than the GFC.
That impact was large enough to be apparent at the national level, CIBC notes, with total spending power of households roughly -1.1% lower as a share of GDP from that shift. Of course the impact on those states of the recent oil price decline will be smaller, given that mining activity only partly recovered. However, without a discernible pick-up in other states, that would still represent a negative for the overall economy.
“The relationship between US economic growth and oil prices has changed dramatically over the past decade,” says CIBC. “And while the country is still a slight net importer of energy, and as such would typically benefit over the longer term from lower prices, in the near term and given the current economic climate the relationship could be reversed.”
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