[VIEWPOINT]Keep watching the price of oilA strange thing happened in the American economy earlier this week. “Stocks fell on news of a big jump in factory orders,” reported the Wall Street Journal. In fact, the Dow-Jones fell for three consecutive days, shedding more than 250 points.
This is a bizarre reaction from the U.S. stock market. Since when is good news ― a rise in factory orders ― supposed to bring on such bad results as plummeting stock markets? It only starts to make sense if one asks traders why the market fell. Their answer is higher factory orders, that is, higher economic growth, will fuel inflation and thus force the Federal Reserve to increase interest rates ― which down the road will slow growth and cut into profits.
The magic word here is “inflation,” which seems to be rearing its ugly head again after almost two decades of very low, or even no, inflation. Indeed, only a few years ago, the Western world worried about deflation, which did occur in Japan.
Investors are beginning to realize that companies will have to raise prices in response to exploding energy bills. These of course will push up not only heating or transportation costs but also prices in every sector of the economy. Higher trucking costs will make everything we buy ― from apples to lumber to TV sets ― more expensive. Steel requires lots of energy and so car prices will go up. So will the price of anything made from oil or natural gas, like fertilizer, plastics and pharmaceuticals.
Even more worrying is the rise of inflation expectations. These expectations are the prime reason why the U.S. stock market took such a tumble this week. In August, consumers were expecting the inflation rate to be 3.1 percent; now, they are expecting prices to increase at an annual rate of 4.6 percent. Also, the price of gold, which is a classic index of rising inflation expectations, is at an 18-year high.
Nor is this happening only in the United States, where Katrina, the storm that devastated New Orleans, has played a dramatic, but only temporary role in driving up the price of building materials for reconstruction as well as gasoline prices because so much refining capacity in the American South was disabled. The European Central Bank in Frankfurt has sharpened its warnings about inflation, which threatens to end a historical low in interest rates ― currently at 2 percent. In August, inflation in the Eurozone was 2.2 percent, in September it had risen to 2.5 percent.
So while the Europeans are not exactly suffering from “demand-pull” inflation ― European consumers are not buying, but saving ― we may be witnessing the return of “cost-push” inflation. Since workers expect inflation to soar, they will push for higher wage settlements and thus set in motion precisely the inflationary spiral that followed the oil price explosions of the 1970s.
And then, there is the approaching departure of Alan Greenspan, the chairman of the U.S. Federal Reserve, who has ruled over American and Western monetary policy longer than anybody can remember. Will his successor have the same magic touch in keeping inflation low and growth high? This heightens the nervousness of Wall Street and the bourses of Europe.
Is there any good news for the world economy? Yes, and it comes from the United States, too. But first, one more piece of bad news. America’s trade deficit is heading for an annual rate of $700 billion. That means that America will have to attract $60 billion per month from foreign investors by offering them a higher return than they could get at home. That, too, will drive up long-term interest rates.
But now to the good news. According to a recent survey, American economists expect the economy to grow at 3.5 percent this year and at 3.4 percent next year because they expect oil prices to drop to $63 per barrel by year’s end, and to $55 by the end of next year.
If these expectations come true, the world can look forward to two good things. One is sustained American growth, which will help to maintain aggregate demand in a world economy where the Europeans, depressed by very high unemployment, are still on a consumer strike, so to speak, and where the Japanese economy still has to replace a 13-year slump with solid growth.
The other silver lining is the expected drop in oil and gasoline prices. If this prediction comes true, then the fearsome vision of renewed global inflation may just be a blip on the radar screen. Keep your eyes on the price of oil. If it comes down, the Western world will be spared a serious attack of inflation.
* The writer is the publisher-editor of Die Zeit.
by Josef Joffe
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