Category Archives: oil

The Fed, China and Oil

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My answers to three questions at the start of 2016 (from Chosun Ilbo, leading Korean newspaper):

1. How do you analyze the recent US interest hike, and how will it influence the global economy in the coming year?

The Fed had telegraphed its decision to raise the interest rate so far in advance and (by December) so clearly, that the policy change was already fully reflected in markets.  For example most of the substantial appreciation of the dollar since 2014 can be attributed to anticipation of the Fed tightening.   Furthermore, the movements in relative monetary policy — the end of quantitative easing in the United States, the first increase in interest rates, simultaneous monetary easing in other countries and the appreciation of the dollar – all reflect relatively greater strength in the US economy compared to most others.  It will create difficulties for some commodity-producing countries that had gone back to large-scale borrowing in terms of dollars.  But the pattern of US growth, monetary tightening, and dollar appreciation is not bad news for the rest of the world overall.

 

2. What is your view on China’s economy, and how will it economy influence the global economy this year?

It was inevitable that China would not be able to sustain a fourth decade of growth rates in the neighborhood of 10%.   Some of the sources of its growth have begun to run into diminishing returns, such as rural-urban migration, heightened capital/labor ratios and an over-stretched environment.

The open question is whether the transition to a more sustainable and moderate rate of growth that we are now seeing will be a soft landing or a hard landing (e.g., a crisis arising from unneeded construction, shadow banking, and bad loans).   A good scenario, the soft landing, is by no means ruled out yet.  The 2015 stock market bubble and crash was not as important as observers thought.  Much of what we are seeing could be the desired shift in the composition of China’s economy, away from the production of manufactured goods and their sale for exports or physical investment, and toward the production of services and their sale to the consumer sector.

Even though China is slowing down a lot, its economy occupies a much larger share of the world economy than it used to.  For this reason, it will continue to be an engine of growth in the world, just not as quite as strong an engine as had been forecast by those who rely on simple extrapolation of past trends.

3. What is your view on oil prices recently? How will the oil price change impact the global economy this year?

The fall in dollar oil prices has many causes, both on the supply side (US fracking, Saudi decisions) and the demand side (weakened demand from much of the world, especially China).   One cause that is often overlooked is the strength of the dollar against other currencies.

Needless to say, the fall in oil prices hurts oil exporters and benefits oil importers.   The benefits for oil importing countries in Asia and Europe in 2016 will probably be greater than what has been evident so far.

Low retail prices for fossil fuels are bad for the environment.  All countries should take advantage of the recent fall in oil prices by either shifting their taxes onto fossil fuels or else, if they currently have wasteful subsidies to fuel consumption, then they should cut them.  They should take their cue from developing countries such as Egypt, India, Indonesia, Mexico and the UAE that have done that recently.

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Gas Taxes and Oil Subsidies: Time for Reform

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World oil prices have been highly volatile during the last decade.   Over the past year they have fallen more than 50%.

Should we root for prices to go up, down, or stay the same?   The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries.  The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero.  But what about effects that are not directly economic?   If we care about environmental and other externalities, should we want oil prices to go up or down?  Up, because that will discourage oil consumption?  Or down because that will discourage oil production?

The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers.  How?   By cutting subsidies to oil and refined products or raising taxes on them.   Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms.  The US should do it too.

Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund.  On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road!  There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance.  The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it.  The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged.  The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries.  Ideally the tax rate would be put on a gradually rising future path.

Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective.   A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:

  1. The budget. It is estimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
  2. Pollution and its adverse health effects.   Outdoor air-pollution causes an estimated annual 3.2 million premature deaths worldwide.  A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
  3. Greenhouse gas emissions, which lead to global climate change.
  4. Traffic congestion and traffic accidents.
  5. National security.   If the retail price of fuel is low, domestic consumption will be high.  High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East.  If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically.   It is ironic that U.S. subsidies to oil production have often been sold on nationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
  6. Income distribution.  Fuel subsidies are often misleadingly sold in the name of improving income distribution.  The reality is more nearly the opposite.  Worldwide, fossil-fuel subsidies are regressive: far less than 20%  of them benefit the poorest 20% of the population.  Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk).   As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.

The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal.   But other countries have political constraints too.  Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low.  Yet some of them have managed to overcome these political obstacles over the last year.  The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production.  Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments.  Most politicians know that sound economics would call for this benefit to be eliminated.  But they haven’t been ab le to summon the political will.  Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.

Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation.  Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal.   ‘

A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year.  (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.)  US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.

Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms.  Oil prices have recently fallen to around $50 a barrel – down from a level well over $100 a barrel in the summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.

For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy.  In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates.  Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.

Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?

[A shorter version of this column was published at Project Syndicate.  Comments can be posted there.]

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Currency and Commodity Markets in 2015

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This is the third and final installment of an interview on the outlook for the New Year.

Part 3. Forecasts for International Currency and Commodity Markets

Q – What is your forecast for the U.S. dollar? Do you think maintaining the strong dollar could ultimately help the U.S. economy, or hurt it?

A – The appreciation of the dollar against the euro and the yen in 2014 was precisely what we should have expected from the economic fundamentals: the strengthening of the US recovery at the same time that the euro and Japanese economies have been slumping and the end of US monetary easing at the same time that the ECB and the Bank of Japan have redoubled their efforts at monetary stimulus.

When trying to forecast exchange rates, one does well to recall the “random walk” principle.  One is doing well if one gets the direction of movement right slightly more than half the time.  Having said that, I would guess that the dollar is more likely to appreciate further in 2015 than to fall, for the same macroeconomic reasons as last year.

Would that be a good thing?  Moderate appreciation of the dollar against the euro and yen is the natural concomitant of the monetary and real economic fundamentals.  Europe and Japan need the stimulus of easy money and competitively priced-currencies.   If the US recovery were to falter in the future, the Fed could reverse its plans to raise interest rates and the dollar in that case would probably come back down.   But as of now, the US economy seems to be doing well.

Q -The oil price continues to fall to near $50 a barrel. How do you forecast the oil price for 2015 and beyond? How will it impact the world economy?

A – Among the reasons for the fall in the price of oil, of course, is the US shale energy boom (techniques associated with “fracking”).  Even though the new shale activity will moderate at these low prices, its ability to resume relatively quickly will work to prevent oil prices from rebounding.

The price decline goes beyond oil. Mineral and commodity prices have also fallen over the last year, at least in terms of dollars.  Disappointing levels of economic activity in much of the world are an obvious explanation.  But the business cycle doesn’t explain why commodity prices are down especially in the US, where economic activity strengthened in 2014.  The Economist commodity price index in 2014 was actually up in terms of euros; it was down only in terms of dollars, though that is what everybody focuses on.

The other factor is monetary policy: the end of quantitative easing in the US and renewed monetary stimulus elsewhere.  That is consistent with some commodity prices falling in dollars while simultaneously rising in terms of other currencies.   We could see more of this in the coming year.

I would say that oil prices and other commodity prices are more likely to continue falling in 2015 than to rise.  To the extent that oil prices are down because of the fracking boom or because some of the worst geopolitical fears have not materialized, this is good for the world economy (even though bad for oil producing countries).

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