There has been a LOT of talk recently on the rising price of gasoline at the pump, so much so, that Obama has now jumped in with both feet admonishing the “evil speculators” for causing such a burden upon the American public. Well, that and to promote a clean energy policy that is ill conceived, ineffective and grossly misunderstood…mostly by him.
However, as in the famous words of Bill Clinton, “What is…IS” and what “is” right now is that gasoline is rapidly approaching, and has achieved in some states already, $4 a gallon. Therefore, that is what should be concerned with right now and when that additional drain on the discretionary income of the average American translates into the next economic recession.
The chart shows the inflation adjusted average of all grades of gasoline (regular, mid and premium) going back to 1990. What we find is that by looking at gasoline prices – spikes have tended to lead to economic recessions. However, during the 90’s households did not substantially increase their debt to maintain their living standards but beginning in 2000, households tacked on an additional 50% in debt to offset the effects of rising oil, food and gasoline prices. In fact, as food and energy consumed a larger and larger percentage of wages and salaries the ability to take on additional debt through credit cards, mortgage withdrawals, etc. to offset the rising cost pressures stalled in 2006 and begin to decline sharply in 2007. This is why we wrote in December of 2007 that we were “either in or about to be in a recession” – a year later the NBER proved us right.
This leads us to the question that we now must answer – how long can the consumer go this time WITHOUT access to easy credit, struggling with high unemployment, and lack of wage growth before the effects of higher food and energy costs put a stranglehold on discretionary spending. This becomes an even more important question as we are already looking at reductions in GDP forecasts across the board and the potential, and most likely temporary, end to support from the Federal Reserve.
So, what would it take in order for this spike not to lead to an economic recession. First, the average American would need to go back to work with an increase in wages to knock the percentage be eaten up by higher food and energy prices back down to the 18% level. Furthermore, the banks would need to open back up the tap to allow consumers to have access to credit. This sounds easy enough until you realize that you just opened Pandora’s box as we have now just instilled the three legs to hyperinflation – commodity inflation, wage inflation and velocity of money. Now the Fed has to raising interest rates to battle rising inflationary pressures and the economy slows into recession as a result of tightening monetary policy. This is why the Fed is trapped in a box and cannot, for very long, withdraw support from the economy and the financial markets – it is a game that will end badly at some point in the future.
The trap is set and there is an increasing probability that by the end of this year, or early next, we may be writing the next chapter in American recessions.