The Economy’s 90/10 Rule

Economists spend nearly all of their time now trying to figure out whether the recovery will stay on course and if GDP in the US will recover at 4% or 5% rate next year. They reason that if things go that well then business activity will provide employment for those without jobs and that rising IRS receipts from enterprises and individuals will begin to re-pay the deficit.

Most experts can give a long list of critical indicators and data that will guide any predictions of how the economy will perform over the next several quarters. Housing and consumer spending are on most lists. So are earnings and industrial output.

This list of data that is tracked for most forecasts is long and complex, as are the models used to interpret them.

There are only two essential figures that will decide in large part whether the economy will continue to recover or not. One is whether unemployment will go over 10% and stay there for two quarters and the other is whether crude will rise above $90 and stay there for the same period. The period in both cases is the first two quarters of next year.

The majority of economists still believe that the recovery that is beginning now is a “jobless recovery” like the two before it. The idea is nonsense. Neither of the previous two recessions or any of those before them in the period since WWII has been as harsh or as long as this one. Consistently high unemployment is not the only problem. The fact that there are so few open jobs compound the negative effects of joblessness tremendously. Corporations are in no rush to get back into the hiring business and small companies, pressed for cash and new customers, are even less likely to add jobs.

It is nearly forgotten that oil was $147 just last July. The price collapsed with the economy. The relatively brief stay that crude had above $100 did cause havoc in major sectors of international business including airlines, autos, and petrochemicals. There is no way to tell how badly these industries and others would have been damaged if crude had stayed historically high for a much longer stretch of time. The airline business would have been ruined. Most industries that rely on fuel or oil-based chemicals would have done very badly and probably have faced staggering losses.

The consumer would have been even worse off, in most cases, if oil stayed well above $100. Two income households with two commuting adults could easily have faced an extra $300 or $400 in gas bills at $3.50 a gallon. That is enough to wipe out the discretionary income in most households. In case either of those working adults lost his or her job, a family would probably face the loss of a home. The costs of a number of other essentials from heating oil to petro-based consumer goods would be passed on to consumers. The effects are incalculable but the extent of the damage would be beyond what many households could handle and remain solvent.

Last summer showed that both businesses and consumers can hold on for a while if crude prices are extraordinarily high, but a protracted period of two quarter or longer would be much different.

Crude prices have hit $80. Analysts believe that demand in most major nations, particularly China and the US, the two largest consuming countries, will rise with the economy. China’s economy may continue to expand at an impressive rate even if GDP in America stagnates. Crude supply does not show any sign of increasing now or early next year. OPEC has not indicated that it will move its production targets at all. Cartel members probably see some benefit, even if it is only short term, to crude oil prices that are closer to $100 than they are to $50. OPEC certainly did little to relieve the pressure on oil consuming economies when prices spiked up in July.

It is nearly certain that the economy in both America and abroad cannot whether long periods of high unemployment and high energy price. Some experts would argue that rising unemployment cuts crude demand. That is only true if the US is looked at in isolation. Oil supply and demand only rely modestly on American consumption now. The number of large oil consuming and producing nations is higher than they have ever been. The life of crude oil prices no longer goes hand-in-hand with US business activity.

The odds of a new recession in America are astronomically high if oil trades above $90 and unemployment stays above 10% for any period of time.

Douglas A. McIntyre