Insight – Soaring Oil Prices Show Economic Cycle Slowdown Is Inevitable

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POLICY MAKERS, economists and journalists often talk about the business cycle using the language of good and bad from a fairy tale.

Booms are attributed to wise and enlightened policies while recessions are blamed on policy mistakes or the need to clean up past excesses.

But economics is not a game of morality.

Expansions are not a reward for virtuous and wise actions, and recessions are not a punishment for bad behavior and mistakes.

The harrowing cycles of production, employment, prices and wages go as far back in history as the data will allow to reconstruct economic performance.

The “business cycle” of ups and downs dates back to at least the early 19th century in Britain and North America.

Only the scarcity of data on production and employment limits its ascent to early modern and medieval Europe.

Cyclical volatility appears to reflect fundamental forces rather than blameworthy behavior by central banks, finance ministries, markets, businesses and households.

There is no evidence that policymakers can stabilize the cycle if they have enough information and knowledge about how the economy works. followed by recessions in 2001, 2008 and 2020.

Reserve capacity

In the case of the oil market, spare production capacity, inventories and the prices of crude oil and refined products are closely correlated to the economic cycle.

Prolonged expansions in the business cycle lead to the gradual erosion of idle crude production and refining capacity, as well as inventory, and ultimately put strong upward pressure on crude prices and refining margins.

Recessions restore a higher capacity and inventory margin for both crude oil and refining and lead to downward pressure on prices and margins.

Right now, the global economy is rapidly running out of spare capacity to produce more crude and turn it into refined fuels, especially diesel. The rapid rebound in oil consumption following the pandemic was compounded by the Russian invasion of Ukraine and the United States and European sanctions that were imposed in response.

The result is an accelerated increase in crude prices and refining margins that mirrors the end of previous booms in 2008 and 2001.

In the United States, the Biden administration has been reduced to helplessly advocating for increased oil production and trying to magically manufacture more refining capacity in the short term.

But based on past experience, the only solution is a sharp downturn in the business cycle to restore higher levels of idle capacity and reverse some of the rising prices and margins.

The problem of consumption exceeding production capacity is not limited to oil.

The same tensions are evident in a host of other commodity markets (including gas, electricity and coal), as well as food, manufactured goods and services, creating a widespread inflation problem .

Central banks in the United States and around the world began to raise interest rates sharply to reduce inflation by forcing slower growth in consumption and investment.

Acceleration of inflation

At this point, a downturn in the business cycle has become inevitable because the only alternative is to worsen shortages and accelerate inflation.

The only question is whether it will be mild, in which case it will be called a “soft patch” and the current cycle will be said to continue, or a more severe one, in which case it will be called a “recession”. ” and the cycle will begin again.

One way or another, the pace of economic growth must slow to rebalance the oil market. —Reuters

John Kemp is a market analyst at Reuters. The opinions expressed are those of the author.

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