The Biz of Pacelinebiz

Turning things on end to achieve results!

Inflation – part 2

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Since 1973, there have been 4 major spikes in crude oil prices.  3 of those spikes have coincided with high inflation.  The 4th spike occurred in 2008 and has been interrupted by a deep worldwide recession.  In 1973 an oil embargo increased the price to about $40/barrel in today’s dollars which about doubled the price in a matter of months. In 1979 unrest in the Middle East caused the price to rise to about $106/barrel in today’s dollars – a record not broken until early 2008.  By the late 1980’s the inflation adjusted price/barrel had dipped back down to below $40/barrel.  By 1990 the first Gulf war had caused another spike in prices and they reached nearly $60/barrel in today’s dollars.  During the 1990’s the actual price fluctuated around $18 to $22/barrel as the inflation adjusted price decreased.  Even with the steady rise from 2000 to 2005 the price was lower than what was paid in the 80’s – adjusted for inflation.  Please visit the website below for a chart of Oil Prices from 1946 to the present in current US dollars. (Click the “back” arrow on your browser to return to the blog after viewing the chart)

 The previous 3 periods of supply shocks that occurred with crude oil had their origins in political unrest rather than an identifiable monetary reason.  The recent increase in crude oil prices may be a classic case of Demand-Pull Theory or “too much money chasing too few goods” At the Federal Reserve Bank of Boston’s 53rd Annual Economic Conference on June 9, 2008, Fed Chairman Ben Bernanke gave some interesting facts regarding the demand for oil coming from non industrial countries.  In his speech on the topic of inflation he stated; “Rapidly rising prices for globally traded commodities have been the major source of the relatively high rates of inflation we have experienced in recent years…”   He continues by saying, “In particular, it seems clear that commodity prices have been importantly influenced by secular global trends affecting the conditions of demand and supply for raw materials.  We have seen rapid growth in the worldwide demand for raw materials, which in turn is largely the result of sustained global growth –particularly resources-intensive growth in emerging market economies.1  And factors including inadequate investment, long lags in the development of new capacity, and underlying resource constraints have caused the supplies of a number of important commodity classes, including energy and metals, to lag global demand”

  • 1According to one study, if the share of world trade and world gross domestic product for non-industrial countries had remained at its 2000 levels, then by 2005, real oil prices would have been 40 percent lower, and real metals prices 10 percent lower, than they actually were (Pain, Koske, and Sollie, 2006).  Since 2005, continued strong growth in the demands for resources of emerging market economies have likely put further considerable upward pressure on commodity prices.  For contrast, the demand for oil by members of the Organisation for Economic Co-Operation and Development (OECD) has been essentially flat since 2004.  The 30 member countries of the OECD are: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece,  Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg,  Mexico, the Netherlands, New Zealand,  Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States.

I will end this week’s discussion with another chart (please visit website provided below) that gives a good picture of the demand pull theory as it relates to scarcity in the oil supply relative to demand for crude oil.  The web site below provides evidence of the supply and demand forces at work.  In the 1970’s crude oil production by OPEC nations was at roughly 30 million barrels per day. By the late 1970’s through most of the 1980’s it had plummeted to only 15 to 20 million barrels per day.  To further reinforce Chairman Bernanke’s statements, the chart of oil production shows OPEC production since 1973 and in particular shows that production has been on a steady general upward trend since the late 1980’s with some disruptions in production occurring during the 2 gulf wars. This general steady increase in production has not reduced the price as demand has been greater (as referenced by Chairman Bernanke’s comments).  The cause of the dip in production in the late 70’s until the early 80’s had much to do with the Iranian revolution and the Iran-Iraq war.  During the war, production was down 6 to 7 million barrels a day.  Even today, both countries production is less than pre war levels accounting for about 3 million less per day. (Click the “back” arrow on your browser to return to the blog after viewing the chart)

 The lesson to be learned from today’s discussion is that we are experiencing a brief respite from high crude oil prices due to the recession.  Unfortunately, once world demand picks up when the recovery begins we may see crude oil at $100 per barrel or more and gasoline prices around $3.50 per gallon.  My advice is to take action now to be better prepared for higher fuel prices in the not too distant future.

 Next week we will wrap up our look at inflation by taking a look at the effects of inflation to your purchasing power.  It has a dramatic effect even in times of “low” inflation such as the past 25 years.


Written by pacelinebiz

October 2, 2009 at 4:26 pm

Posted in Business

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