Shock Proof

Summary:

This oil shock is 'different’ from those of the mid and late 1970s/early 1980s

• this one’s due to strength in demand, not to interruptions to supply
• strong demand is helping to sustain strong global growth, as well as pushing up oil (and other commodity) prices

Oil prices are likely to be higher for longer

• but (to the extent that history is a guide) would need to reach, and exceed for some time, US$80-90 per barrel to start seriously detracting from economic growth

More fundamentally, the rise in oil prices is just one aspect of a major shift in relative prices'¦which is just one of the consequences of China’s rapid growth and industrialization'¦one from which Australia (to a much greater extent than most other countries) stands to benefit a great deal

• provided we continue to focus on what we’re good at, and don’t try to kid ourselves we can play Canute with the things that we’re no good at

The rising price of oil and its economic consequences

Although the oil price has risen sharply, in real terms it is still well below its 1980 peak

The world economy is less sensitive to swings in oil prices than it used to be

The most recent rise in oil prices hasn’t led to sharp rises in inflation or interest rates

Economic growth has been much less affected by higher oil prices than in previous 'oil shocks’

Currently high oil prices result from a'demand' shock, not a 'supply shock’ as in the 70s and 80s

OPEC is pumping about as much oil as it can: the supply constraints are in non-OPEC producers

China is the world’s second largest economy, and its second largest consumer of oil

Over the past four years China has accounted for 38 per cent of the growth in world oil demand

Capacity pressures at the refining stage are also contributing to higher prices for 'heavier’crudes

Better macro-economic policies and globalization are combining to keep global inflation down

Despite pushing up the prices of commodities, China is pushing down the prices of finished goods

China’s global impact on relative prices is hugely beneficial for Australia

The China-driven reversal in Australia’s terms of trade has been a key element in the A$ recovery

The reversal in Australia’s terms of trade has also boosted Australians’ relative living standards

China is also helping to keep the US$ from falling and global bond yields down

The US$ has fallen a lot less than in previous US$ bear markets despite an unprecedented deficit

Strikingly, US long-term rates have fallen even though US short rates have more than trebled

Long-term interest rates are declining all over the world, not just in the US

The decline in long-term rates is helping to prolong the household spending boom in the US