10 Ways Rising Oil Prices Endanger the U.S. Recovery

By Daniel Indiviglio

Generally, more democracy has a positive effect on the global economy. Freer people have the ability to buy, sell, and innovate as they please. But the political unrest in the Middle East is having a negative effect on the markets thus far. What makes those revolutions different? The Middle East is a major source of the world's oil. Political uncertainty in the region leads to oil supply uncertainty. For that reason the recent events in nations like Egypt and Libya have been worrying investors and businesses: if less oil flows out of the region to the rest of the world, fuel prices will rise.

In fact, we're already seeing oil prices hit highs this week not seen in two-and-a-half years. These increases come after oil prices already began to rise moderately throughout much of 2010, as the global economy strengthened. High fuel costs could dampen global economic growth, since firms and consumers would be forced to spend more on energy. This effect could also thwart the recently strengthening U.S. economy. Here are ten ways rising oil prices endanger the recovery:

First, it's important to note that none of these ten factors are mutually exclusive. Indeed, many are complementary. It's not likely we would see consumer sentiment fall without the residential real estate market taking a hit, for example. That's why prolonged high oil prices are so dangerous -- they could create a domino effect that would poison many different aspects of the U.S. economy.

Of all these factors, a decline in consumer spending is arguably the most significant. As mentioned above, a huge portion of the U.S. economy depends on Americans' willingness to spend. Consequently, spending is intrinsically connected to a number of the factors noted above. The potential harm to spending is hard to overemphasize if oil prices remain elevated or climb further. This morning, Chris Lafakis from Moody's Analytics noted in a CNBC segment:

Oil averaged around $80 [per barrel] in 2010. If it were to average $92 in 2011, that would wipe out a fourth of the $120 billion in payroll tax reduction that we got in the tax compromise in December. If oil were to average $103 in 2011, that would wipe out half of the tax break we got.

He went on to say that a $92 average sounds reasonable. As of Wednesday morning, the Nymex Crude Future priced a barrel of oil at $96.65.

While all of these possibilities are serious, it's not time to panic just yet. The problem with political uncertainty is that you don't know how things will ultimately turn out. If the democracies that rise in the Middle East continue to export oil much like the regimes they replace did before, then oil prices shouldn't increase more rapidly than they would have simply due additional demand from the global recovery.

If oil prices are only temporarily elevated due to unrest, then the U.S. recovery should escape relatively unscathed. But if the revolutions in the Middle East push oil prices much higher permanently, then the economic recovery would have a significant obstacle in its path.

This article available online at:

http://www.theatlantic.com/business/archive/2011/02/10-ways-rising-oil-prices-endanger-the-us-recovery/71604/