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Economics
Economics – Markets – Strategy
Global growth
survived the rise in
oil prices because it
drove the rise in oil
prices
Inflation presents a
serious problem to
central bankers
everywhere. But
more so in the G3
than in Asia
Will Asia immiserize the G3?
Where does all this leave us? We have noted that disaster planners could not
have invented a more hellish scenario for Asia than the current reality. US
demand growth has fallen to zero over a three year period and oil prices have
tripled over the same three years (and risen fivefold in five years). Yet rather
than collapsing, Asia continues to grow better than it should even on a clear
day.
We have argued that demand – Asian demand mostly – explains both of these
puzzles. Asian final demand kept Asia on an acceleration path for 3 years while
the US slowed. And demand, not supply, appears quite compellingly to be the
driving force behind the fivefold increase in oil prices that occurred over the
past five years.
Moreover, the data clearly show that Asia accounts for the lion’s share of the
growth in worldwide oil consumption since 2001. Indeed China and India
alone accounted for almost two-thirds of the global growth in oil consumption
between 2005 and 2006. And while a portion of this was undoubtedly intermediate
demand, the growth in Asia’s aggregate final demand – that which kept Asia
accelerating for three years while the US slowed – suggests that Asia’s demand
for oil was, likewise, made in Asia.
In short, global and especially Asian growth ‘survived’ the rise in oil prices because
it drove the rise in oil prices. An important corollary is that, unlike when prices
surge due to a contraction in supply, there is no hammer waiting to fall on
economic growth. It has already dropped, bit by bit. Higher oil prices are a
burden but when driven by an expansion in demand it is shouldered in real
time – two steps forward, one step back. Two steps forward, one step back.
And efficiency gains over the decades have helped make the backward steps
smaller.
Perhaps all this sounds too good to be true. New world this, new order that.
Everything’s paid for, nothing to worry about. The hypothetical disaster scenario
became a reality and guess what? Growth accelerated to above potential rates
and it’s still there. We met the first enemy. We outgrew him. We met the
second enemy. It is us. Things are fine.
Well....not completely. Inflation is on the rise and that presents a problem for
many a central bank, not just, and probably not mainly, in Asia. In Asia, food
has been the key driver of inflation over the past year but ex-food inflation is
accelerating now too and will soon jump much more noticeably in countries
like Indonesia, Malaysia and India, where oil-related subsidies have been cut
sharply in recent weeks. They had become too expensive for governments to
maintain.
Inflation is rising in the US and Europe too, thanks mainly to higher oil prices.
Eurozone (HICP) inflation has risen to 3.6% YoY, the highest since June 1992. US
CPI inflation has risen to 4% YoY, the highest since July 1991, save for two short
spikes (also oil related) in Sep05 and June06. With the latest surge in oil prices
(Brent crude is up by 45% since the start of the year in USD terms) inflation is
undoubtedly headed higher in the near term and central bankers on both sides
of the Atlantic are already making noises about rate hikes.
If you take the view that higher oil prices are due to temporary supply disruptions,
then hiking interest rates is probably not first-best policy, especially in the US
where domestic demand growth is already at ground-zero. Inflation would, on
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