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VOL. 127 | NO. 42 | Thursday, March 01, 2012

Will Higher Gas Prices Derail the Economy?

CHRISTOPHER S. RUGABER & MATTHEW CRAFT | Business Writers

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NEW YORK (AP) – The price of gas has jumped 45 cents since Jan. 1 and is the highest on record for this time of year, an average of $3.73 a gallon. On Wall Street, talk has turned from the European debt crisis to another worry: Will higher gas prices derail the economic recovery?

Not yet, economists say. They argue that the United States is in much better shape than early last year, when a similar surge in fuel prices weighed on economic growth by squeezing household budgets. Americans spent less on clothes, food and everything else.

Rising gas prices hurt less when an economy is improving than when it's slowing down. So economists expect other spending won't be badly hurt, at least for now. If gas breaks its record of $4.11 a gallon, however, all bets are off.

"Can the economy withstand the increase we've seen so far? The answer is yes," says David Kelly, chief market strategist at J.P. Morgan Funds.

The reasons:

  • Jobs. The country has added 2 million over the past year. Those 2 million people with paychecks will spend them, which helps the economy. Lower unemployment also makes people feel better about the economy – and less likely to cut other spending way back.
  • Job security. Unemployment claims, the best measure of layoffs, are at a four-year low. Fewer Americans are worrying about losing their job, so they can take the punch of higher gas prices and move on.
  • A steadier housing market, the Dow Jones industrial average's clearing 13,000 and other signs of an improving economy also help. Add them together and consumer confidence is the highest in a year. More confidence makes people more likely to keep spending on other things even if gas goes up. "The public will howl as we approach $4 gas, but they will probably continue to increase spending," says Carl Riccadonna, a senior economist at Deutsche Bank.
  • Gas wasn't the only thing getting more expensive last year. Prices for milk, meat, bread and other foods were rising because of higher prices for grains and other farm goods. Natural gas prices were also on the rise, making it more expensive for Americans to heat their homes. This year, natural gas prices have plummeted. Unlike like year, filling up the car's tank is about the only thing getting dramatically more expensive. Last year, when Americans were feeling it from all sides, they made tough choices, like cutting out expensive dinners.
  • The increase in the price of gas has been more gradual this year, which could make it easier on the psyche of the American consumer. Last year, prices at the pump rose from $2.78 to a peak of $3.98 in mid-May. The national average for a gallon of regular on Wednesday was $3.73, up from $3.28 at the start of the year.

The key is what impact gas prices have on other spending in the economy. All consumer spending isn't equal. A dollar spent on gas has less of an impact on the U.S. economy than a dollar spent in a restaurant or at a baseball game. The U.S. is an oil-importing country, so many of the dollars spent on gas ultimately leave the country.

The rule of thumb among economists is that a 25-cent increase in gas knocks $25 billion to $30 billion off consumer spending in a year and lowers economic growth by 0.2 percentage points, says Carl Riccadonna, senior economist at Deutsche Bank.

The price of gas averaged $3.51 last year, so a move above $4 should only divert $60 billion from consumer spending this year, Riccadonna says. Last year, it drained an estimated $120 billion.

"It's really a two-horse race," Riccadonna says. "There's rising energy costs, and then there is households' ability to handle those rising costs."

So far, households appear to be keeping up. Economists think the economy will grow at a 2.2 percent annual rate in the first half of this year, compared with 0.9 percent while gas prices crept up in the first half of last year.

An oil shock would change everything. The scenario making the rounds on Wall Street starts with Israel bombing Iran's nuclear facilities. Analysts expect Iran would retaliate by trying to block access to the Persian Gulf, an attempt to pull 20 percent of the world's oil supply off the market.

In the event of a blockade, oil would skyrocket – think $150 or beyond – easily topping the record of $145 set in 2008.

"That's the wild card," says Kelly of J.P. Morgan. "That's the really big 'What if?'"

Some economists believe oil and gas prices are already nearing a danger zone. If gas exceeds the all-time high of $4.11, they say, Americans will think twice about a trip to the restaurant.

"We're getting close to a point where we should start worrying," says Thomas Simons, a market economist at Jefferies & Co. "People hate paying for gas. You get no pleasure out of it, unlike food or clothes."

If gas goes to $4.50 a gallon and stays there, it would cost each household about $1,000 more this year than last to buy the same amount of gas. That would eat half of the $2,000 savings a typical household will get from this year's cut in Social Security taxes.

It would also land a hard psychological blow, Kelly says. Jumps in oil and gas prices triggered recessions in 1973 and 1990, and gas prices last peaked months before the financial crisis shook markets in 2008.

Kelly says another spike could lead many Americans to worry that history will repeat itself.

"Americans have a fuzzy grasp on most economic matters," he says, "but one thing they're clear on is that high gas prices are a danger sign."

Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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RECORD TOTALS DAY WEEK YEAR
PROPERTY SALES 74 312 10,190
MORTGAGES 103 400 13,275
FORECLOSURE NOTICES 16 76 2,614
BUILDING PERMITS 221 783 24,307
BANKRUPTCIES 72 299 9,832
BUSINESS LICENSES 39 110 3,713
UTILITY CONNECTIONS 129 519 14,482
MARRIAGE LICENSES 13 81 3,144

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