It must be the noxious fumes or the stratospheric prices because crude oil crossing the $100 threshold makes normally thoughtful individuals funny in the head.
The early symptoms of high oil price syndrome, or HOPS, can easily be masked or confused with a more generalized form of lazy economic thinking.
For example, those afflicted with HOPS start making assertions that higher oil prices are inflationary, as if relative price changes can morph into an economy-wide rise in prices without help from the central bank.
HOPS sufferers aren’t beyond doing a quick 180, pronouncing higher oil prices to be deflationary because they sap consumer demand.
Which is it?
When oil prices aren’t standing in for the central bank, the ultimate arbiter of all things monetary, they’re doubling as the tax man. HOPS sufferers claim oil prices are a tax on the consumer, even though the effect is nothing like a tax, which drives a wedge between consumers and producers.
Finally, higher oil prices devastate the economy and destroy jobs. What happens to producers’ profits?
I find myself getting light in the head from all this nonsense. For my own peace of mind, I need to set the record straight. Here goes.
No. 1. Sometimes a cigar is just a cigar
For folks who use the term “inflation” interchangeably with higher prices -- as in wage inflation or commodity inflation --they are not the same thing. A higher price for oil and/or other commodities is a higher relative price until ratified by the central bank.
What does the central bank have to do with it?
Inflation is a monetary phenomenon: too much money chasing too few goods and services.
Where does the money come from?
In the U.S., it comes from Ben Bernanke, chairman of the Federal Reserve, and his trusted band of governors and district bank presidents.
To be more accurate, it comes from the New York Fed’s Open Market Desk, which buysTreasury securities (generally) from a group of primary dealers at the direction of the Fed’s policy committee.
Higher oil prices don’t cause inflation. They aren’t synonymous with inflation. Higher oil prices represent a relative price increase until proven differently.
No. 2. Zero Sum Game
Higher oil prices are always viewed as a negative because they crimp consumer purchasing power.
It’s not a one way street. Wealth is transferred from consumers to producers and recycled.
Higher prices act as an incentive for oil exploration. Exxon Mobil Corp. buys new drilling equipment and hires more workers. Those dollars go back into the economy, they don’t suck life out of it.
Because the U.S. imports about half of its crude oil, according to the U.S. Department of Energy, some of those profits end up in the pockets of the Saudi royal family and other Middle East potentates.
What do they do with them? They spend them on U.S. goods and services. They buy U.S. stocks, bonds, trophy real estate and F-16 fighter jets.
This doesn’t happen simultaneously, of course. But to portray every dollar of oil profit as a net drain on the economy is inaccurate.
When oil prices rise, consumers have to allocate more of their household budget to filling the tank and heating the house, leaving less for discretionary purchases. The composition of their spending may change, but nominal spending shouldn’t be affected. There will be some effect on real GDP, but that depends on the Fed.
No. 3. Taxing Thought
The claim that oil is a tax on the consumer is one of the most common talking points during every oil-price spike. It also happens to be dead wrong.
An excise tax raises the price to the consumer, who will demand less, and lowers the price received by the producer, who will supply less. The result is deadweight loss.
The recent increase in oil prices qualifies as a supply shock -- a decline in Libyan oil production and expectations of further disruptions in Middle East supply -- on top of what was already a demand-driven rise as the world economy recovered. Crude oil had already breached the $90 a barrel mark at the end of last year, well before Egyptians took to Tahrir Square in January to demand that President Hosni Mubarak step down.
A supply shock results in higher prices and a lower quantity demanded. It’s only taxing if you think about it incorrectly.
No. 4. Mo’ Money
The Fed needs to respond to higher oil prices, HOPS victims say.
Bad idea, especially if “respond” means print more money. That was the medicine applied in the 1970s. The result was higher inflation and slower growth, which created a problem for those who thought there was a trade-off between the two.
“Respond” could have another meaning for those who think higher oil prices are inflationary (see No. 1 above) -- tighten policy. HOPS victims will have to sort that one out before they decide on a recommended course of action.
Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)