From: Brad Foss, Associated Press
Published September 20, 2006 12:00 AM

Economists Say Falling Energy Prices May Feel Good, but Aren't a Panacea

WASHINGTON — It should only be this simple: Oil prices plunge 20 percent, leading businesses and consumers to ramp up their spending, which gives a nice jolt to the economy.


That seems to be the conventional wisdom on Wall Street right now, where the pullback in energy prices is being cheered by investors.


But some contrarians think that view could be missing the point. While the decline in prices will provide some relief to motorists, it also reflects the country's weakening economic outlook. In other words, any benefit from falling pump prices may be outweighed by higher interest rates and a stagnating real-estate market.


Moreover, the economy did not crater in the face of soaring fuel prices -- because energy costs are only a small portion of the average U.S. household budget -- so why should the reverse be true?


"Lower oil prices don't mean that the economy is going to improve," said David Resler, chief economist at Nomura Securities in New York.


Crude oil futures fell sharply to around $62 a barrel Tuesday as traders focused on rising global inventories, easing supply threats and weakening demand. The interplay between energy and the economy, in the context of a real-estate slowdown, is likely to be a key issue at Wednesday's Federal Reserve meeting. The agency left interest rates unchanged in August amid signs of slower economic growth, and many economists expect the central bank to again hold its short-term rate steady at 5.25 percent.


To be sure, the nickels and dimes Americans save on fuel add up -- the country is spending roughly $70 million a day less on gasoline today than a year ago, according to the Oil Price Information Service. This may make consumers feel a little wealthier, and they could very well spend the extra pocket change on other things.


"But it's not going to stimulate spending that wouldn't have been there," said Resler. "It's just going to reallocate the spending" -- from, say, Exxon Mobil Corp. to Wal-Mart Stores Inc.


That somewhat pessimistic view is even a little too sunny for Peter Schiff, president of Euro Pacific Capital, Inc. of Darien, Conn.


Schiff said the economy has grown in recent years despite soaring gasoline prices thanks to historically low interest rates that made credit-card debt look cheap while fueling a housing boom that prompted many homeowners to take out home-equity loans.


According to the Federal Reserve, U.S. consumers owed $841 billion in credit-card and other revolving debts in July, compared with $804 billion a year earlier. Non-revolving debt, which includes automobile and personal loans, totaled $1.51 trillion in July, compared with $1.46 trillion a year earlier.


But as adjustable rates on mortgages and credit cards rise, "all of a sudden, $2.50-a-gallon might feel more expensive than $3," Schiff said.


Instead of spending all of their savings at the pump on other goods and services, Schiff expects many consumers to buckle down by either paying down debts or putting more money in the bank.


Indeed, the nation's retailers have a somewhat similar outlook. The National Retail Federation said Tuesday it expects retail sales in November and December to rise by 5 percent -- below last year's 6 percent increase.


That assessment is backed up by signs from the trucking industry that its peak pre-holiday shipping season will be a disappointment even after the benefits of cheaper diesel prices are factored in.


"The negative freight trends significantly outweigh the benefits of declining fuel prices," Merrill Lynch trucking analyst Ken Hoexter said in a research note.


And as if any further confirmation of the housing market's woe was necessary, the Commerce Department reported Tuesday that construction of new homes dropped a bigger-than-expected 6 percent in August -- the fifth decline in six months.


Still, Global Insight chief economist Nariman Behravesh sees reason for optimism.


He acknowledged that the anemic housing market is like a dark cloud hanging over the economy, but said it is all the more reason why the drop in oil prices should be seen as a ray of light.


"It helps to cushion the blow, in terms of the impact on the consumer," Behravesh said.


With oil at $65 instead of $75, Behravesh sees U.S. gross domestic product getting one- to two-tenths of a percentage point bump over the next year. A chunk of money that had flowed to foreign oil-producing nations will now go to American companies, he said.


Indeed, Wall Street already seems to have factored in a likely economic boon. Since July 14, when oil prices peaked above $78 a barrel, the S&P 500 Index has climbed by almost 7 percent. (Of course, part of the stock market surge is tied to expectations that the Federal Reserve is done raising rates for the time being.)


Merrill Lynch economist Sheryl King said investors may not be putting the recent drop in oil prices in the proper perspective.


Over the past 52 weeks, retail gasoline prices have averaged $2.62 a gallon, or 12 cents more than the current nationwide average of $2.50, according to Energy Department data. So it doesn't make much sense to get giddy about the post-summer slump, King said.


"The $3 gas price wasn't there for very long," King said.


Or as Schiff put it: "We're talking about $60 instead of $70. We're not talking about $20."


Source: Associated Press


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