How Easily Higher Oil Prices Could Push Us into Recession

Out of all the possible headwinds to cause economic contraction in 2012, there is one I haven’t written about lately: oil prices.

It is estimated that, in 2011, real personal consumption—the money consumers spend on all goods and services—increased by $107 billion (source: Bloomberg).

At the same time, since October of 2011, the increase in gas prices has resulted in an extra hit to consumers’ wallets to the tune of $56.0 billion (source: Bloomberg).

Thus far in 2012, real incomes and personal spending are flat. Should these trends continue and oil prices remain at current levels, then at least half of the increase in consumer spending would be directed to paying for the higher gas prices ($56.0 billion / $107 billion = 52%).


Of course, consumers could cut back on gas consumption, but the bottom line is that if gas prices remain at current levels, GDP growth will be cut by $56.0 billion or 0.6% in 2012.

I’ve argued that two percent of last year’s GDP growth was due to inventory restocking, which will not be repeated going forward. This concept is simple to understand. If a grocer restocks his shelves fully, he won’t restock again until actual sales empty out his shelves.

So, if real GDP growth is currently at only about one percent after taking away inventory restocking, and the current rise in gas prices is taking away 0.6% of GDP growth, then we are left with 0.4% GDP growth.

This means that, if oil prices were to rise roughly $20.00 a barrel from the current $105.00 a barrel level—that is, to $125.00 a barrel—then it would wipe out the 0.4% GDP growth and just “drive” us into a recession.

These numbers are rough estimates, but they give us an idea, dear reader, of where we stand. Even if the conflict with Iran were to resolve itself tomorrow, and gas prices would drop to say $80.00 a barrel, there are still other headwinds that could drag us into a recession, as GDP growth might be nonexistent in 2012.

As of today, the conflict with Iran is at a heightened level. Despite theU.S.and other countries wanting to use sanctions and diplomacy to reach the desired goal of halting Iran’s nuclear ambitions,Israelis not waiting.

Israel has made it clear that it is growing impatient and that it will act independently of other nations if something isn’t done about Iran’s nuclear ambitions, in order to protect itself. How can the world experience GDP growth under these circumstances?

Of all the headwinds the economy faces, the persistent rise in gas prices alone could wipe out GDP growth in 2012 and lead us quickly into a recession. So watch that stock market rally and keep a close eye on gas prices—the $125.00 a barrel oil price—and Iran. They are pointing to recessionary troubles ahead.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this morning up 5.6% for 2012.

The bear market rally in stocks that started in March of 2009 is tired and long in the tooth. But it still has some life left to it. The stock market is not in a speculative phase as monetary policy remains very favorable, while stock market advisers are not overly bullish. I expect one more run to the upside before this rally subsides. However, for the majority of my readers, the risk in the market might outweigh the reward.

What He Said:

“Home sales down 8.4%, could be the bottom,” read the headline in last Friday’s USA Today. What do they know that I don’t? They know what realtors and their associations tell them and that’s about it. Unfortunately, the real estate news is predominately written by reporters—not real estate investors with years of experience to share. The hard facts about the real estate market in the U.S. are truly scary. How can the U.S. economy escape the hard landing in U.S. home prices? As we’ll soon find out, it simply can’t!” Michael Lombardi in PROFIT CONFIDENTIAL, January 31, 2007. While the popular media was predicting a bottoming of the real estate market in 2007, Michael was preparing his readers for worst of times ahead.