Resident Fellow Desmond Lachman

One has to wonder whether Martin Wolf is not painting too gloomy a picture of oil price prospects over the next few years and whether he is not giving too much credence to Goldman Sachs' gloomy prognostication that oil prices might soon spike to US$200 a barrel. More specifically, one must wonder whether Mr. Wolf is not underestimating the serious damage that the recent run-up in international oil prices is inflicting on the global economy and whether he is not overlooking the very grim overall macroeconomic context within which the current oil price shock is occurring.

Mr. Wolf correctly observes that over the past year international oil prices have approximately doubled to their present level of around US$125 a barrel. Past experience with oil price increases would suggest that, if sustained, such a run-up in oil prices could very well shave a full percentage point off US GDP growth in the near-term and a further full percentage point over the longer-run.

A key factor distinguishing the present oil price shock from previous oil price shocks is that it is not occurring in isolation. Rather it is playing out in the context of the bursting of the largest US housing price bubble in the post-war period. It is also occurring at a time that the US economy is experiencing the "mother of all credit crises", as Paul Volcker so aptly describes it, and at a time of major de-leveraging in the global financial system.

In the face of these two major non-oil price shocks, it is difficult to see how the US economy could sustain the currently record high international oil prices without experiencing a prolonged recession. By the same argument, one must suppose that the US economy would experience a major recession were Goldman Sachs' US$200 a barrel forecast to be realized for any meaningful length of time.

With the US still consuming around 25 percent of the world's oil production, one would have thought that any significant slowing in US growth would have a significant impact on global energy demand and hence on world oil prices. There are, of course, those who argue that China's very rapid economic growth rate makes it of relatively little consequence as to what occurs in the industrialized economies. However, a crucial point that they overlook is that China's very rapid economic growth is primarily export driven and that the prospects that US and European markets stay open to China's exports has to be considered rather minimal in the event of a prolonged and deep global economic recession.

As a final point, I think that Mr. Wolf is too dismissive of the possibility that speculation might be playing a big part in the recent dramatic run-up in oil prices. One knows that pension funds and insurance companies have of late been allocating meaningful amounts of money to commodity purchases. If they are doing so by buying forward contracts, it is not clear that one would expect to see a big build up in physical inventories.

Desmond Lachman is a resident fellow at AEI.