Recession risk rises with record oil

Economists say economic expansion that shrugged off $70 or $80 oil could finally be tripped up by oil above $90 a barrel.

There was a time when economists predicted that $60-a-barrel oil would cause a recession. Then they said $70 oil would. Then $80.

So it might be tough to take the recession threat of $90 a barrel oil very seriously. But some economists say that would be a mistake. They note that the current record-high oil prices are hitting when the economy is at its most vulnerable point in years - with the housing downturn, credit crunch and sliding value of the dollar posing threats that weren't present when oil passed its previous benchmarks.

The whole game has changed, said John Silvia chief economist of Wachovia. If they're sustained here, going into the holiday season, you're going to have a pretty horrendous fourth quarter.

Silvia said the downturn in housing and the problems in credit markets that hit in August have left the employment picture significantly weaker than it was six or nine months ago, when oil prices took gasoline prices into record territory.

The background is totally different now than it was in the spring, he said. The ability of the system to respond just isn't as great as it was then.

Still, Silvia says there slightly less than a 50-50 chance of a recession in the coming months, even if oil prices don't ease up. He said he expects that the Federal Reserve will step up its rate-cutting efforts and go beyond the quarter-point cut he is expecting from the central bank on Wednesday.

David Wyss, chief economist with Standard & Poor's, puts the chance of a recession at less than 50 percent. But he agrees with Silvia that the risks are greater with the combination of increased oil prices and the current weakness in other parts of the economy.

The more things that go wrong, the less room there is for anything else to go wrong, he said. With housing diving, the problems in the credit market and rising oil prices, eventually one of these things is going to break the camel's back.

Wyss still thinks that the current record highs are just short of the breaking point needed to tip the economy into recession.

My feeling is $90 doesn't get us there, he said. My guess is we have to go over $100 to get to a recession. How much over $100, I'm not sure.

Wyss said that the economy is less susceptible to oil shocks than in 1980 and 1981, when oil hit what was widely seen as record highs. Adjusted for inflation, the price then was between $93 and $101 a barrel, depending upon how those historical prices are calculated.

The growth of the service sector and the shift away from manufacturing means oil prices are less important to corporate profits and overall economic activity today than they were then. But the current economy is hardly immune to such problems.

Procter & Gamble, the nation's leading maker of consumer products, warned Tuesday that profit margins and earnings in the current quarter would likely be less than forecasts, citing increased energy prices as part of the reason. Auto sales, particularly among U.S. automakers, have taken a hit from high gasoline prices this year, Wyss points out.

And some service sector companies can also be squeezed by higher oil.

Retailers could be hurt if consumers cut back purchases due to higher gasoline prices, while higher fuel would jump could hurt some transport firms, particularly airlines.

Oil's impact is smaller than it used to be, but that sure doesn't mean it's trivial, Wyss said.

But Lakshman Achuthan, managing director of the Economic Cycle Research Institute, believes that the economy has shown enough underlying strength, especially in the labor market, to take even this latest oil shock.

There's obviously not a magic number [on oil prices] that defines if economy will tip into recession, he said. It might be easier if prices were lower. It doesn't feel good to dig into your pocket for extra gas or mortgage money. But it makes a big difference whether or not you're getting a paycheck.

Achuthan points out that despite all the focus on the credit crunch and housing downturn this year, the economy grew at a 3.8 percent annual rate in the second quarter. Furthermore, the third quarter is only forecast to slow to a 3.1 percent pace of growth when the government gives its first reading on the quarter's gross domestic product on Wednesday.

Certainly we're slowing, but you have some room to slow without going in recession, he said. You can never say never, but it [a recession] should not be the predominant concern. There's more resilience in this economy than people think, because you have not had a recessionary downturn in this employment market yet.

Source - CNNMoney