$100 Oil May Mean Recession as U.S. Economy Hits Danger Zone

Rising fuel prices that businesses and consumers took in stride earlier this year may now be near the point of pushing the weakened U.S. economy into recession.

We are in a danger zone, says Nariman Behravesh, chief economist at Global Insight Inc. and a former Federal Reserve economist. It would take two shocks to bring the economy to its knees. We got one shock in the form of the credit crunch. Oil could be that second shock.

Crude-oil prices are poised to cross the $100-a-barrel mark while the U.S. economy is still reeling from a surge in corporate borrowing costs. Europe and Japan are vulnerable as well, after the U.S. subprime-mortgage collapse contaminated their credit markets.

Even before the latest jump in energy costs, economists expected U.S. growth to slow to less than 2 percent in the fourth quarter -- half the third quarters pace. Andrew Cates, an economist at UBS AG in London, said his models suggest a 45 percent chance of a U.S. recession next year, up from 33 percent last month, as oil prices prove a growing concern.

Japan risks its fourth recession since the early 1990s, with its index of leading economic indicators falling to zero for the first time in a decade. The European Commission last week cut its 2008 growth forecast for the 13 nations that share the euro to 2.2 percent from 2.5 percent, partly because of costlier crude. The economy grew 2.8 percent last year.

Energy Efficiency

The world economy may still dodge recession as emerging markets continue to expand. A report last week by Deutsche Bank AG said gains in energy efficiency mean the effect of more expensive oil will remain muted.

Even so, gloom is spreading at a speed that suggests were walking a really fine line, says John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. Even a month ago, you probably wouldnt have thought wed be seeing a sustained credit problem and oil holding up above $85 a barrel.

Crude oil traded at a record $98.62 last week on the New York Mercantile Exchange and ended the week at $96.32, bringing its increase this year to 58 percent. Prices adjusted for inflation exceed the previous record, set in 1981 when Iran cut exports.

The dilemma for central banks is how to balance oils drag on their economies against the risk of higher inflation. Fed Chairman Ben S. Bernanke told Congress Nov. 8 that oil prices threaten both renewed upward pressure on inflation and further restraint on growth.

Accelerating Inflation

Such concerns prompted the European Central Bank to keep interest rates on hold last week, and President Jean-Claude Trichet said he still sees a danger that inflation will accelerate.

Clayton Jones, chief executive officer at Rockwell Collins Inc., says central bankers should err on the side of supporting growth. Jones, whose Cedar Rapids, Iowa-based company makes aircraft-cockpit instruments, said in an interview that hes much more worried about recessionary impacts rather than inflationary impacts.

Manufacturers are among the first to feel the pinch: Rising energy prices are increasing their costs while drooping consumer and business confidence erodes demand.

In the U.S., the Institute for Supply Managements manufacturing index fell to a seven-month low in October as gauges of orders and production declined.

Lower Profits

Peoria, Illinois-based Caterpillar Inc., the worlds biggest maker of bulldozers and excavators, cut its profit forecast on Oct. 19 and said the economy would be near to, or even in, recession in 2008.

The pain doesnt stop there. Rising jet-fuel prices are forcing airlines to curtail expansion plans. Chicago-based UAL Corp.s United Airlines said it may cut capacity in 2008 to make up for higher fuel costs. Cologne-based Deutsche Lufthansa AG is raising fuel surcharges on long-haul flights.

Dallas-based Southwest Airlines Co. is reconsidering our growth rate for next year, because of very significant cost increases, Chief Executive Officer Gary Kelly said Nov. 7.

Meanwhile, U.S. shoppers, who helped propel most of the current expansion, may cut back as gasoline and home-heating costs rise. Retail-sales growth from November through January may be the slowest since 2002, consultant Ernst & Young estimates. Consumer spending accounts for more than two-thirds of the U.S. economy.

Biggest Decline

Heidelberger Druckmaschinen AG, the worlds largest maker of printing machines, last week reported its quarterly profit dropped by almost half, triggering the biggest decline in its shares since 2004. Energy and raw-material costs have made life difficult, says Dirk Kaliebe, chief financial officer of the Heidelberg, Germany-based company.

The pain extends to China and India as governments pare energy subsidies, putting more of the burden on companies and consumers. China increased fuel prices by as much as 10 percent Nov. 1, and India may follow as soon as this week.

The stage is set for a significant slowdown in global manufacturing, says Joseph Lupton, a former Fed economist now at JPMorgan Chase & Co., which predicts industrial-production growth worldwide will decelerate by more than half before the end of this year, to about 3 percent.

The speed of the latest jump in oil prices tests the resilience of economies that weathered previous increases, says David Hale, president of Chicago-based Hale Advisors LLC.

Weve had stages in which the price has gone up over a period of two or three years, he told a Nov. 7 teleconference. The recent price spike from $85 to $96 has happened in just a few weeks, so this will pose more of a risk.

The longer prices remain high, the greater the threat, says Neal Soss, chief economist at Credit Suisse Holdings Inc. in New York.

While Soss doesnt expect a recession, he compares the danger to driving on an icy road: You may get away with it for a while, but the risk of having an accident has gone up.

Source - Bloomberg