(image: marketoracle.co.uk)

If you’re the type of person who enjoys unhappy paradoxes, here’s a real pearl: persistent confidence in the global economy may actually be hurting the global economy. Fatih Birol, chief economist of the International Energy Agency, warned Reuters on Monday that rising oil prices, which are in part caused by optimistic traders convinced of a revived market, threaten to undermine the world’s financial recovery. If you’re the type of person who finds such paradoxes irksome or downright confounding, you are advised to skip the rest of this article.

The price of oil has more than doubled since the end of 2008, when the global financial system collapsed and a barrel of crude sold for only $30. Since then, many investors, eager to get things moving again, have eyed the economy for signs of recovery, perhaps mistaking strong financial reports from several bellwether companies for an indication that everything is well again. After all, increased business worldwide would mean a greater demand for oil, which in turn would mean that traders could begin selling commodities for more money. Discontent to wait for the sluggish market to pick up, some traders have already begun selling oil long, despite consistently low demand.

However, analysts have warned that driving up oil prices will ultimately hinder economic growth. As an article published last week by Fortune put it, higher energy and oil prices “could complicate recovery in an economy that, despite the tumult of the past two years, remains as consumer-driven as ever.” It doesn’t take an economist to spot the dampening implications of decreased consumer spending; when Americans expend 6 percent of their income on energy costs, they have less to spend on other goods and services. It seems no coincidence that as fuel prices rose 6.3 percent last month, the Consumer Price Index indicated that consumer prices for October were higher than last year despite numerous price declines. Given the recession, this figure does not bode well for economic recovery.

Birol has joined a chorus of concerned financial analysts decrying inflated oil prices and their threat to economic recovery. None other than Nouriel Roubini, who in 2006 foretold of the global economic crisis and the unraveling of the housing market, has warned that skyrocketing oil prices spell doom for the global economy. “The price increase we have seen is too much, too fast,” Roubini said at a commodities conference in New York earlier this month. “If oil goes to $100 today, it will have the same effect on the global economy as what $147 oil had last year,” he said, referring to the staggering price of oil just before the US financial crisis escalated into a global recession in 2008.

In a recent report, the IEA suggested that the run-up in oil prices between 2003 to mid-2008 played “an important, albeit secondary” role in the global economic downturn, as higher oil prices made oil-importing countries more vulnerable to the financial crisis. With Roubini-like prescience, the agency predicted in 2006 that inflated oil prices would “pose a significant threat to the world economy, by causing a worsening of current account imbalances and by triggering abrupt exchange rate realignments, a rise in interest rates and a slump in house and other asset prices.” Given that oil prices have reached $80 per barrel, this is not a heartening thought.

The price of oil (depicted, NYMEX per barrel performance, US$) has taken off in recent months, and its negative effect on economic recovery is now coming into focus. (image: markets.ft.com)

According to economic experts, rapidly increasing oil prices are taking their toll on American consumers and slowing recovery from the recession. On Wednesday CNN reported that the Consumer Price Index—the U.S. government’s primary gauge for inflation—indicates that overall consumer prices for last month were slightly higher than last year despite numerous price declines. How is this possible? The culprit is high oil and gas prices. During the month of October fuel prices rose by 6.3 percent, with oil currently priced at almost $80 a barrel—more that twice what it was at this time last year. And although current oil prices are nowhere near last summer’s prices of $145 a barrel, economic experts have recently expressed concern that recovery could be hampered if Americans have to continue to devote greater amounts of their paychecks to fuel. Looking at the recent CPI data, it appears that that feared scenario is playing out right now. As a Fortune article published yesterday put it, higher oil and energy prices “could complicate recovery in an economy that, despite the tumult of the past two years, remains as consumer-driven as ever.”

HeatingOil.com has been monitoring oil’s climb. On Friday, energy expert Jason Schenker, president of Prestige Economics, explained that oil’s excessively high prices are a result of optimistic traders investing as though the economy is quickly recovering and oil demand is high. Daniel Yergin, chairman of IHS Cambridge Energy Research Associates, Inc, agreed with Schenker, asserting on Monday that current oil prices are not based on supply and demand but on faith in economic recovery and the weakness of the dollar.

If speculation, a weak dollar, and unjustified optimism in economic recovery are the causes of such high oil prices, the potential effects of the oil run-up are alarming. Rising energy costs naturally result in consumers spending more of their money on oil-based products such as gasoline and heating oil. According to CNN, current oil prices are pushing gasoline closer and closer to $3 a gallon. Economics professor James D. Hamilton warns that $3 a gallon is when “you start to see a change in behavior as budgets get squeezed.” To put it in another context, Hamilton asserts that Americans who spend $3 a gallon on gasoline are “are devoting 6% of their budgets to energy costs. Hitting that point in recent years seems to have prompted Americans to pull back.” Economics professor Nouriel Roubini agrees. On November 6, HeatingOil.com reported that professor Roubini believes that high oil prices could prove catastrophic to the U.S. economy, stating “if oil goes to $100 today, it will have the same effect on the global economy as what $147 oil had last year.”

Another summer 2008 gas spike just around the corner? (image: _Faraz via flickr.com)

The CNN report also noted the link between the cost of oil and past and present recessions. Confirming the IEA report that said oil prices served as a secondary cause of the economic crisis, Professor Hamilton asserted that “the price of oil played a bigger factor in the recession than people seem to be remembering.” And Steven Kopits, managing director at energy market forecaster Douglas-Westwood, stressed the link between oil surges that have pushed U.S. oil consumption beyond 4% of gross domestic product and every recession since 1972. According to Kopits, the price that would push U.S. consumption to that point today is $80 a barrel.