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As Barack Obama and Benjamin Netanyahu discuss next steps regarding Iran, investors are becoming increasingly jittery. At one point late last year, the Brent oil price was around $90 per barrel. Now, even after falling on Tuesday on news that talks with Tehran were to be reopened, it is still well above $120, reflecting both renewed economic optimism and fears over how, precisely, Iran’s nuclear ambitions can be contained.
We have been here before. At the beginning of last year, oil prices moved higher due to Tunisian and, more pointedly, Libyan concerns. At the time, economists mostly shrugged off these increases: recovery was on track and nothing, it seemed, could go wrong. Yet, within a few months, growth prospects had slumped, double-dip fears had returned and the Federal Reserve had again delved into its box of unconventional monetary tricks.
Whether we like it or not, the world economy is still addicted to oil and hence vulnerable to movements in oil prices. The effects vary, however. For the emerging world, the immediate problem is inflation, a threat that last year was thwarted through some aggressive "“ sometimes unconventional "“ policy tightening. Slower growth is now the result, notably in China.
For the developed world, growth is a far more immediate problem. Although higher oil prices inevitably push inflation up, economic permafrost rules out any kind of meaningful wage response. Real incomes are squeezed and demand slumps. Last year's collapse in sentiment "“ an outcome that persuaded the Federal Reserve to launch the second round of quantative easing "“ owed a lot to the unanticipated effects of higher oil prices.
There is, however, more to the story than just Iran, important though it is. Oil prices have been steadily rising since the beginning of the millennium, a remarkable turn of events given persistently disappointing growth rates in the developed world. In the past, US economic weakness would have been associated with falling oil and other commodity prices. Not any more. Oil prices "“ and other commodity prices "“ are increasingly determined by burgeoning demand in China, India and other fast-growing emerging nations, particularly for resource-intensive infrastructure projects.
Oddly enough, the west's pursuit of quantitative easing may simply have hastened this process. With western households and companies busily deleveraging and with investors still on a quest for yield, the benefits of loose monetary policy have increasingly flowed to the more dynamic "“ and more resource-intensive "“ parts of the world. The recent increase in oil prices reflects not only the impact of Iran (both the fear of conflict and the impact on global oil supply of sanctions) but also misjudged attempts by western policymakers to kick-start their own economies.
Too often, the market worries about oil price spikes alone. Admittedly, outright conflict in the Gulf could potentially take oil prices all the way up to $150 or even $200 per barrel, an outcome that would send the west into a recessionary tailspin. Spikes, however, tend to be reversed. The past 12 years have seen, instead, a slow but relentless increase in oil prices, which demonstrates how the global economy is steadily being reshaped. For all the gloom in the west, we have just lived through a period of incredibly impressive global economic expansion. Higher oil prices are but one reflection of this success. They are also, unfortunately, a key reason behind the failure of the western economic recovery to gain traction.
The writer is HSBC Group's chief economist and the bank's global head of economics and asset allocation research. He is the author of ‘Losing Control: The Emerging Threats to Western Prosperity’
© The Financial Times Ltd 2012 FT and 'Financial Times' are trademarks of The Financial Times Ltd.
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