Politics & Policy

Time to Energize The Economy

Is this a liberal moment?

As an economic commentator, it’s not easy to find anything positive to write about these days. Stock prices continue to plunge. Declining factory orders, shipments, and production are all sending off recessionary signals. The Fed is still behind the curve — way too tight. The tax-cut story in Washington is completely muddled. McCain’s campaign-finance bill will choke off legitimate economic policy dissent come election time. U.S.-China hostilities threaten a trade war.

And so it goes. Grim. At least the Yankees won on opening day.

But there is one economic area that might be throwing off a bit of light at the end of the tunnel. Energy prices continue to decline, even while OPEC tries to tighten production. Since last September, crude oil has dropped 30%. And since late December, natural gas has fallen nearly 50%. These price declines will generate a tax-cut effect on the economy over the next 6 to 12 months, reversing the energy-shock tax-hike effect of the past two years.

Even more, veteran energy analyst Charles Maxwell told me over lunch Monday that crude oil could drop to $23 per barrel next year, and $20 in 2003, from today’s level of $26. Also, he believes that natural gas could decline to less than $4 in the next two years, another 25% reduction from the current $5.10 level.

Energy-cost declines would be hugely positive for corporate earnings whose sagging fortunes continue to pull down share prices. Actually, the majority of economists, including myself, underestimated the contractionary consequences of rising oil and gas prices — especially the most recent round of price hikes registered during last autumn and winter.

Consumer-purchasing power was drained by roughly $65 billion as household incomes were transferred from U.S. families to OPEC producers. Also, higher prices for oil, home heating fuel, natural gas, gasoline at the pump, electricity, and other energy goods caused roughly $100 billion of consumer spending to be diverted from non-energy purchases to pay humongous energy bills.

Even worse, energy price spikes have decimated corporate profits. While the Fed’s tight money has restrained retail prices at the consumer level, especially non-energy retail prices, spiking oil and gas substantially raised business-input prices at the wholesale level. Consequently producer price increases (4% over the past 12 months) have been running nearly 2 percentage points above the consumer-spending price deflator (2.3%). In other words, manufacturers have been forced to buy high and then sell low.

This is particularly true for technology makers who are more electricity sensitive than old-economy producers. As a result, profit margins have been badly squeezed by the energy shock. In last year’s fourth quarter, business firms suffering from back-to-back oil and natural-gas spikes suffered a 4.3% after-tax annual rate of declining profits. Profits in the first quarter will probably fall at an even faster pace. So, help from lower energy prices can’t come fast enough.

Ironically, with congressional opposition moving President Bush to back off his plan to reduce energy prices by producing more supply in the Alaskan wildlife refuge, key political liberals seem to be embracing free-market energy policies that would increase production and conservation. On the Left Coast, People’s Republic of California utility commissioner Loretta Lynch has proposed a 40% increase in retail electricity rates. This comes on top of 20% rate hikes already approved. While Democratic Gov. Gray Davis hasn’t yet signed on, his staff consulted extensively with Ms. Lynch before the rate hike was announced.

The move to market-based retail electricity rates will offset the wholesale energy-price hikes that up to now have nearly bankrupted the state’s two largest investor-owned utilities — which, by the way, were forced to buy high and sell low. Also, temporary spikes in retail energy prices will curb energy use, bringing energy prices back down before long. Deregulation works. If Gray Davis doesn’t stand in the way, he will get credit for solving an energy crisis that was originally brought on by a Republican governor — Pete Wilson — who authored the crazy buy-high, sell-low energy plan several years ago. Score one for the liberals.

Now, on the East Coast, in the former Moscow on the Hudson, Democratic U.S. Senator Charles Schumer (D., N.Y.) has endorsed increased domestic energy drilling in oil-rich areas such as the Gulf of Mexico, and told the New York Post he would back exploration for oil and natural gas in the Colorado Rockies. The liberal Mr. Schumer is therefore one of the first Senate Democrats to back increased energy production, leaving extremist environmental groups behind. Score another one for the Left.

What’s going on here? Is this a liberal moment? Well, electricity blackout prevention is the political mother of all free-market energy invention. You might call it free-market common sense. Who knows, if the stock market’s recessionary plunge continues, perhaps Hillary Clinton will soon endorse lower marginal tax rates.


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