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The price of oil

Discussion in 'The Economy' started by lorrimer, 7th Jun, 2008.

  1. lorrimer

    lorrimer Well-Known Member

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    In the past couple of weeks I've witnessed startling signs of how the consumer is suffering in the current economic climate. The local Aldi supermarket is packed, furniture shops virtually empty.
    As for prices, we used to buy lamb shanks for $2, they are now $3 each. A box of fruit at our local market has gone up from 10 to $20.
    My question is, how much of all this inflation is due to the price of oil?
    I happen to think that it is a major factor, and if this is the case, why is the RBA continuing to heap pain on the consumer by raising interest rates.
    Australia is a vast country and the increased cost of transporting goods is obviously going to translate into higher prices.
    So if the cause of the inflation is oil, rather than discretionary spending, the RBA run the risk of squeezing the consumer dry and bringing the economy to a halt.
    I would be very interested to hear the views of other forum members on this matter,
    Thanks
     
  2. Chris C

    Chris C Well-Known Member

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    I don't know if I'm the best person on these forums to respond to this question as I'm only 23 and haven't really seen a lot (if any) business cycles since I have taken an interest in investing, but here is my two cents anyway.

    It isn't just the oil prices driving up inflation (though it is a significant factor) - lots of other factors are weighing into inflation like the Australian mining booms (in addition to high commodity prices) and global food shortages. That said I'm not in a position where I could accurately "guesstimate" what percentage what due to oil, but intuitively I'd think it definitely isn't making up the anywhere near the majority of inflation pressures but is still a very significant factor.

    As for why the RBA continues to raise interest rates - well in short the RBA is just attempting to "smooth" the business cycle, because if inflation and growth are left unchecked then it creates a situation where there are more dramatic boom/bust cycles in the economy which might provide great returns in boom periods but unfortunately this is countered by a very unstable environment and dramatic down turns in bust periods where many that don't time the market well will be sent bankrupt and would put a lot of strain on economy not mention build fears around the instability of the economy, which doesn't make for a great investment environment as the majority of us prefer stable returns.

    So the RBA believes that rather than having dramatic boom/bust cycles, we are all better off having the RBA employ some monetary policy (interest rates manipulation) to cool and heat up the economy when needed. The government essentially does the same thing on the fiscal policy side of things, reducing spending in periods of high inflation and high growth, and boosts spending to stimulate the economy in periods of low growth.

    At the end of the day I don't think the RBA cares if Australians have to do it a bit tougher for a couple of years and stretch those household budgets a bit considering what the alternative is - high unemployment in bust periods. The reality is the vast majority of Australian families can squeeze a few extra dollars out of their weekly spendings to contribute to their mortgage repayments. Alternatively they can't pay their mortgage if they are unemployed. I think once again it isn't scared of bringing the Australian economy to a halt (which it would be hard pressed to do in the near future) considering the Australian economy is still experiencing significantly higher growth than most other develop western countries.

    Also in the RBA's defense in the last 17 years Australia hasn't seen an extended period where our real GDP growth has dropped below 2%, and most of the time we have been happily sitting between 3 - 5%.

    With all that said, the argument could be made that our inflation targeting method of regulation isn't ideal when the majority of the inflation pressures on our economy aren't being generated by Australia's expansion, but rather inflationary pressures on key world resources. I think that is why the RBA has let inflation get well above its 3% target band and seems to have accepted that our inflation rate will probably be above the 3% target for the next two years, and is wary of the fact that high inflation isn't just an issue in Australia.

    Long story short, the world economy is slowing, Australia is no exception, people need to get read to buckle down for a tougher 2 years - the RBA is just giving us the heads up.
     
  3. eddyl

    eddyl Well-Known Member

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    While what you say is ostensibly correct Chris, you need to analyse the type of inflation that the RBA is trying to dampen. There is alot of debate over whether it is demand push or supply pull inflation in australia at the moment. This is because of the interest economic environment in which we currently sit. America, the worlds largest economy is experiencing stagflation(low growth, high inflation), where as it is argued that australia is buoyed by ravenous chinese demand. Sim recently posted an article over whether inflation targetting such as monetary policy is effective in real terms because, what it effectively tries to do is target local demand, but if the price of essential goods(oil and food) internationally is racing ahead there is little they can do.
    In short I don't think the RBA is currently too worried about the tougher 2 years ahead, it is more worried that australia is growing at a rate that is unsustainable. It a boom is too big, it should be corrected by a large bust.

    Cheers,
    Eddy
     
  4. crc_error

    crc_error The Rule of 72

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    personally I think the global economy is screwed.. dow was down again 200 pts over night.. these oil prices will brng on a depression, like they did once before...
     
  5. Chris C

    Chris C Well-Known Member

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    It seems that many people are suggesting that oil is one of the biggest factors in whether this world slow down is going to be relatively light or significant.

    There are a fair few people out there suggesting that fundamental prices for oil shouldn't be much more than $100 - $110 and that the current prices are being forced up by speculators, and that the current prices are what are causing so much havoc on economies, with the old catch 22 being that a slowdown should see a drop in the demand for oil, which I imagine might spook the speculators out of the market and putting some strong downward pressure back on oil prices...

    That said with reporters loving to hype up the struggles of the world it would seem that everyone would rather predict that oil is going to $250 rather back down to $110 which isn't helping.

    So my prediction is there will be further drops on the markets, reports will come out from the US that they are indeed headed for the recession they thought they were going to dodge, China's growth will decline slowly in 2009 after the effect of the Olympics has played through and oil prices will drop back significantly providing some growth stimulus for the world, and the majority of the world will avoid recession, and Australia will continue to do what it does best - grind away.
     
  6. crc_error

    crc_error The Rule of 72

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    Australia might keep on doing what it does, but our market doesn't reflect fundementals here, but it responds to what is happening overseas.. ie the US.
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Funnily enough, I've started seeing reports this morning predicting that Australia may well hit recession before the US does :rolleyes:
     
  8. crc_error

    crc_error The Rule of 72

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    Labor comes in and another recession we had to have!

    Australians deserve what they get voting out a proven government. why? because they didn't like howard.. well the attack was personal, but the results wont affect Howard, but the whole country.

    You look around, everyone is quiet, shops are empty, prices are sky rocketing.. means only one thing... kevin07 recession08 depression09
     
  9. bennymarsh

    bennymarsh Well-Known Member

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    I don't know where your shopping, but i can't remember seeing more people in shops, both in the cbd, and in the 3 suburban shopping centers i had the misfortune of visiting last weekend!

    Anyway, this was an interesting article on SMH this morning.

    T's Chief Economist, Chris Caton


    Petrol Prices vs The Economy - June 2008

    Well the Budget has come and gone, and not much is different. Share markets rose again in May, although not by much, and the US economy continued to send off mixed signals, thus enabling both the optimists and pessimists to maintain their views. I continue to think that there is worse economic news to come from the US, which will be a challenge for share markets.

    The continued rise in oil prices was a feature of the month. At end-April, a barrel of West Texas Intermediate cost $116; in late May this price hit $135. Oil prices have doubled in little more than a year. There are those who ascribe all of the rise to “fundamentals” (that is, supply and demand), and there are fanciful forecasts out there that the price may hit $200 per barrel in relatively short order. Count me among the sceptics. Those who claim the price rise is all justified by fundamentals need to be able to identify exactly which fundamentals have changed so much in the past year. Did we not know a year ago that demand in the developing world was likely to continue to rise? Has there been any massive reassessment of the future supply of oil?

    If (at least some of) the price rise is not due to fundamentals, then the next move may well be downwards. My personal view is that oil will trade at $100 per barrel before it trades at $150. This, incidentally, is the same forecast that I gave my audiences a year ago.

    If oil prices are to retreat, then they will soon begin to dampen inflation, although we have not yet seen the peak effect on overall inflation of the rise to date. The rise in oil prices has, of course, reduced the real income of consumers. In the US, consumer spending is growing more slowly than at any time in the past 16 years, and “working families” are complaining vociferously about petrol prices in Australia, leading both sides of politics to look for means of alleviating the pain. If I am correct, and oil prices do fall, then this latest outbreak of “bad economics” will be halted before it can do too much damage.

    Am I the only one who thinks that our politicians should be engaged in weightier matters than ensuring that everyone is free to drive the Tarago at the lowest possible cost? I don’t expect to win many friends by saying so, but we should be taxing petrol more than we are, rather than less.

    The consumption of petrol is taxed in every developed country that I am aware of, and for good reason. First, there is an enormous amount of public infrastructure associated with petrol consumption. Why shouldn’t petrol users pay for that? Second, unlike most goods and services that we consume, the consumption of petrol imposes costs on others, mainly in the form of environmental damage and congestion. If petrol is untaxed, then we will use more of it than is socially optimal. In Australia, this tax burden is relatively small; I am aware of just two developed nations, the United States and Canada, that impose a lower tax burden. One can imagine that the present outburst of rampant populism on this issue could well lead to the “quarantining” of petrol when Australia gets serious about reducing carbon emissions. Were this to occur, greater cutbacks will need to be made elsewhere, and the consumer will suffer, with electricity prices, for example, being far higher than otherwise.

    There is a further consideration. The “burden” of the increased cost of petrol is commonly exaggerated by stories of how many dollars it takes to fill the family car (imagine that, a problem exaggerated by the media!!). The chart shows the ratio of consumer spending on gasoline to total personal income. It shows that, as of the December quarter last year, this ratio was 2.8%. Data for 2008 are not yet available, but this share is still likely to be little more than 3%. Note that the share was higher for almost the whole time from the onset of OPEC II until early 1987. How can this possibly be true, given that the pump price is so high and, as I showed last month, the price of petrol relative to total consumer prices is at a record high, and about 30% higher than it was in the early-to-mid-80s? There are two main reasons. First, cars are more fuel-efficient than they used to be. Second, in the past 20+ years, our real incomes have risen, but we have not increased the distance that we drive nearly so much.

    Petrol spending as a share of personal income

    http://www.investsmart.com.au/promo/images/catton_smgraph_june.gif

    Ben
     
  10. lorrimer

    lorrimer Well-Known Member

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    Well I've never prospered under a labour government. In fact I left the UK in order to escape one, only to end up with Tony Blair mark 2 here.

    I personally think the RBA are going to lead us into a recession that we didn't need to have.
    They have turned the screw far too tightly and seem to have paid little regard to the rapid rise in the oil price and the turmoil caused by the credit crunch.
    As I said I have noticed a dramatic slowdown up here on the Sunshine Coast.
     
  11. bennymarsh

    bennymarsh Well-Known Member

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    Ahhhh see, that is the reserve bank, that isn't the Labor party, or Tony Blair mark 2, or the previous government for that matter.

    The RBA are an independent body who have been charged to make sure the economy stays on track. The Labor party has just as little control (none) over their policies as the coalition government did. Why do you think Howard and Costello did so much chest beating at them leading up to the election when they were raising interest rates anyway? Did it do any good???? No, they put them up despite the Treasurer and Prime Minister chastising them for doing so.

    And i have to agree with you, that if the country is going to go into a recession, it will be on the RBA's hands, it won't be on the governments, be it this one or the previous. When 0ver 50% of our inflation is imported into the country due to higher oil prices and food prices, how can it do anything but go up, and how are interest rates going to control that????? They can't! A high school student should be able to figure that one out!

    Although it has to be suggested that the previous government has squandered the last 5 years of the resources boom giving frivolous tax cuts to those who didn't need them. What have the past 9 years of budget surpluses done to improve the country..........nothing! Where has been the encouragement for people to save?????? A last minute......if your really really rich, you might like to put $1million into super before we discourage you from adding money to super by imposing large tax penalties for saving for your retirement so you don't need to go on the age pension.....which by the way, we'll waste more tax payer funded dollars by making it easier to get for those who don't need it!

    As for being quiet on the Sunshine coast, i'll have to take your word for that, and all i can suggest is that increase oil prices and strains on the family budget (both of which the Labor government has no control over) have meant people can't afford to fly or drive up there. I remember 7 years ago a trip to Melbourne (I'm only using this because i have a direct comparison) cost me $90 in air fares and $25 in taxes. I went down last weekend, and it cost $110 (fine.... inflation), and $161 in taxes and fuel surcharge. Thats why people aren't traveling! And thats why a tourist location like the sunshine coast will be suffering. Nothing to do with this or the previous government. As i said, shops in Sydney seem to be as busy as ever!

    Ben
     
  12. Billv

    Billv Getting there

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    Not for long
    I know Bunnings are not as busy as they used to be
    and retail shop sales will be down as well.
    Cheers
     
  13. Chris C

    Chris C Well-Known Member

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    Where are you hearing these reports???

    I find it hard to believe that Australia will dip into a slow down that puts our real GDP growth below 1% let alone a recession...

    AHAHAH! That's the funniest thing I have read all week... kevin07 recession08 depression09 - not that I really believe it will happen or that it is Kevin's fault, but it still cracks me up!

    I don't think it is fair to blame any present economic slowdown on good ole Kevie Rudd, he has been in power for 6 months as opposed to Johnny Howard's 11-12 years. Whilst I'm a big Johnny Howard fan - he was riding on the back of our mining boom combined with relatively decent global economic conditions, whereas Kevie Rudd has come into power with the US on the brink of recession and rampant World inflation... it seems the Labour government just need to time their runs for office a little better...

    :rolleyes:
     
  14. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Can't remember specifically - I think it was from a news website - I saw the headline in my RSS reader during my morning scan.
     
  15. Tropo

    Tropo Well-Known Member

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    Oil is too important to leave to market forces

    ....But another more important aspect of the oil boom is now attracting political attention: An oil price above $100 a barrel is an enormous danger to the world economy.
    It threatens to reignite global inflation, wreck development plans in China and other emerging countries and magnifies geopolitical risks by redistributing some 7 per cent of global GDP, roughly $4 trillion per annum, from the stable societies of America, Europe and developing Asia to potentially hostile regimes.
    These regimes then leak this money to Wahhabi fundamentalist madrassas, communist insurgencies in South America and mafia activities from former Soviet states........

    Oil is too important to leave to market forces | Anatole Kaletsky - Times Online
     
  16. eddyl

    eddyl Well-Known Member

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    It's a bit ridiculous to blame this slow down on the labour government. It takes time for fiscal policy to effect an economy. The Rudd-Labor government have only been in cabinet for less than a year. This is a very naive comment.
    I think what we have to bear in mind is that Australia is actuall overheating. Consumer sentiment was still high up until this month when the Westpac-Melbourne institute CSI drop markedly. Inflation fears are very much demand driven within Australia. The RBA is effectively trying to dampen the economy.
    Indeed, it is argued that the reason why the RBA did not raise interest rates last board meeting, was because they were waiting for the lag effect of monetary policy to take effect.

    Cheers,

    Eddy
     
  17. lorrimer

    lorrimer Well-Known Member

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    Yes the RBA are completely independent and their remit is to keep inflation within certain levels.
    However this doesn't mean that the government shouldn't at least be trying to exert some external pressure to make them think slightly differently.
    I do not believe that fighting inflation should be the one and only consideration and be fought at all costs, especially when much of the inflation is imported.
    But rather than help the Australian people by stating the significance that the oil price is having on inflation, they seem to be constantly talking up internal inflationary pressures.
    Since Bush decided to invade Iraq the price of oil has shot up by some 400%.
    You don't have to bee a brain surgeon to work out that this in itself is a huge inflationary pressure, given that everything that we buy or consume needs to be transported from A to B.
    I would love to hear someone from this government come out and say something to try to bring some confidence back to the financial markets.
    When the sub-prime crisis first broke, I recall Costello coming out and stating that we shouldn't be as badly affected as the US because our banks were far more conservative in their lending practices, and our economy was still strong.
    As yet the write downs from Aussie banks has been minimal in comparison to those in the US.
    Despite this our stock market has performed far worse the both the US and the UK.
    By my reckoning we have now had four corrections of 10% or more in the past 12 months.
    Confidence in the stock market has been shattered and some peoples Super funds have been decimated. Meanwhile this government has stood idly by and watched it happen without hardly a whisper.
    The other thing that I find hard to understand is how interest rates here can be so high when Australia sources it's money from overseas markets. The Aussie dollar has never been as high and interest rates in the US and UK are much lower than here.
    Once again I've heard nothing from the government on this matter either.
     
  18. bennymarsh

    bennymarsh Well-Known Member

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    The Australian market is a lot smaller and less mature than the US and UK, so will always be more volatile. Should we have been as affected, no, but until Australian investors (and fund managers for that matter) become more sophisticated traders, we will always follow the US on a daily basis. For the investor, look at the 5 year markets trends, they are totally different, and you just ignore what is happening on the market daily anyway.

    People who are worrying about their super funds being down in value don't understand their finances properly. As i ask all of my client, "Are you accessing all of your money today?".....if the answer is no, then you don't need to worry about corrections. "Have we set aside enough cash for you for the next 2-3 years?" Yes........then you don't need to worry about what the balance of your fund is, it will recover before you need to draw down more into cash.

    Again, the super fund story is a just a media beat up trying to sell advertising. "Your financial planner has set up your super so you don't need to worry about the stock market" doesn't sell as many papers as "YOU HAVE LOST ALL YOUR SUPER!!!!!!! PANIC!!!!!!!!".

    Again, if your not accessing it ALL today, it will recover! It sucks looking at a lower balance, but it will come back! If you did need it all today and you had it all in shares, you were taking too much risk.
     
  19. Chris C

    Chris C Well-Known Member

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    What will be really interesting is how oil prices react to the latest announcements that Saudi Arabia (the worlds biggest producer of oil) is going to increase their supply to prevent price getting to a point that they stimulate innovation.

    It's a bit of a shame for the world in the long run especially with our battles against climate change, but I get the impression that it will definitely restore a lot of confidence back into the world knowing that the world's biggest produce of oil isn't going to let things get completely out of control.

    Does anyone else think that this might be a big turning point in this current economic slow down?
     
  20. bennymarsh

    bennymarsh Well-Known Member

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    Has anyone seen the documentary Crude awakening? A Crude Awakening: The Oil Crash (2006)

    It discusses the fact we are probably past peak oil with a much higher consumption rate and that at best estimates we are 50 years from an alternate power source which could replace oil, but that we would need a lot of oil to produce the technology, so it's a lose lose situation really.

    Again, Australia is probably in a good position being a net energy exporter whatever happens.