$100. $90. $80. $70. $60. All the way down to $48 (US$). The drop in oil prices over the past several months has been astounding. It’s thrown pundits, traders, and oil producers into a frenzy—but what does it mean for consumers?
In short, the impact could effectively be considered as a massive tax cut. And we should be delighted by it.
Take a driver in the LA area—where I grew up—who has a typically long LA commute to work every day. Over the course of the year, he might save about $1000 due to cheaper gas prices. A lot of that money is going to go right back into the economy (and hopefully some of it saved for retirement).
We already know from past experience that tax cuts of this size have a measurable stimulative effect—and we shouldn’t look at this any differently. It means more cash in the pockets of consumers and lowered costs for businesses. And this isn’t just in the U.S., but all around the world.
Raghuram Rajan, the head of India’s central bank, told me he thinks that lower oil prices will increase Indian GDP by more than 1%. Earlier this month when I spoke to leaders in China, they were very enthusiastic about the positive impact of energy prices. This is particularly important given that a slowdown in China slowdown has been a major (if overblown) worry for markets over the past year.
Overall, it might prove to be one of the most significant redistributions of wealth we’ve seen in a century. (The less money you make, the larger the share of your income you spend on essentials like transportation.) That’s something we should welcome at a time when wages are stagnating and income inequality is continuing to increase.
Eventually, prices will equalize a bit: As higher-cost production methods like fracking feel the pressure from low prices, supply will start to slow and prices will rise marginally. But I think we’re likely to see sustained lower prices, in part because the technological transformations in the industry (which took the oil oligopoly by surprise) are here to stay, and are only going to become more efficient—more refined.
Of course, there’s always a catch—in this case, deflation. I spent last week in Davos, and one of the main concerns that we discussed was the risk of deflation, which was a key factor in the European Central Bank’s important decision to begin a robust asset purchase program.
I would call lower oil prices “good deflation”—they’ll help reduce the costs of things that consumers are somewhat locked into paying for, like the gas for their cars or the heat in their homes. But technology, particularly the “sharing economy,” can also help drive more traditional deflation, as it causes significant changes in behavior for consumers and capital expenditures for businesses. I’ll be discussing that more in my next post.
The opinions expressed are current as of January 2015, and are subject to change. Reliance upon information in this article is at the sole discretion of the reader.
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