Middle East crisis may leave world over an oil barrel

There are shades of the turmoil of the early 1970s in today’s inflation, financial instability and political chaos in Egypt For those with long enough memories, it all seems eerily familiar. Against a backdrop of already-rising inflation, the Middle East descends into chaos , sending the oil price surging and tipping the global economy into recession. Back in 1973-74, this is precisely what happened as a result of the Arab-Israeli war, via a boycott of the west by producers in the Opec cartel and a fourfold rise in the cost of crude oil. The crisis, though, had deeper roots: the inability of the US to anchor the international financial system, given the cost of the Vietnam war and Lyndon Johnson’s Great Society programmes, a steady increase in price pressures over the previous half-decade, and the easy availability of credit as politicians tried to keep the long post-war boom going. Not that difficult to read across from 1973-74 to 2010-11, is it? The period since 2007 has seen an international financial crisis which is, arguably, even more profound than the break-up of the Bretton Woods system in 1971. The US has been left severely impaired by military over-stretch and the bursting of its housing bubble. The flooding of the global economy with cheap money has hastened economic recovery, but at the cost of record food prices, copper at $10,000 a tonne, and Brent crude back above $100 a barrel. Now the dominoes are toppling across north Africa: yesterday Tunisia, today Egypt, tomorrow perhaps Algeria. The equally undemocratic regimes in the Middle East, sitting on a large chunk of global oil reserves, look on anxiously. Should history repeat itself, the result will initially be higher inflation as companies mark up prices and workers seek higher wages. This will be followed by deflation caused by a squeeze on corporate profitability and consumer real incomes from dearer food and energy, coupled with a tightening of monetary policy as central banks seek to bring inflation down again. Financial markets, it has to be said, appear remarkably relaxed about this Life on Mars scenario. Share prices are roaring away on the back of optimism about the growth prospects for the world’s two biggest economies, China and the US. Bond markets also seem to have shrugged off the risk that policy-makers may soon start to increase the cost of borrowing. This view of the world, however, is based on a series of assumptions, some more plausible than others. The first is that there will be a peaceful transition to democracy in Egypt. The second is that there will be no ripple effect across the oil-producing states of the Middle East. The third is that, even if the protests do spread to, say, Saudi Arabia, oil flows would be relatively unaffected. The fourth is that the global recovery is now robust enough to shrug off any local difficulties thrown up by events in north Africa and the Middle East. And finally, that rising commodity prices are a sign of a recovery that is starting to put down roots. Parts of this analysis ring true. Egypt in 2011 with Hosni Mubarak on his way out looks a lot different to Egypt in October 1973 with the Israeli army crossing the Suez canal. There is no inherent reason why a new government should adopt an anti-western stance, and in the longer term the transition to democracy across the region would add to geo-political stability. Nor is it inevitable that other regimes will crumble. High food prices and chronic levels of unemployment affecting a young population are as evident in Saudi Arabia as they are in Egypt, but high oil prices mean the government is rolling in money and would seek to buy off the dissent. Having said that, the Saudi King Abdullah’s description of the protesters in Egypt as “infiltrators who seek to destabilise their country” shows that the Saudis will offer stick as well as carrot should the calls for regime-change spread. The current situation in the Middle East is not anomalous to that in eastern Europe in 1989 (when Mikhail Gorbachev pulled the plug by withdrawing Soviet military support) but one lesson from the end of communism is that even the most stable-looking of regimes can topple quickly in the right circumstances. But for oil supplies to be seriously affected, the unrest would have to spread and lead to regimes willing to use their crude stocks for political purposes. There has been a spike in oil prices, but for the moment that is all it is. There are long-term reasons explaining high oil prices, but no obvious reason why events in Egypt should see the cost of crude approaching the record levels of almost $150 a barrel seen in 2008. But what’s “obvious” does not always matter that much in financial markets, where prices are influenced by waves of over-confidence interspersed with bouts of panic. At the moment, the mood is one of supreme optimism, marked not just by a willingness to shrug off events in Egypt but also to downplay evidence of overheating in Asia and the commodity speculation encouraged by the Federal Reserve’s cheap money policy. Ironically, this will lead to even higher oil prices and even dearer food, increasing the chances of an eventual hard landing. So where does this leave policy? Those pressing for monetary tightening argue that the lesson from 1973-74 is that once inflation becomes embedded it is awfully difficult to remove. Policy has been too loose for too long, they say. Doing nothing runs the risk of even more air being pumped into asset bubbles, which will eventually burst, leading to recession. Those arguing for policy to be left unchanged or loosened say that unions are much less powerful than in 1973 and cannot bid up the price of their labour in response to higher commodity prices. The rising cost of oil and food act in effect as a tax on consumers, they would argue, leading to deflationary pressures and eventually lower inflation. Tightening policy would simply turn a slowdown into recession, particularly in countries such as Britain, where high levels of personal debt mean individuals are vulnerable to higher interest rates. For the moment, interest rates are likely to be left unchanged but events in the Middle East have added to an already tricky policy dilemma. In truth, it is hard to see how this ends well. The reason oil is so expensive reflects what is going on in China and the US rather than Egypt and Tunisia, but we should still be concerned. Why? Because each of the four major recessions since the early 1970s have been preceded by a leap in oil prices. Crude facts Oil Economics Middle East Egypt Hosni Mubarak Inflation Larry Elliott guardian.co.uk

Posted by on February 7, 2011. Filed under News, Politics, World News. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry