Oil Shocks Affect World Trade

Macroeconomists say that since the mid-1970s major oil price increases have had a lesser impact. Yet sharp rises in oil prices have preceded 8 of the past 9 recessions.

It should be no wonder that many countries are agressively looking for alternative fuels.

For example, Norwegian oil company Norsk Hydro ASA and paper maker Norske Skog ASA are exploring ways to produce biodiesel from wood. Biodiesel can already be made mainly from vegetable oil.

In our article Moonshine Fuel Replaces Oil we learn about one major South American country that has successfully introduced an alternative to gasoline.

But we shouldn't let our idealistic quest for alternative fuels get ahead of what's real now that oil prices have skyrocketed.

This weekend I went on a cruise of Toronto's harbourfront. The tour guide mentioned that the CN Tower, the world's tallest building at 1815.5 feet, sometimes sways 3 feet in either direction in a storm. Also, the tower is hit by lightning hundreds of times each year. However, that doesn't mean that the CN Tower will topple over any time soon. Most of the concrete in the tower is below ground level, which provides substantial support for the vast majority of stresses that hit above ground.

The same idea applies for replacing oil. Too many countries have invested too much in their oil industries for us to expect an overnight switch to more environmentally friendly fuels.

Think of car manufacturers whose vehicles are designed to run principally on gas. And the manufacturing processes that are fuelled by oil products. How expensive would it be to switch to an alternative fuel source? Probably exponentially expensive not to mention disruptive to the world economy.

The bottom-line on oil is that it does not by itself cause recessions. Rather it is the monetary policies that accompany oil price shocks that lead to substantial slowdowns in economic activity.

Don't just keep your eye on the gas gauge when evaluating the effects of oil and gas prices. Instead pay close attention to the rate and frequency of accompanying interest rate increases that can and probably will cause a global recession starting later this year.

And don't forget the winners, specifically the oil-exporting countries with deep reserves that we discussed in our article Top Ten Oil Countries.