The Bernanke finesse

Oil figured prominently in the important June 7 speech during which Federal Reserve Chairman Ben Bernanke offered a somber economic outlook while finessing a central question about fiscal policy. His comments left a wake sure to rock the oil and gas industry.

At a conference in Atlanta, Bernanke regretted failure of the US economy so far this year to grow at expected rates and “a loss of momentum in the labor market in recent weeks.” As effects of the Japanese disaster on manufacturing fade, “and with some moderation in gasoline prices in prospect,” the Fed chairman said, “growth seems likely to pick up somewhat in the second half of the year.”

Pricing primer

Having placed gasoline prices at the center of economic hope, Bernanke offered a primer on commodity pricing. He pointed out that the price of gasoline largely tracks that of crude oil and said, “With the demand for oil rising rapidly and the supply of crude stagnant, increases in oil prices are hardly a puzzle.”

The explanation nicely responds to populist idiocy about victimization of consumers by oil companies and the supposedly derivative need to replace oil with energy vastly more expensive and less abundant.

But what about the serious analysts for whom changes in market fundamentals don’t fully explain recent crude-price gyrations? The Fed chief anticipated objections from that camp by challenging a reason often given for crude oil prices higher than what supply and demand seem to warrant: dollar weakness.

In this view, commodities recently have come to be traded as an asset class, stimulating oil-dollar arbitrage and making crude oil prices sensitive to currency markets. A weakened dollar thus strengthens crude prices—a pattern frequently but not consistently evident over the past few years.

Bernanke will have little of this. Acknowledging criticism of Federal Reserve efforts to keep interest rates low to encourage spending and investment—and the dollar consequently weak against foreign currencies—he said crude oil prices have increased proportionately by far more than the foreign-exchange value of the dollar has fallen. So no one should blame the Fed for painfully high gasoline prices. Bernanke’s words probably will not prove to have been the last ever uttered on this subject.

More important for the oil and gas industry was the Fed chairman’s warning against “a sharp fiscal consolidation focused on the very near term,” which he said could “undercut the still-fragile recovery.” With that he dodged a searing political issue crucial both to general elections next year and to an industry uniquely targeted for sharp tax hikes.

The industry should welcome Bernanke’s caution against abrupt fiscal adjustment, which almost certainly would include higher tax rates. But it should worry about his implication that the barely recovering US economy drifts in some delicate condition that mustn’t be disturbed.

Two experiments

In fact, the economy squirms under the pressure of two grand experiments undertaken after the financial collapse of 2008. One tests the perverse hypothesis that the government creates jobs and other economic goodness by spending money as fast as it can. The other tests the supposition that regulators make economic decisions superior to those made by people acting in their own interests.

The results of those experiments so far: unprecedented national debt with its looming threat of increased taxation, stubbornly high unemployment, work stifled if not stymied by bureaucracy, and reluctance of investors to place capital at risk.

These problems, which hit the oil and gas industry especially hard, carry political weight that keep them mostly out of a US central banker’s realm. But they dissolve the basis for any suggestion about hewing to the current course.

The US economy isn’t just struggling to recover from recession; it’s wondering what comes next in an historic spree of federal spending and regulation. Under these conditions, “fragile” doesn’t do justice to economic recovery or evoke sufficient response.

A better word, and one a central banker can’t ignore, would be “unsustainable.”

Oil Gas Journal