WASHINGTON – U.S. forces have nearly taken Baghdad,
but the vengeful Saddam Hussein blows up his oil wells
and hits Tel Aviv with scud missiles, drawing Israel
and, in turn, Egypt and Syria into the conflict.
A full-blown Mideast war drives up oil prices to more
than $50 a barrel.
It’s a scenario few talk about, but it’s not beyond
the realm of possibility, analysts say. And it would
sink the U.S. economy, which is still recovering from
“If oil prices hit $50 a barrel, and they stay there
for a year, it would knock $100 billion out of
consumer disposable income, which would lead to a
double-dip recession,” said Douglas G. Duncan, chief
economist at Mortgage Bankers Association of America
here in Washington. In an interview yesterday, he said
that although he expects a short war, he cannot rule
out such a scenario.
Fifty-dollar crude would translate into gas prices of
$2-$3 a gallon at the pumps, Duncan explains, which
would raise the cost of commuting and travel and cut
into household budgets for entertainment and shopping.
Consumer spending accounts for about two-thirds of the
nation’s Gross Domestic Product.
At around $35 a barrel, crude is already trading at
historically high levels due to the anticipated war in
Iraq, which has the world’s second-largest proven oil
reserves behind Saudi Arabia.
Duncan says the business sector, thanks to recent
gains in productivity, is less exposed to oil-price
shocks than in the past, although higher fuel prices
would still increase the cost of transportation, along
with the cost of producing petroleum-based products.
“The business sector is tremendously more efficient,”
and can better absorb such energy shocks, he said,
citing recent research by the Dallas Federal Reserve
But another jump in prices at the pumps would amount
to a huge consumer “tax,” he said, and would come at a
time when consumer
confidence is already at its lowest level in a
However, economist Brian Wesbury of Griffin Kubik
Stephens & Thompson doubts that even higher oil prices
will tip the economy into a recession. Oil shocks have
occurred alongside previous recessions – including
the 1990-91 slump during the last Gulf war – but he
says tighter monetary policy actually caused the
recessions. And the central bank, which held interest
rates steady Tuesday, has been easing, not tightening,
Record-low mortgage rates have spurred growth in the
shaky recovery, boosting new-home construction to
all-time highs and fueling billions of dollars in
additional consumer spending through mortgage
refinancing. Refinancing puts more money in
homeowners’ pockets by reducing the size of their
monthly mortgage payments (even though they may also
have increased the size of their mortgages).
But Duncan says refinancings have peaked, and 30-year
mortgage rates have bottomed at about 5.6 percent.
Mortgage rates tend to track 10-year Treasury yields,
which appear to have bottomed this week. Duncan says
he refinanced his own home mortgage in November, and
again last week.
The last Gulf war in 1990-91 saw a temporary run-up in
rates as crude prices spiked.
“There was a little upward shift in interest rates,
but it went away quickly,” and rates fell back down,
Wesbury predicts interest rates will rise slowly in
the first half of this year.
“Our worst-case scenario puts the 30-year mortgage
rate near 7.5 percent,” he said, which he says would
still not be enough to kill the housing sector, which
has been the catalyst for overall economic growth.
Even if mortgage rates do not climb this time, pinched
consumers won’t likely be able to find relief from
refinancings in a worst-case environment of
$50-a-barrel oil prices, Duncan says.
“There would be little interest in the housing market
because of all the layoffs,” he said.
Housing prices would fall from softer demand, he
notes. To get more consumer-spending stimulus from
refinancings and equity loans, housing prices would
need to keep rising.
What’s more, layoffs would trigger mortgage
delinquencies, which are already on the rise due to
the jobs slump, and lead to foreclosures, Duncan says.
He says some needed stimulus could come in the form of
proposed accelerated cuts in marginal income-tax rates
and a proposed exclusion of corporate stock dividends
from individual taxable income. He estimates the White
House proposals would add 0.9 percentage point to real
GDP and a million new jobs.
Without it, however, the economic consequences of a
Mideast oil shock from a prolonged war would be dire,
even if Saudi Arabia honors its promise to keep its
oil taps open to help ease supply disruptions and
blunt price spikes. The U.S. economy is in a fragile
state, and the timing of the Bush administration’s
preemptive Gulf war couldn’t be worse, some economists
say. Consider the following:
- American households – more than half of whom now own
stocks, mainly through equity mutual funds – are in
the throes of the worst bear market since the Great
- Uncertainty over the war contributed to the economy’s
anemic 1.4 percent growth in the fourth quarter, a rate well
below historic standards for a recovery.
- Payrolls shed a surprising 308,000 jobs last month,
although the loss was due in part to called-up
reservists and delayed construction from snow storms.
- Retail sales plunged a breathtaking 1.6 percent last
month, three times larger than the consensus estimate,
though bad weather also was a factor.
- The dollar is down, and gold prices are way up.
- Normally the central bank might raise interest rates
to support the dollar, but it’s forced to keep rates
low to stimulate sagging consumer spending and avoid a
recession (the federal funds rate is already at its
lowest level since 1961).
- Inflationary pressures are on the rise, as seen in
recent jumps in prices at the wholesale level (the
Producer Price Index is up 2.8 percent on a
year-over-year basis, which is a dramatic reversal
from the 2.8 percent year-over-year decline reported
in January 2002, Wesbury points out).
- The federal budget deficit is approaching the record
high set during the last Bush administration, as the
White House and Congress have gone on a relatively
unchecked spending spree since the Sept. 11 attacks.
And now the projected billion-dollar-a-day Iraqi
invasion-cum-occupation will only widen the budget
- Soaring energy prices, loose monetary policy and
mushrooming government spending “is a recipe for
inflation,” Wesbury warned.
Duncan says the direction of the economy now depends
almost entirely on the outcome of the war in Iraq.
“The war is the biggest wild card,” he said.
If as expected the war is short, lasting just 60 days
or so, with a clear U.S. victory, few casualties and
no related terrorism, Duncan said consumer confidence
could rebound and “the business sector could come
He says businesses have held back on fixed business
investments because of uncertainty over the war.