Oil May Be Spike in Economy's Heart

www.thestreet.com By Rebecca Byrne Staff Reporter 02/13/2003 11:40 AM EST

Not long ago, all but the most fanatical bears on Wall Street scoffed at the idea of a double-dip recession. But after a recent surge in oil prices, no one is laughing any more.

Over the last three months, crude oil has risen 44% to its highest level in more than two years amid concern about a war with Iraq, and as a strike in Venezuela reduced supplies from the world's fifth-biggest exporter. Meanwhile, retail gasoline has jumped to $1.60 a gallon -- the highest level since June 2001.

Because energy costs essentially act as a tax on consumers, economists worry that this recent increase could force consumers to tighten their purse strings. That could be devastating to the economy because consumer spending accounts for two-thirds of gross domestic product.

"It seems pretty clear to us that we are experiencing an old-fashioned oil shock," said Merrill Lynch chief U.S. strategist Richard Bernstein. "Nothing destroys consumer purchasing power as effectively."

Bernstein said that every significant oil shock in the last 30 years has caused, or at least contributed to, a recession, and he believes the odds of the same thing happening this time round are "starting to increase significantly."

Already, higher energy prices have had a significant effect on real wage growth, and hence, spending. Although real wages have been steadily increasing for almost 10 years, the rate of increase has slowed sharply since January 2002. Wages grew at a sluggish 0.5% in December, according to Bernstein, and economists say the weakness continued into 2003. In fact, the month-to-month increase in average hourly earnings grew in January at the slowest pace in 10 years.

Real wages are defined as average hourly earnings minus inflation. If inflation goes up because workers have to pay more for energy, then their salaries are effectively being reduced. And lower wages usually lead to lower spending. On Thursday, the Commerce Department said retail sales fell more than expected in January, although sales excluding autos were up a respectable 1.3%.