$100 Oil

THE BE YOUR OWN ECONOMIST ® BLOG

Today was a good day. Congress reached – or is close to reaching – agreement on the financial-rescue package. Most observers believe implementation of the package will have a salutary effect on the credit markets.

Better still, oil closed at $108 a barrel. That’s above a recent low of around $90, but well below its all-time high of about $140. Say we’re in the $100 range. That’s good news, too.

Maybe and maybe not. Oil fell because recession is systematically and systemically reducing demand for most goods and services. This is especially true for industrial commodities such as oil. Demand for and the prices of materials such as ferrous and nonferrous metals, cement, chemicals, wood products, textiles and oil surge during business-cycle expansions and drop during the follow-up recessions. The prices of these goods, which have relatively little value added, fluctuate dramatically.

(The prices of raw materials, with little value added, fluctuate more than the prices of finished goods, with a great deal of value added, because the value added – chiefly wages – fluctuates little. Therefore, price volatility varies inversely the degree of processing.)

Oil’s decline is a good sign that inflation will abate. But it also signals a weaker economy ahead.

© 2008 Michael B. Lehmann