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Using an Appropriate Deflator When Calculating Oil Prices

On Economist.com's site in their fee-based premium area, there is an article comparing the current oil crisis to the ones in 1973-74, 1978-80 and 1989-90. Essentially, it is an analysis of why we haven't experienced the recession as we did those other occasions. There are some good points made; however I believe the recession is still coming. In fact, their prime explanation agrees with the general opinion presented in the book The Oil Factor, by Donna & Stephen Leeb. The thought is that while oil has tripled in price over the past 4 years, that it has been gradual enough to prevent a recession. In fact, the Leeb book suggests that oil needs to rise over 80% in 12 months time in order to facilitate a recession.

On August 31st, 2004... Light Sweet Crude Oil closed at $42.12. A year later, it closed at $68.94. That is up about 64%. It won't take much to push the 12 month increase above the 80% threshold. There is another thing to note that the article nor the book mentioned. What are the effects of a sustained high increase in energy costs? Annual increase of 50% or more has been the norm the past few years, it may be possible that such a sustained rise in prices could facilitate a recession without hitting the 80% mark.

But what I found most interesting in the article, was the discussion on which deflator to use when comparing oil to historical prices. People who are skeptical of the Peak Oil crisis are quick to point out that oil is cheaper than it was in the 70's crisis when adjusted for inflation. This fact is arrived at by using the American Consumer Price Inflation data. The Economist article speaks of 2 other deflators, both of which they argue are more realistic. If you use the American Producer prices data, we are equal to the highs set in the 70's. Furthermore, if you use World Export prices, which they argue are most appropriate to use, we have far exceeded the prices set in the 70's.

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