Nothing new under the sun

Twenty-six years ago the Organisation of Petroleum Exporting Countries – the oil producers cartel – used its market dominance to push the price of oil up in what became known as the Arab Oil Crisis. In the same year, John Howard entered Federal Parliament, and Gough Whitlam won his second election. The economy was booming. The next year the economy crashed and Gough Whitlam was swept from power by a combination of factors including an increase in interest rates partially caused by an increase in the oil price. Is history about to repeat itself, but this time tipping John Howard from office?

The stock market suggests not, at least as far as oil prices staying high is concerned. A quick examination of its entrails says that the price of oil will come back down shortly. 12 months ago the Energy Index stood at 1409.1. As I write it is around 1600. Hardly the sign of a sector expecting booming and sustained price rises. But if the stockmarket is always right, how is it Kerry Packer is so rich? What do other indicators suggest?

Yesterday I received a pamphlett from my local member encouraging me to protest about the price of petrol by going to www.qld.gov.au/petrolpricewatch, an indication of what focus groups are saying. In Europe protestors against high prices are blocking fuel shipments, while Tony Blair has the army on standby. Meanwhile a few months ago prominent US economist Paul Krugman posted an article to his web site suggesting that oil prices may stay up due to "multiple points of equilibria". The intellectual market place suggests that the stockmarket may well be wrong. (Counter to that, I have not yet heard that sales of gas-guzzling automobiles have dried up, as they did in the '70s.)

The stock political response around the world, including Australia, suggests that most ruling politicians are surprised by the extent of the rise and expect the price to retreat. Their response is reactive and does not seek to put the issue in context. This allows it to be defined by their opponents in terms of something else. In Australia’s case, that something else is the GST. By taking that line they are leaving themselves open to damage if the price does not subside, and they miss out on much of the upside if it does. In Australia’s case, the same is true for the Opposition – they are missing the opportunity to exploit the full possibilities of the issue.

In the long term, oil will be more expensive. The WTGR Economics graph shows that oil is almost unique among commodities. Measured in constant 1996 $US it is actually more expensive now than in 1947. In fact, the average is $19.27 US - higher than it was late last year. This points to a commodity that is in relatively short supply. In the 1970s Malcolm Fraser didn’t have a problem handling the politics of the oil price rise. There was an easy enemy to identify – the OPEC cartel, frequently described, xenophobically and inaccurately, as the Arabs – and there was the larger issue of conservation. While OPEC is again copping the blame, it is that last issue that provides the opportunities.

In all the demonstrations and discussions at the World Economic Forum in Spetember, no-one mentioned the real danger of globalisation. That by increasing world living standards, and promoting Third World Nations into the First World, food and energy resources will become scarcer sooner. If every Chinese were to drive a Landcruiser, there simply wouldn’t be enough diesel to go around. Someone would have to go without. The demonstrations we have seen are nothing to what will occur when this happens. There is an urgent need to find alternative sources of fuel. Economics says that as the price of one commodity rises, alternatives will be substituted as they become relatively cheaper. If we are going to find alternative energy sources, then in a market economy, we need the price of oil to go up. This is the first reality that a responsible Government and Opposition should agree on.

It needs to be pointed out, to Australians at least, that we have gone to sleep on the job. In real terms the price of oil is lower than it was 14 years ago, and we have gone back to driving larger cars and taking Sunday drives as a cheap form of entertainment. That was never going to last. More than that, we need to declare war on our reliance on expensive fossil fuels – a better and more honest mark than OPEC.

It is in the government’s interest to frame the debate in these terms because they also have a major problem in selling the practical outcomes of the Kyoto agreement. They need to engender a feeling of urgency in the community, and the oil price rise gives them that opportunity. As conservation issues tend to favour the Opposition, there is also mileage for them in taking this line and criticising the Government for doing too little, too late. Rather than spending some of the increased tax revenue on roads, which will encourage petrol consumption and further increase the price, it could be argued it should be spent on research and development of substitutes.

At the moment the ALP is running on the circumstantial link between the introduction of the GST and the rise in the price of petrol. This is a dangerous game. An enquiry into the price of petrol has got to be on a par with an inquiry into the tide height at the Brisbane Bar – a point the Government will surely make when the Olympic party is over in Sydney.

There is another argument the Government needs to win, and that is the argument that they must have with the Reserve Bank. The last oil crisis saw the world caught in stagflation - inflation coupled with low growth. Australia suffered worse than most other countries thanks to the antics of the Whitlam government, which threw fire on the petrol by embarking on rampant deficit budgeting at the same time as it boosted domestic incomes, and frightened off overseas financiers. The result was tight monetary policy that eventually drove the economy into the ground.

This time things are different, but the RBA needs to make sure that its reflex is not the same. While we have loose monetary policy, it is nowhere near as loose as it was under Whitlam. The wage system is also far more decentralised, and therefore less prone to institutionalised break-outs. Wages have also been tamed by the progressive dismantling of tariff barriers (a process ironically kick-started by Whitlam). Now, if a worker down the road can’t be found to produce at a reasonable price, there is another in the intermediate geographical vicinity, like Fiji, Indonesia or China, who will.

True, domestic economic activity is strong, bloated by Olympic and infrastructure expenditure, and the low Aussie dollar, but the capacity restraints are lower than they were in the 70s so this is less of a risk.

While the high price of oil is on one hand inflationary, on the other it is potentially deflationary. It is a question as to how its increase in price is handled. Central Banks exert power through the monetary system, but money is just a commodity with some unique features. The reason that it is potent in terms of managing the economy is that it is involved in almost all transactions, but then, so is fuel. Probably more so, because the increase in the price of a commodity such as money affects large borrowers, like business and new home-buyers, more than any other category, while practically everyone is touched by the price of oil. The increase in the price of an input like oil will be just as effective as the increase in the price of another input like money if all other things are able to be kept the same. An open economy ensures that most other things can be kept the same.

However, oil has a further advantage over money – it has in-built fiscal stabilisers that will slow the economy without the need of interest rates, actually allowing rates to drop. As the price of Australian petrol is almost 50% tax, any increase has a bearing on fiscal policy. Higher oil equals higher taxes, equals higher national savings, as long as the government does not cave in to demands to spend it. That is not to argue that tight monetary policy is the solution to this problem, just that it actually delivers the Reserve a fiscal tool that it can use.

If the government does not win that argument, it will face an election in twelve months time with high interest rates, a plunging stockmarket and employment growth heading in the wrong direction. This is bad news for a government that will be relying on its record as a good economic manager more than anything else for its re-election.

If the Opposition does not take a responsible course on the issue, it risks being in government in 12 months time with no credible basis for dealing with a problem that may still be around.

No wonder John Howard has been talking about retiring. He has been in politics long enough to have seen most of it before. In this instance that should give him an edge.