G8 caution, oil price optimism grows

The downbeat closing statement from the finance ministers of the G8 countries yesterday is a reminder that financial markets have gotten rather ahead of reality in terms of pricing in a global recovery.

After an unprecedented collapse in global trade – which might be bottoming out but is far from over – ‘the situation remains uncertain and significant risks remain to economic and financial stability’.

You do not need to look far for these significant risks from banking problems in Eastern Europe to nervous bond markets and to the rising price of oil.

Oil price optimism

Goldman Sachs, whose analysts correctly forecast the $150 price spike seen last summer, is now predicting a four-stage oil price increase with an average price of $95 for the second half of 2010. There is no talk of a price set back over the summer before oil starts a new bull market, it is already here.

Other forecasters reckon prices will hit double digits by the end of this year amid a general commodities rally that will also take the gold price beyond $1,500. Gold and oil generally rise together as the US dollar falls.

The Goldman Sachs’ argument is that the ‘recent oil price rally was driven by credit normalization and the market has not yet priced in economic recovery’. The money supply being pumped into the global economy is easing credit and will now facilitate some degree of economic recovery.

Now this is all very well but also largely self-defeating for global economic recovery. A higher oil price is a tax on consumers and industry to the benefit of the oil producer nations. It is a negative and not a positive for global economic recovery.

Hence, the G8 finance ministers’ caution perhaps. This oil scenario does look a repeat of the 1970s and stagflation when rising oil prices carried a high cost in terms of higher consumer price inflation and higher interest rates. Stagflation is higher inflation and low growth.

Regional pain

What would this mean for the Middle East? It clearly has to be positive after the economic slump that followed the oil price crash last autumn.

However, the oil price boom of the 2000s created a major bubble in key regional economies that has now burst, and that has left a trail of financially stretched companies, half completed projects and a property oversupply.

This will not be righted quickly, and banks will probably pull the plug on indebted groups as the upturn will allow them to recover some of their lost money in asset sales. That might make a recovery feel like a recession for sometime to come.