LONDON – Violent swings in oil prices are destabilizing economies and financial markets worldwide. When the oil price halved last year, from $110 to $55 a barrel, the cause was obvious: Saudi Arabia’s decision to increase its share of the global oil market by expanding production. But what accounts for the further plunge in oil prices in the last few weeks – to lows last seen in the immediate aftermath of the 2008 global financial crisis – and how will it affect the world economy?
The standard explanation is weak Chinese demand, with the oil-price collapse widely regarded as a portent of recession, either in China or for the entire global economy. But this is almost certainly wrong, even though it seems to be confirmed by the tight correlation between oil and equity markets, which have fallen to their lowest levels since 2009 not only in China, but also in Europe and most emerging economies.
The predictive significance of oil prices is indeed impressive, but only as a contrary indicator: Falling oil prices have never correctly predicted an economic downturn. On all recent occasions when the price of oil was halved – 1982-1983, 1985-1986, 1992-1993, 1997-1998, and 2001-2002 – faster global growth followed.
Conversely, every global recession in the past 50 years has been preceded by a sharp increase in oil prices. Most recently, the price of oil almost tripled, from $50 to $140, in the year leading up to the 2008 crash; it then plunged to $40 in the six months immediately before the economic recovery that started in April 2009.