Libya gives world economy needed break

August 23, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

For Libyans the fall of Muammar Gaddafi comes about 40 years too late, but from the point of view of the global economy it is not a moment too soon.

The apparent end of the reign of Gaddafi, whose whereabouts were unknown on Monday after rebels took Tripoli, will take pressure off of the price of energy, especially in hard-hit parts of southern Europe, and thus ultimately may remove roadblocks to further easing by either the European Central Bank or Federal Reserve.

Brent crude futures, the key European measure, fell by as much as 3 percent on Monday following the taking of Tripoli by Libyan rebels before settling about 1 percent down, while the U.S. measure rose about a third of a percent.

Libya accounts for about 2 percent of global oil production and in particular has supplied much of the oil consumed in Italy. While experts caution that it may take some time to restore production and exports, the nightmare option of mass sabotage by the falling regime now seems unlikely. Regime change also opens up the possibility that production and exploration in Libya are more competently and aggressively pursued than they had been. Corruption and kickbacks are rife in Libya, and while that may or may not improve, if it does, look for production figures to improve over the longer term.

Lower energy prices are an unalloyed good at this point for the global economy. High gasoline and heating costs act as a brake on consumer demand, something the hard-hit southern euro zone nations can ill afford as they descend into a vicious cycle of austerity and economic contraction.

To be sure, the impact of Libya, even at best, will be small, especially considering the fundamental challenges facing the global economy. Lower gas prices will help consumers in Milan and Little Rock, but it does nothing to improve the equity positions of banks in Italy, and precious little to underpin house prices in the U.S.

That said, it is about time the global economy caught a break, and if this is the one it is going to get, well, things could be worse.


With any luck, falling energy prices will give the European Central Bank reason, or at least plausible cover, to reverse their disastrous recent hikes in interest rates. The ECB has hiked key rates twice since April, by a total of a half a percentage point to 1.5 percent. That, simply, is exactly the last thing the euro zone needs as half of it slides into recession and the other half considers if it wants to pick up the check or run for the exit.

At its last interest-rate-setting meeting two weeks ago, the ECB said risks to inflation were still to the upside and that the risks to the economy were balanced, indicating that it was at that time considering yet another increase. Rising oil, gas and electricity prices have contributed strongly to inflation in key measures considered by the ECB, so a reversal would allow the hawks to side with the few doves.

Even if the ECB does nothing, and given their track record that is perhaps the most likely outcome, lower energy prices will help consumption, especially in Italy, and will, at the margins, help to make uncompetitive southern European industries a bit better able to win business internationally.

Again, energy will do nothing to help the banking industry, nor to smooth the path towards fiscal union.

In the U.S., the effects of a new Libya will be less, but even there it will perhaps make the Fed’s position slightly easier.While the Fed concentrates on core inflation, which does not include energy prices, energy costs obviously have a strong impact on inflation over time, and on inflation expectations, which often look through the core figures to focus on the actual out-of-pocket pain at the pumps.

If energy prices fall and the fall is sustained, that will remove one argument against making some new attempt at easing monetary conditions, perhaps even by a third round of quantitative easing.

That said, it is unclear if QE3 will come to pass even if oil drops dramatically, and even less clear if it would be a good idea under any circumstances.

There is still strong internal and political opposition to QE, and for that to be resolved the Fed may need to see a continuing weakening in the economy and employment. At any rate, QE has a poor record of helping anything other than risk assets, and those temporarily.

And of course, the ultimate irony is that should the Fed get radical again by buying up bonds, that in itself will likely fuel a rally in oil which may undermine much of the benefit. That’s what happened last time, after all.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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I don’t see any real energy price break in the offing. Libya won’t stabilize very soon, and its oil output won’t reach former levels for some time. Plus, other destabilizing factors (Syria and Iran) are coming more and more into play too.

The Fed is strategically arrogant and bone-headed, so why should we expect common sense and wisdom now? I’d say its policies are going to be even more inflationary going forward. So oil is going to soon resume its climb, as will gold.

I think oil’s price is only taking a brief respite. The economies of the developed world are in desperately serious trouble on a strategic basis. We’ve mostly done it to ourselves. No quick fixes now. Just have to ride it out and hope the Fed and ECB et al play less stupid rather than more stupid.

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