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Energy prices could drain energy out of the economy
By Barbara Hagenbaugh, USA TODAY
The U.S. economy has digested surging energy costs in the past few years with little more than a hiccup.
But now, some economists are warning, energy prices have gotten so high that the economy could lose steam. Not helping is the fact that the latest gains are coming as some economic cushions for consumers that have been in place for several years, such as a strong housing market, are slipping.
"At some point, we can't absorb it," National Association of Realtors chief economist David Lereah says. If oil prices stay at current levels, or go higher, "confidence is really going to come down. ... It is possible that this economy can get hit."
Oil prices in recent weeks have gushed to record levels, not adjusted for inflation, while the average price for regular gasoline is exceeding $3 a gallon in many parts of the USA. Gasoline prices have risen more than 40 cents in the last month.
In a USA TODAY survey of economists taken April 20 to 25, 40% said higher energy prices are the No. 1 risk for the economy. While other risks were cited, such as a decline in the housing market and terrorism, energy was the top concern.
Economists mentioned that higher energy prices pose potential troubles for both economic growth and inflation.
While none of the economists forecast a recession - or even a single quarter of declines in economic output - this year, some said higher energy costs might act as a significant drag and warned it could get worse.
"If (energy prices) were to go up significantly higher, then I think recession would get up on the screen," DuPont corporate economist Robert Shrouds says.
Retailer Wal-Mart estimates it will still see sales gains in coming months, compared with a year ago, but those increases will be smaller than they would be were it not for higher energy prices.
"It is presenting some difficulties for us," spokesman Marty Heires says. He notes that Wal-Mart is paying more in transportation costs, and its customers - many of whom are lower-income - are apt to buy less with gas costs higher.
For Sara Jones, owner of Fit for Moms, gas prices are a serious issue. She drives all over Columbus, Ohio, for her business, which provides in-home personal training for new mothers and moms-to-be.
"I live out of my car," says Jones, who fills up her Honda Element every other day. While she can't raise prices for current clients, she has increased fees for new clients - but some potential clients have balked at the added costs. She estimates her profits are taking a 10% to 15% hit because of higher gas prices.
"It's an endless cycle. I don't know what to do," she says.
Timing could spell trouble
Some economists, such as Richard DeKaser of National City and Tim McGee of U.S. Trust, say they're concerned. It's not just the level of energy costs that matters. The timing of the latest oil surge could spell trouble, particularly for consumers.
"A number of headwinds have come together at the same time to hit the consumer. The $3 a gallon gasoline is one more part of it," McGee says.
?Pre-summer. Rising gasoline prices are coming ahead of the busy summer driving season, not after, as they did last year, potentially causing more trouble for consumers and for the economy.
"We're not even in the peak driving season," Wachovia economist Jason Schenker says. "Imagine what it'll be like the Fourth of July weekend, or even Memorial Day."
?Housing. The housing market is slowing, reducing the so-called wealth effect from housing. Wealth effects can lead consumers to spend more, because they feel better financially when they see their neighbors' homes sell for a bundle - even if they don't plan to move.
A slower housing market also means fewer people are seeing big sales gains, money that can be spent. Refinancing has also slowed substantially. In recent years, cash-out refinancings, in which homeowners increase the amount of their mortgage and pocket the difference, have been a popular way of fueling consumption.
?Interest rates. The Federal Reserve has raised interest rates 15 times since June 2004 to the highest level in five years. That means consumers with adjustable-rate mortgages that are due to change, those with home equity lines of credit that are tied to the prime rate, and people with credit card debt are seeing their monthly bills rise. That makes it harder to pay for higher energy costs and to continue other spending.
Traditionally, higher energy costs have affected the economy in two ways. They slow the economy if consumers and businesses spend less money in the broad economy because they're forced to pay more money for energy. Rising energy prices can also feed inflation if businesses are able to pass along their rising costs to customers.
With inflation low and faith in the Federal Reserve strong, the bigger economic concern when it comes to higher energy prices in recent years has been related to economic growth.
In USA TODAY's quarterly survey of economists, 52% said higher energy prices would both lower economic growth and lead to rising inflation this year. Another 38% said energy costs would act solely as a drag on economic growth.
Healthy economic growth
In the last three years, oil prices have nearly tripled, and gasoline costs have nearly doubled. At the same time, the economy has grown at a healthy clip, and consumers, the lifeblood of the U.S. economy, have spent strongly.
"Consumer spending has remained relatively robust into 2006," says Michael Niemira, chief economist at the International Council of Shopping Centers.
Consumer confidence rose in April to the highest in nearly four years despite the increase in prices at the gas pump, according to the Conference Board. The Dow Jones industrial average is trading at a six-year high, and is less than 500 points from an all-time high, reflecting strong investor confidence.
David Wyss of Standard & Poor's and William Hummer of Wayne Hummer Investment point out that the increase in prices has evolved over a number of years, giving most consumers and businesses plenty of time to adjust their budgets to the higher costs.
"We have become somewhat inured," Hummer says, predicting the recent increase in energy costs will have little impact on the economy. "Companies and individuals have learned to live with this."
Says Jay Seven, a 51-year-old Los Angeles film industry technician, while putting a few dollars of gas into his Ford pickup: "It's happened for the past five summers. It's not new."
That doesn't mean higher energy costs are having no impact. In a recent survey of 1,000 adults conducted for ICSC and UBS Securities last week, more than half said they were decreasing their discretionary spending, which includes items that aren't must-haves, such as jewelry, electronics and meals out.
In a Gallup poll of 1,005 adults conducted April 10-13, 12% said energy costs were the most important financial problem facing their family. That was up from 8% two months earlier but still below the percentages recorded late last year.
Fed Chairman Ben Bernanke recently estimated that higher energy prices have reduced U.S. gross domestic product growth between half a percentage point and a full percentage point per year since late 2003, not enough to halt the economy entirely.
Less energy intensive
One of the main reasons higher energy prices have so far had only a minor impact is that the U.S. economy has become much less energy-intensive. It takes about half as much energy to produce a dollar of U.S. gross domestic product today as it did 50 years ago.
Plus, adjusted for inflation, oil prices are still $10 below the record high hit in January 1981, according to the Energy Department.
Some economists argue that in addition to consumers and businesses getting accustomed to the higher prices, the overall economy is strong and can withstand the rising energy costs. Illustrating that fact: Despite higher prices at the pump, gasoline demand is still up from a year ago.
Helping consumers face higher energy prices now is a strong job market. The unemployment rate is the lowest in 41/2 years. With the labor market so tight, wages are on the upswing, helping to offset the increase in energy costs, says Jeff Thredgold of Thredgold Economic Associates.
Average weekly earnings of non-supervisory workers were up 3.8% in March from the same month a year earlier, according to the Labor Department. Although much of the gain is being eaten up by rising prices for a number of goods, not just energy, the increase is larger than the 2.4% rise seen in March 2005 from March 2004.
"For a certain portion of the workforce, they do have to make discretionary choices if they are spending more on gas," Thredgold says. But, "for many people, it's just one of those minor irritations that we've come to expect."
Some economists, such as Lyle Gramley of Stanford Washington Research Group and David Huether of the National Association of Manufacturers, warn that strength in the economy means that a pass-through of higher energy prices into inflation is more likely as businesses have stronger pricing power. But the Federal Reserve said in a report out Wednesday that firms so far were having only "mixed success" when trying to raise prices to cover added costs.
Gains for some boost economy
It's also important to note that while many people lose when oil prices rise, many also gain, adding to the economy.
While it's well-known that oil companies are raking in record profits, other companies are also benefiting from higher energy prices.
Caterpillar, for example, reported record profits Monday for the first quarter. Profit-per-share rose 48% as demand for heavy equipment from a number of industries, including energy, rose.
Smaller companies are also benefiting.
Jennifer Boulden and Heather Stephenson launched Ideal Bite, a company that provides daily e-mail tips to subscribers about how to reduce energy consumption, in June. Subscriptions have increased about 20% each month, and now 40,000 people are signed up.
Although Ideal Bite is free for subscribers, advertisers pay based on the number of subscribers. More subscribers mean more money. Boulden credits higher energy prices for the firm's quick success.
Investors who own shares of natural resources funds, which invest part or all of their assets in oil-related stocks, are also enjoying a profit windfall. Through Monday, those funds were up more than 20% for the year, the best return among all domestic fund categories, according to Lipper.
An investor who bought shares of U.S. Global Investors Global Resources Fund in 2002 would have enjoyed annual gains of 17.8% in 2002, 99.6% in 2003, 30.4% in 2004, 49.0% in 2005 and almost 30% so far this year.
"Energy stocks have been on fire, and the big gains they've posted will more than offset what people (who own these stocks) have been paying at the pump," says Andy Brooks, head trader at money management firm T. Rowe Price.
"There is a circular flow to all this extra spending on energy," ClearView Economics President Ken Mayland says. "I tell people that if you worry about energy prices, buy some energy stocks."