Oil, Crisis and Recession

December 16, 1990

Even before Iraq's invasion of Kuwait on Aug. 2, the U.S. economy was heading into recession. Even if war can be avoided, with Iraqi and Kuwaiti oil production moving again to market, the recession will still have to run its course.

Yes, the post-invasion spike in oil prices to $41 a barrel hastened the downturn. And, yes, oil prices are poised to plummet below the pre-invasion price of $21 a barrel if some kind of a peace settlement emerges, thus giving the U.S. economy some cushion. But this would be no panacea. Despite a recent downward drift in oil prices to the $27 level, as world oil supplies recovered, the U.S. economy remains mired in profound problems that cannot be corrected quickly.

According to Paul W. Boltz, chief economist for T. Rowe Price Associates of Baltimore, "we have gone too far to avoid a recession." Business plans have been curtailed; layoffs are under way; inventories are being pared. Fourth quarter growth will be negative, with every expectation that the first quarter of 1991 will produce similar bleak results.

Because the Federal Reserve Board continued to ease monetary policy even before the downturn was fully upon us, Mr. Boltz believes the recession will be relatively mild and short-lived. Obviously, a peaceful settlement in the Gulf and a fall in oil prices would reinforce his scenario. But just as obviously, an outbreak of war, with oil at unprecedented levels, would prolong the doldrums.

So there are profound economic consequences in the outcome of the diplomatic maneuvers now going on between Washington and Baghdad.

Saddam Hussein's biggest complaint, before he gobbled up his small neighbor, was that Kuwait and other Persian Gulf states were ignoring OPEC production quotas and pushing oil prices down to a level that complicated Iraq's recovery from its debilitating war with Iran.

Today, the Iraqi economy is a shambles. Its oil facilities are shut down, not earning a dime. It faces a crisis outcome in which either its oil fields are hobbled by war, or oil prices drop below the pre-invasion level with peace, or its current enemy, Saudi Arabia, cooperates in stabilizing prices around a $20 level. If Saddam saves more than face, his gains will be political -- not economic.

Much the same can be said about President Bush. If he succeeds in keeping together an international coalition that gets Iraq out of Kuwait and gives pause to other would-be aggressors, he will have succeeded in political terms. But even the most favorable peaceful solution would leave the U.S. economy burdened by the multi-billion-dollar costs of Operation Desert Shield and recent high-priced oil purchases. If he is to achieve any lasting economic gains out of all this, it would have to be in terms of a new U.S. energy policy that both protects the environment and makes the United States less dependent on foreign oil.

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