The Fallacy Of The Positive Impact From Falling Oil Prices

“If you repeat a falsehood long enough, it will eventually be accepted as fact.”

In the financial markets, and economics, it is a common occurrence for the media and commentators to latch onto a statement which supports a cognitive bias. They then repeat that statement until it is a universally accepted truth.

When such a statement becomes universally accepted and unquestioned, well, that is when you should probably question it.”

Last week, I had a conversation with a friend of mine about the plunge in oil prices in recent weeks. One of the biggest fallacies about plunging oil prices, and subsequently lower gasoline prices, is that it is a huge windfall for consumers. Even President Trump stated as much last Wednesday morning. To wit:

But is that really the case?

Oil prices are indeed important to the overall economic equation and, as I showed recently, there is a correlation between the oil prices and inflation, and interest rates.

“Oil is a highly sensitive indicator relative to the expansion or contraction of the economy. Given that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness…the chart combines rates, inflation, and GDP into one composite indicator to provide a clearer comparison. One important note is that oil tends to trade along a pretty defined trend…until it doesn’t. Given that the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which have a negative impact on the manufacturing and CapEx spending inputs into the GDP calculation.”

“As such, it is not surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates.