It’s like something out of a cheesy disaster movie. Just when we thought all was lost, and the Western world was going to be consumed by recession, the mighty US market drags itself back to its feet. The Dow Jones jumped by more than 300 points on Friday.

The rebound was driven by a slump in crude oil prices (partly down to a leap in the dollar), which has pundits on both sides of the Atlantic getting excited. Lower oil prices, means lower inflation, which means lower interest rates, they argue. And it also reduces one of the pressures on consumer spending.

So can the collapse in oil prices save the economy from recession? Sadly not. The rising oil price was a symptom, not a cause, of the unchecked global boom that lead us here. And the fact that it’s falling now is merely a sign that we’re already in the grip of a huge downturn…

Why falling oil prices won’t save the economy from recession

The main reason why falling oil prices won’t save the global economy is that high oil prices were never the problem in the first place.

Oil prices rose for many reasons. Pure demand was one reason, as more and more people used less and less energy-efficient cars, more people took flights, more industries were set up, more goods were made, etc.

Supply was another, as low oil prices meant that oil companies didn’t invest in finding more. That means it takes a while to catch up by the time prices have shot up far enough to encourage new investment.

And speculation has definitely played a role. The jury is out on the precise mechanism by which pure investment money has had an impact on oil prices, but it seems madness to suggest that you can pump all those extra billions into a market without having some effect on it.

At least two of these factors – demand, and speculation – have been driven to a greater or lesser extent by the availability of cheap money. Commodities have been turned into consumer goods in the East, which were then bought with borrowed money by the West. The East then used this money to build more factories to make more consumer goods, which the West then bought with more borrowed money, much of which also came from the East.

But the days of cheap money are gone. And so it seems, are the days of rocketing oil prices. A barrel of crude is trading below $120 now, after peaking at just above $147 earlier in the year.

None of the central banks is serious about fighting inflation

Now what’s the good news? Well, a fall in the oil price might help to prevent the inflation problem from growing any worse, certainly. That’ll allow central banks to cut interest rates, say the pundits, and we can then set the whole ball rolling again.

But the idea that central banks even care about inflation is a farce. The European Central Bank puts up the best front of all the major central banks, but none of them is serious about fighting inflation.

For example, by holding the base interest rate at 5%, while inflation keeps rising, the Bank of England has been allowing real interest rates to fall for months now. If Consumer Price Index inflation hits 5% as many analysts believe it will by the end of the year, we’ll have our very own zero interest rate policy here in the UK.

Meanwhile, in the States, the Federal Reserve has already slashed nominal interest rates to 2%, which means that real interest rates have been negative for some time (headline annual CPI inflation in the US is standing at 5%). So central banks have been doing as much as they can to loosen monetary policy – yet it hasn’t helped matters.

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Source: The Slump in Oil Prices is a Bad Sign