If oil is “just another commodity,” then there shouldn’t be any connection between oil prices, debt levels, interest rates, and total rates of return. But there clearly is a connection.
On one hand, spikes in oil prices are connected with recessions. According to economist James Hamilton, ten out of eleven post-World War II recessions have been associated with spikes in oil prices. There also is a logical reason for oil price spikes to be associated with recession: oil is used in making and transporting food, and in commuting to work. These are necessities for most people. If these costs rise, there is a need to cut back on non-essential goods, leading to layoffs in discretionary sectors, and thus recession.
- The amount it costs to extract the oil or copper (including taxes, shipping costs, and other indirect costs), and
- The selling price for the commodity. The selling price reflects the customers’ ability topay for the product, based on wages and debt availability. It also reflects other issues, such as the availability of cheaper substitutes.
- They make the monthly payments for a new home or new car higher, reducing the sales of both
- They reduce the sales price of existing bonds (carried on the books of banks, pension funds, and insurance companies)
- They likely will reduce stock market prices, because bonds will look like they will yield better in comparison.
- Also, the country will be shifted into recession, and lower stock prices will result based on the apparently worse prospects of most companies.
- The resale value of homes will likely drop, because fewer people will be in the market for a move-up home.
- The US government will need to pay higher interest on its debt, necessitating a rise in taxes, further pushing the country toward recession.
- With higher taxes and more layoffs, there will be more defaults on debts of all kinds. Banks, insurance companies, and pension plans will be especially affected. Many will need to be bailed out, but it will be increasingly difficult to do so.