NEW YORK (CNN/Money) -
Though oil prices are at fresh 13-year highs, many analysts are preaching calm, saying the U.S. economy and stock prices can withstand the surge -- though inflation could be more of a headache than ever.
On Wednesday, a barrel of crude oil for June delivery was fetching more than $40 on the NYMEX, the highest level since October 1990, when Saddam Hussein invaded Kuwait.
Ugly images from Iraq -- including abuses of Iraqi prisoners and the beheading of a U.S. citizen -- and recent terror attacks in Saudi Arabia, the world's top oil exporter, have raised fears that spreading violence in the Middle East could disrupt the flow of oil to the rest of the world.
Wednesday's surge pushed U.S. stock prices sharply lower, as traders remembered the economic havoc high oil prices have wreaked in previous decades.
"Investors have a long memory -- in those cases where we've had major oil shocks, overall demand has dried up," said Michael Carty, stock market strategist at New Millennium Advisors. "People are looking towards and fearing a slow-growth, inflationary environment -- stagflation."
Since the 1970s, with just one exception, whenever oil has spiked, the economy has fallen into a recession:
- The 1973 Arab oil embargo nearly tripled oil prices, and a recession followed in 1973-1975.
- The 1979 Iranian revolution and the subsequent war with Iraq more than doubled oil prices, and recessions followed in 1980 and again in 1981-1982.
- Saddam's invasion of Kuwait in 1990 was followed by another recession in 1990-1991.
- A spike in oil prices in 2000 was followed by another recession in 2001.
- No recession followed the jump in oil prices at the beginning of the Iraq war in 2003, but economic growth was sluggish.
Meanwhile, gasoline prices continue to hit record highs and will likely hit an average of $2.03 a gallon in the United States this summer, according to the government.
Since most U.S. consumers, whose spending fuels more than two-thirds of U.S. gross domestic product (GDP), don't have much choice but to fill their tanks, higher gas prices could slow other purchases, putting a drag on the economy. And higher oil prices put a sort of tax on all businesses that use oil -- which is to say, all businesses, pretty much.
"When combined with the increase in long-term interest rates that has already occurred since their recent lows of mid-March, this could be enough to slow the nascent pickup in economic activity over the balance of this year," Hofstra economics professor Irwin Kellner wrote in an article posted at Economy.com last week.
Some silver linings
Still, oil's current price is far lower, in inflation-adjusted dollars, than during past spikes.
And oil prices aren't that much higher than they were a year ago. In fact, they've been relatively high for some time, and many economists believe the economy can adjust more easily to steady increases as opposed to sudden shocks.
"It's a moderate economic headwind," said Jan Hatzius, senior economist at Goldman Sachs. "It takes a couple of percentage points off of the GDP growth rate, but it's not the sort of oil shock that would be required for a much more significant slowdown."
In addition, the economy is in different shape now than it was in, say, 2000, when the late-1990s economic boom was winding down. A surge in oil prices then helped push the economy into a recession.
Now, the U.S. job market seems to be in the middle of a turnaround, and many of the world's major economies are strengthening.
"Four years ago, the economy was in a very vulnerable state," said Anirvan Banerji, director of research at the Economic Cycle Research Institute, a private firm that publishes its own monthly inflation gauge. "Right now, the economy's window of vulnerability has slammed shut. Even though oil prices might have some impact on consumer spending, it's not likely to trigger a new downturn."
Inflation still a problem
But higher oil prices will also add to the inflationary forces gathering in the world's economies, which could fuel uncomfortable price gains and eventually inspire the Federal Reserve and other central banks to raise interest rates more quickly.
"Up until recently, oil price hikes have offset disinflation. This time around, we're in a situation where inflation is starting to peek its head above the parapet, and policy makers will see it more as an inflation threat," said Alan Ruskin, research director at 4CAST Ltd., a market and economics research firm. "That's problematic -- if they have to start reacting to higher inflation pressures by raising rates, that does slow the economy down."
So far, the Fed and most other U.S. economists have been mainly watching labor costs, which make up the majority of production costs for U.S. firms. A weak labor market and sluggish wage growth have kept those costs down in recent years, making many economists fairly sanguine about inflation.
But some analysts think their colleagues may risk being blindsided by a surge in oil and raw materials prices, which are much bigger factors than labor costs for firms in China, India and other developing nations -- where many of the goods Americans consume are made.
Of course, there's always the possibility that oil prices will fall soon. Though there's rampant fear that oil supply is tight and that violence in Iraq and elsewhere in the Middle East could make it tighter still, some analysts doubt that market fundamentals support such high prices.
"Oil prices have been exceeding the most bullish forecasts for the past year and a half, and that's not driven by industry fundamentals, but largely by speculation and fears of a potential supply disruption," said Fadel Gheit, oil analyst at Oppenheimer & Co.
That sounds a lot to Gheit like a bubble -- one that will pop, though there's no telling when.
"It could be a month, it could be a year, but I hope it's not longer," Gheit said. "The longer prices stay high, the more trouble there will be."
-- This is an updated version of a story that first ran on May 6, 2004.