I don’t want to see the economy collapse. I am not even wishing for a mild recession. But I watch as Wall Street continues to celebrate the Trump presidency, and I know this can not end well. I once worked as a financial advisor for Morgan Stanley. There are many reasons why it did not work out for me, but one was the toxic political environment I found there. There was a near religious belief in Republican policy prescriptions, despite the fact that the market had ultimately fallen in every Republican administration, and risen in every Democratic one, since World War II. That was in 2001, but even though it remains true today, Wall Street does not seem to have learned anything from this streak. I have talked about the reason for this disconnect before: the market is not the economy. Supporters of Donald Trump like to point to the Wall Street rally under his rule so far as evidence that the Republicans got it right this time, so let’s take a look at why the market, and corporate profits, are doing so well, and why that might not continue. I am not an economist, so I am going to focus on something most people aren’t talking about yet: the price of oil.
The price of oil is something anyone can see for themselves at the gas pump. It has a great impact on consumer spending. Far away from Wall Street or Capitol Hill, most Americans live from paycheck to paycheck, so more expensive oil means we must cut costs elsewhere in order to afford fill our tanks. When gas prices jump, there is a period of denial, in which Americans increase borrowing to make up the difference. We are in such a period now, but borrowing has its limits, so gas prices must come back down soon if consumer spending is to remain unaffected. Even now, Wall Street is being surprised by earnings reports in the retail sector. There are some exceptions, but the story these earnings reports are trying to tell is that Americans are downshifting their spending, so McDonalds and WalMart are doing well, but mid-range retailers and restaurants are not.
So what does Donald Trump have to do with the price of oil? Americans enjoyed a sharp drop in oil prices during the Obama administration. To give credit where it is due, this was partly due to a continuation of energy policies started in the administration of George W Bush that promoted and greatly expanded domestic oil production, and Trump is continuing this effort, possibly even expanding it by pushing for exploration and drilling on public lands. That’s bad news for the environment, but it helps keep prices lower at the pump. However, Obama also applied downward pressure on oil prices with his push for alternate energy, and here, Trump has completely dropped the ball. Trump has exerted upward pressure on oil prices by placing obstacles in the way of alternative energy development, thereby freezing our dependence on oil at current levels.
Less obvious but possibly more important is the conduct of foreign policy. Obama had a fully staffed State Department, and he understood the subtleties of diplomacy. While he was president, OPEC was knocked off balance, and it became harder for them to commit to unified actions to control the global market for oil. Perhaps it is just a coincidence, but Trump believes the State Department is wasteful, and he has deliberately left many key positions unfilled. He also appointed as Secretary of State former oil executive Rex Tillerson. Tillerson knows that more expensive oil globally means increased profits for companies like the one he used to lead. Just recently, OPEC seems to have recovered their balance: their recent agreement to lower production quotas has been the main driver behind the recent rise in oil prices.
There is one other driver to consider, and that is the Republican tax plan. Tax cuts and credits for the working poor and the middle class translate to consumer spending. But when you have all the money you need already, a big tax cut allows you to put more away for the purchase of stocks and more speculative investments. One of those speculative investments is oil futures. The price of oil on world markets includes a speculative premium. By that, I mean that investors buy oil futures, and those purchases translate into higher prices at the gas pump than you and I would otherwise pay. In normal times, this speculative premium is modest, and the sale of futures helps to stabilize prices. But now the Republican tax plan threatens to provide oil speculators with additional funds to play the futures market. No one wants to miss the party, and we have seen that other trends are favorable, so the speculative premium for oil is increasing in anticipation of the Trump tax cuts. This is true even if the tax cuts do not ultimately pass, because speculators do not want to wait to take their positions until the tax bill is law, for fear of missing the profits to be had in the meantime.
So I expect that oil prices will at least remain at their current elevated levels, and possibly go higher still from here. That will put pressure on consumer spending, as would any cuts to safety net programs that Republicans manage to pass. Eventually, even Wall Street will notice, and with stock prices already high by most historical measures, that won’t be pretty. It is notoriously difficult to predict the timing of the stock market, and I failed badly last December. So I will simply leave you with this meditation on oil, and a song about oil prices from forty years ago: