The 2014 Oil Shock

The most significant economic event of the year has to be awarded to the 2014 oil price shock.

In this chart you are looking at $30-$35 decrease in the price of WTI and Brent crude oil in the matter of 5 months.

Economists and analysts in the energy sector have been saying this shock is due to an increase in oil supply and not a decrease in oil demand.

This supply side increase should have the following implications on the world economy according to general economic theory and also economic models created by the IMF.

1) Significant short-term decrease in world inflation forecasts.

- This is because all products in the world will use oil for production at some point along their supply chain, thus this deflationary pressure on costs should have a deflationary effect of prices across the globe. Therefore inflation forecasts with this new oil price included should decrease.

2) Upwards revision of global GDP. 

- This is because there is a reallocation of resources from oil producer to oil consumers. This drop of $30/$35 dollars puts a significant amount of money back into the pocket of oil consumers that are predominantly households.

- Time lags is what causes this increase of GDP. This is because consumers who get extra dollars back into their pockets are very fast to spend it and put it back in the economy. However oil producers (90% rich families and governments - 10% oil companies) are very slow to decrease their spending, in response to falling revenues. Therefore the total demand in world economy increases and therefore leads to increase in GDP.

Has this happened in reality?

The short answer is no.

The 1st effect has. Many economies around the world have revised their inflation forecasts, such as the Bank of England now expecting inflation to fall below 1%.

Along with the European Central Bank and the Bank of Japan looking for more QE stimulus.

However...

The second condition certainly has not happened. GDP revisions around the world have been revised down, so what is happening?

- What is happening is that built into economic models around the world, they are pricing in the effects of a large economic slow down. The eurozone is slowing down and expecting a long period of deflation, Japan is fearing negative growth and China has slowed to its lowest rate since the height of the crisis.

Are these views correct?

Despite fears that the global economy is slowing down due to a variety of different reasons, which is affecting the growth forecasts of analysts around the world...when we look at a chart of global GDP we see a different story...

Here we can see on a chart that global GDP has been really stable. Eurozone weakness has been offset by USA growth and emerging markets have been stable despite a slowdown from a very incredible rate of growth.

My conclusion

I believe that market analysts around the world are over reacting to slightly negative data in recent months. Global GDP is stable. And I believe this oil price shock will prove to act as a proxy for a short term growth worldwide despite analysts expecting the opposite.