How Will Surging Oil Prices Impact the Economy in 2021?

Now that the Keystone XL pipeline is being shut down and southern parts of the United States are experiencing extremely cold weather, how will increasing oil prices impact the economy as the COVID-19 vaccine is being rolled out?

With West Texas Intermediate (WTI) crude closing at $58.22 per barrel on Feb. 11, 2021, and likely higher due to the cold snap in the United States, the price of oil is expected to impact the U.S. and global economy.

Consumer Demand

One of the major impacts of increasing oil prices is the rising price of gasoline. With higher oil prices rippling throughout the economy, understanding how it impacts consumers is one way to see how the economy in 2021 is likely to perform.

As the Federal Reserve Bank of San Francisco points out, there’s a close correlation in pricing between gasoline and crude oil pricing. They point out that WTI and what American consumers pay for gasoline to fill up their car track each other quite closely — as oil prices increase, so do consumer prices for gasoline.

Historic Price Trends in Relation to Today

When it comes to looking at how oil prices impact inflation, looking at historical prices gives helpful insight. In the 1970s, the price of oil increased tenfold, from $3 in 1973 (pre-oil crisis) to more than $30, due to Middle East tensions in 1978-1979 resulting from the Iranian Revolution, according to The Federal Reserve and the U.S. Energy Information Administration (EIA).

However, as time progressed beyond the two oil crises of the 1970s, this correlation became weaker. When the 1980s began, so did the association between oil prices and rising inflation. The U.S. Bureau of Labor Statistics (BLS) explains this rapid increase in the cost of oil drove the consumer price index (CPI), one way to measure inflation, from 41.20 in the beginning of 1972 to 86.30 as 1980 came to a close. As the BLS illustrates how the 1970s experienced high inflation, it took three times as long (24 years) for the CPI to double between 1941-1971.

With the two Oil Shocks passed, the 1980s and the 1990s ushered in a new divergence of how oil prices ultimately impacted what consumers paid for oil and oil-dependent products. This is illustrated by looking at the impact of the Producer Price Index (PPI), or wholesale cost, versus how consumers ultimately felt, or the Consumer Price Index (CPI).

CPI and PPI Data and Oil Prices

Looking at the CPI, especially in the 1990s, statistics from the EIA show that the price per barrel of crude oil went from $14 to $30 in six months. However, data from the BLS shows that CPI started at 134.6 in January 1991, eventually reaching 137.9 in December 1991.

Later, from 1999 to 2005, the EIA’s data shows the price of a barrel of oil jumped from $16.50 to $50. While the price nearly tripled, the BLS’ CPI jumped from 164.30 in January 1999 to 196.80 in December 2005, an increase of 33.5 over nearly six years.   

Looking at the Producer Price Index (PPI) data, per the Federal Reserve Bank of St. Louis, from 1970 to 2017, the correlation was 0.71. For the CPI, during the same time frame, it was only 0.27. The difference between the CPI and PPI, according to the Federal Reserve Bank of St. Louis, is due to the higher proportion of services provided in the United States, which are less oil-reliant for raw materials.

External Factors

With the expected relief payment of $1,400 per individual and additional money allotted for dependents, coupled with continuing vaccinations and the reopening on the U.S. and global economies, there’s much stimulus expected to provide consumers with a financial cushion. However, with the increased spending by the federal government and pressure on the U.S. dollar, only time will tell how the price of crude oil will impact consumer spending and company earnings.

How Will Single Party Governing Impact the Markets in 2021?

Biden Stock MarketAbout four in 10 Americans (41 percent) look positively toward single-party control at the national level, according to an October 2020 Gallup annual governance survey. This is compared to 23 percent of respondents desiring multiparty control. Breaking it down by party, 43 percent of Democrats want single-party rule, while 52 percent of Republicans desire single-party governance.

One notable finding is that, looking back to 2002, 32 percent preferred single-party control when it comes to independents. This was the highest-ranking over the past 18 years. As the Brookings Institution points out, now that Jon Ossoff and the Rev. Raphael Warnock are U.S. Senators, the U.S. Senate is divided 50-50 with Vice President Kamala Harris able to break a tie. According to political experts’ forecasts, President Joe Biden is likely to accomplish much of his agenda in light of these circumstances.

However, as the Brookings Institution notes, many are expecting West Virginia Sen. Joe Manchin to be the deciding vote on many upcoming pieces of legislation in 2021. His track record proves he’s been a wildcard depending on the legislative topic at hand.

When Manchin was West Virginia’s governor from 2005 to 2010, he lowered taxes, gave teachers higher salaries, helped repair the state’s worker compensation system, and reduced the state’s overall liabilities. He’s opposed to adding additional justices beyond nine (other than replacing justices who have retired or passed away) and is against reducing funding for public safety needs. Yet, he did not support President Trump’s tax cuts in 2017, nor did Manchin have any interest in reducing the scope of the Affordable Care Act.

President Biden Tax Proposals

If President Biden’s proposed legislative priorities on the campaign become a reality, they will undoubtedly impact personal and publicly traded companies’ earnings. According to The Tax Foundation, Biden proposes increasing the highest personal marginal income tax rate to 39.6 percent from 37 percent. He’s also expected to advocate changing the highest corporate income tax rate from 21 percent to 28 percent.

Additional proposals include taxing capital gains at 40 percent for those who earn $1 million or more, along with The Tax Foundation reporting the potential for at least a tax of 15 percent on income that publicly traded companies disclose on financial statements available to equity holders.  

Implications of Tax Cuts (and a Lack Thereof)

According to Stanford Graduate School of Business and research done by Rebecca Lester, associate professor of accounting at Stanford Graduate School of Business, there are some insightful findings on how tax policy impacts corporations’ bottom lines.

One of the primary findings is that while companies take some of the increased savings from fewer taxes and deploy it outside the United States when it comes to using it domestically, it’s used for automation, not to create additional employment opportunities.

For example, the Domestic Production Activities Deduction (DPAD) gave companies a tax deduction that would essentially lower their income tax obligations on earnings from domestic manufacturing. However, there was no requirement to increase domestic manufacturing or employ more Americans.

Based on this example, companies cannot only save money directly from the tax cuts but also indirectly through long-term gains via automation. Looking forward to how a Biden Presidency will shape corporate earnings and the resulting market performance will likely depend on how a few moderate Senators vote. 

How Will the Biden Administration’s China Policy Impact Markets?

The Obama and Trump administrations couldn’t have had a more different approach when it came to U.S. relations with China. As the Institute for China-America Studies (ICAS) explains, under the Obama administration, the United States favored a trade and investment approach when dealing with China, while the Trump administration had a national security focus. The ICAS believes the Biden administration will address trade and economic imbalances through a modified approach, including reducing tariffs on imported Chinese goods over time to decrease inflation for American consumers. Another example is maintaining pressure on China to cut government subsidies for competing industries, currency games, and exporting products to the United States at artificially low prices.

While the Obama administration engaged China through trade and investments, it didn’t emphasize engaging the country on the national security side. The Trump administration looked to make American industries independent of Chinese production, especially for rare earth metals, pharmaceutical precursors, etc. With the inauguration of President-elect Biden, the incoming administration is expected to maintain the Trump administration’s quest to give many American industries a fighting chance of survival, albeit how it will be accomplished will likely vary.

The Biden administration is projected to lower tariffs on Chinese imports gradually. This is expected to be done to reduce the tension of the existing trade war. It’s also expected to be done to lower the rate of inflation and help businesses that import input materials from China.

Based on statistics according to the American Action Forum, approximately $57 billion was paid by consumers on an annual basis per 2019 import numbers, due to tariffs instituted by President Trump. This action is likely to increase consumer spending and increase companies’ earnings. However, the Biden administration is still expected to keep other forms of trade pressure on what many believe are unfair trade practices by China.

Biden also is expected to raise the same concerns the Trump administration did regarding Chinese trade and commerce, including China subsidizing its industries, flooding the American market with goods to undercut American producers, and requiring so-called forced technology transfers from U.S. companies.  

However, the trade deficit the U.S. has with China isn’t expected to see much attention. This could negatively impact how much China is ultimately expected to import from the United States.

When it comes to colleges and universities, research-based collaboration, and artistic-based areas, relations are expected to be more friendly. However, when it comes to fighting China’s human rights violations, individuals or business entities might be targeted. Based on Vice President-elect Kamala Harris’ proposed Uyghur Human Rights Policy Act of 2020, there’s an expectation the Biden administration will keep the pressure on China.

Beginning in 2017, Biden began to discuss plans for America and how some of America’s crucial industries could be more self-sufficient and less reliant on China. Examples include pharmaceutical products, medical equipment, and rare earth minerals.

Potential actions the Biden administration could implement against China include sanctions; U.S. government-sponsored legal action against Chinese firms; and becoming more involved in the World Trade Organization (WTO) and similar organizations. This is seen by some as the U.S. becoming more in-step with Europe to better pressure China in WTO and related disputes. It might also include courting America’s allies in reducing or prohibiting Chinese investment of domestic industries to make it more difficult for Chinese firms to obtain cutting-edge technology.

While there is no way to accurately predict how the Biden administration will treat China, there will likely be continued pushback on China. How these actions will ultimately impact trade and the markets will be seen in the near future.

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