Gas Prices Averaging $4 a Gallon

When I was on holiday this last weekend, one of the croupiers starting talking politics, and he thought gas prices were without a doubt one of the biggest issue this election year. Sure, this is anecdotal, but we're hearing stories like this from around the country (see, for example, "Rural U.S. Takes Worst Hit as Gas Tops $4 Average").

It turns out that the Wall Steet Journal's got an interesting frontpage story on this, "Gasoline Hits Average of $4 a Gallon." Of all the economic issues outside of the mortgage mess, a continuing run-up in gas prices will likely provide for an earthquake of electoral volatility this November:

The average price of gasoline in the U.S. hit $4 a gallon for the first time Sunday, the latest milestone in a run-up in fuel prices that is sapping consumer confidence and threatening to nudge the nation into recession.

The record nationwide average for regular-gasoline prices, announced by auto club AAA, follows Friday's near-$11 surge in oil prices to a record $138.54 a barrel. Both are part of what, by some measures, is the worst energy-price shock Americans have faced for a generation, in terms of its toll on their pocketbooks.

In recent days, soaring fuel prices and disappointing employment data have reignited fears that the nation's economy -- which has taken a pounding over the past year from a housing downturn, credit crunch and weakening job market -- will slip into recession, or pull back further if a recession is already under way. Rising fuel prices are straining household budgets, damping the spending that drives more than two-thirds of the nation's economic activity.

"What we're seeing here is a lot of additional pressure on a consumer sector that was soft to begin with," said Alliance Bernstein economist Joseph Carson. "Is it a tipping point by itself? It's close."

Gasoline prices, which have risen 29% over the past year, have been high for months, and in some markets, such as Alaska and California, consumers have been paying more than $4 a gallon at the pump for weeks. But the latest increase at the nationwide level from a previous average of nearly $3.99 a gallon seems likely to deliver at least a psychological blow to many Americans.

The current drain on consumers' income from rising fuel prices is greater than it was during most of the worst energy-price run-ups of the past. Spending on fuel as a share of wage income has shot above 6%. That exceeds the percentage seen during the 1974-75 and 1990-91 oil-price shocks and approaches the 7% to 8% seen during the 1980-81 price surge, according to Mr. Carson.

Comparing the rise in fuel spending to income growth, which has been especially weak in recent years, the current shock is far worse than any of the three prior ones, he said.

"It's just gotten out of hand," said 53-year-old Yvonne Brune of Des Moines, Iowa, referring to the rising cost of gasoline. Because of higher gasoline prices, Ms. Brune, who works for a printing company doing marketing on weekdays and separately as a bridal consultant on nights and weekends, no longer makes the drive home at lunchtime -- a 30-mile round trip -- to spend time with her dogs. Because of rising airfares, she has canceled plans for a trip to Texas to visit relatives. "I think the airlines are going to see their industry implode because people are going to stop flying," she said.

Some economists hold out hope the current oil-price surge won't be as devastating as some in the past. For one thing, consumers and businesses are far more fuel-efficient today than they were during the oil shock of the mid-1970s, requiring half as much energy to produce a unit of economic output.

Interest rates also are far lower than they were then, and the Federal Reserve is expected to hold its interest-rate target steady at 2% for much of this year. The dollar's weakness, meanwhile, is raising overseas demand for American products, and growth in exports is a key reason why the U.S. economy has continued to expand -- albeit slowly -- over the past six months.

Most important, consumers have shown surprising resilience over the past five years, despite continued surges in their fuel costs. "While it certainly makes it tougher for the economy for the next few quarters, I still believe consumers can adapt," said Peter Kretzmer, a Bank of America economist.

Still, as gasoline prices climb, they eat up money that consumers might otherwise spend on appliances or movie tickets or vacations. That could force businesses, hit by weaker consumer demand and an increase in their own costs, to pare operations and cut more jobs in an already weak labor market. The government reported Friday that the unemployment rate jumped to 5.5% in May from 5% in April as employers shed 49,000 jobs last month -- a fifth-straight monthly decline.

Check out the Journal's lead editorial today as well, "That Stagflation Show." A major factor in the increase of petroleum costs is Federal Reserve policy, which has sought to guarantee liquidity rather than defend the dollar.

The main trend I see in these stories is that international factors and U.S. monetary policies, have contributed to rising economic dislocation, and that Democratic Party solutions for Keynesian pump priming are not likely to provide the robust level of stimulus needed to invigorate the dynamic, diverse American economy - which has surprisingly weathered the recent shocks without the gas lines or rationing that we saw in the 1970s:

John McCain has a chance to break with this Beltway consensus and offer a pro-growth policy mix. To wit, tighter money to defend the dollar, burst the oil bubble and protect middle-class purchasing power; and marginal, immediate and permanent tax cuts to boost incentives and restore risk-taking.

No doubt Democrats would block a tax cut in Congress this year, and Barack Obama would say it's for the rich. But this is a fight Mr. McCain should welcome. Without his own economic narrative and policy breakout, Mr. McCain will find himself lashed to the status quo and playing defense. The markets are saying they don't want a repeat of the 1970s, and if they aren't heeded the voters will deliver the same message in November.

I'm not betting the Democrats will shift to pro-growth fiscal and trade policies on the advent of an Obama administration, but there's considerable bipartisanship rumblings for such a move.