Gasoline, Disposable Income and The Economy

With oil prices on the rise once again, analysts wonder why higher gasoline prices have not yet crimped demand. They frequently cite inflation-adjusted prices, which are near all-time highs reached back in the 1980's.

However, gasoline and oil expense as a percentage of disposable income is still 25% lower than the high reached in 1981. All other things equal, it means that average retail gasoline prices would have to rise towards $3.50/gal before they create the same "pain" experienced in the 1980's.

Data: US Dept. Of Commerce

Of course, this is a static comparison - the economy is completely different today. For example, household debt is now 130% of income vs. 65% in 1980 and financial obligation payments take up 19.5% of income vs. 15.5% in 1981. The saving rate was 11% then vs. -1.2% today, meaning there was much more earned income left over in 1981 to cushion the impact of higher prices. Today, surplus income has disappeared and additional spending for gasoline has to be met by more borrowing, selling assets or curtailing spending on other items.

There are two reasons why more borrowing is difficult: (a) credit conditions are finally tightening and (b) more debt means more interest expense; since spending already exceeds income, any additional borrowing will be of the Ponzi type (borrowing to pay interest).

This leaves households with two choices: selling assets and cutting spending. I believe both are in the cards. For example, households have been net sellers of equities four years in a row and retail sales are slowing down, although spending on services is still quite healthy.

Bottom line? Though the percentage of income going towards fuel expense is still below the record highs reached in 1981, the overall economy is more vulnerable right now to a rise in oil prices than ever before.