May 18, 2010 2:33PM

The Good Side of Bad News in Europe

What does the Greco‐​Euro currency/​debt crisis mean for the U.S. economy?

Nearly everyone except the uniquely wise economist John Cochrane assumes very bad “contagion” effects –on U.S. banks, exports and particularly U.S. manufacturing.

This echoes identical anxieties while the world went through a far more dramatic Asian currency crisis after July 1997, and a Russian debt crisis the following May.

The most widely ignored effect of that crisis, however, was to depress foreign demand for oil, and thus slash oil prices to U.S. buyers from $25 a barrel in early 1997 to $11 by the end of 1998.

Oil is a major input into the manufacturing process (e.g., chemicals and plastics), and a major cost of distribution (trucks, trains and airplanes). It is also a major determinant of the cost of all energy sources used in making other goods such as aluminum and paper. When marginal costs go down, it becomes profitable to expand production.

At the height of the Asian/​Russian crises, the table below shows that U.S. manufacturing output rose by more than 10 percent. It’s an ill wind that doesn’t blow somebody some good.

Looking at the same phenomenon from the other side, every recession but one (1960) was preceded by a big increase in the price of oil. For oil importers like the U.S., cheaper oil is definitely better.

During the last big foreign currency/​debt crisis, the real growth of U.S. Gross Domestic Purchases (the home‐​grown portion of GDP) jumped by 4.7% in 1997 and 5.5% in 1998. Yet the Fed cut interest rates three times in October and November of 1998 because of what was happening in other countries.

The table show what happened to the price of oil and to U.S. manufacturing from June 1997 to December 1998. The middle column is the price of a barrel of West Texas crude, and the column to the right is the U.S. industrial production index for the manufacturing sector.

1997-06 19.17 87.80
1997-07 19.63 88.12
1997-08 19.93 89.69
1997-09 19.79 90.45
1997-10 21.26 90.98
1997-11 20.17 92.05
1997-12 18.32 92.52
1998-01 16.71 93.36
1998-02 16.06 93.31
1998-03 15.02 93.13
1998-04 15.44 93.68
1998-05 14.86 94.25
1998-06 13.66 93.53
1998-07 14.08 92.96
1998-08 13.36 95.40
1998-09 14.95 95.11
1998-10 14.39 95.96
1998-11 12.85 96.08
1998-12 11.28 96.63

In recent weeks, as the debt and currency problems in Euroland hit the front page, the price of crude oil fell by about 20 percent.

Once again, as in 1997–98, everyone may be watching the wrong ball in the wrong court.