Flooded

Washington divides deeply on partisan and regional lines over carbon policy, with the most entrenched opponents even challenging the premise that climate change is, in fact, real. As a result of the stalemate, the effective price of climate risk in the United States is zero. That means we’re taking on too much of it.

“There’s a sense the housing risk … has been transferred to the government.” —Viral Acharya, New York University

We’re also putting a lot of bystanders in harm’s way, including island nations vulnerable to rising oceans and farmers in developing countries whose subsistence crops could dry up with too little rain or wash away with too much. The bystander effects pose a risk by themselves: Food shortages, in particular, can fuel political upheaval and disrupt the lines of global commerce on which the U.S. economy increasingly depends. Witness the Middle East this year.

America’s more immediate economic risk in the Middle East flows from oil and the chance that spreading protests could slow production to a trickle across the Arabian Peninsula. Presidents dating back to Richard Nixon have warned of the risks of foreign-oil dependence, but American consumers are not paying anything close to the full costs of those risks. We have driven our cars
too much and invested too little in meaningful alternatives to petroleum-based transportation. Now we are just hoping to dodge a catastrophe.

If unrest on par with Egypt’s or Libya’s breaks out across Saudi Arabia, disrupting supplies from the world’s largest oil exporter, analysts say that crude prices could soar past $200 a barrel. That’s $6-per-gallon-of-gasoline territory in the United States, and a sure prescription for a dip back into recession.

Every post-World War II economic downturn in the United States except one has followed a surge in oil prices, according to economist James D. Hamilton of the University of California (San Diego), one of the nation’s foremost experts in oil-price shocks. “The correlation between oil shocks and economic recessions appears to be too strong to be just a coincidence,” Hamilton wrote in a research paper released in January, adding that “supply disruptions arising from dramatic geopolitical events are prominent causes of a number of the most important episodes.”

The math is straightforward. Because Americans remain locked into dependence on oil for transportation—a dependence enabled by comparatively low gasoline prices in flush economic times—the United States has few immediate recourses when prices spike. The more gasoline costs, the larger the share of their incomes Americans spend on it, and the more U.S. assets flow to oil producers overseas. That leaves less money to spend on everything else in the domestic economy. Right now, the U.S. needs all the consumer spending it can get as it climbs gingerly toward robust economic and job growth. But as oil prices have risen amid the Middle Eastern unrest, gasoline’s share of the spending pie has ticked up, too.

If prices skyrocket and divert huge amounts of consumer spending, and if the economy turns down again, the next recession will be deep—and the climb out from the recent financial crisis will seem easy by comparison.

LIMITING RISK

Nearly every economist National Journal interviewed noted how extraordinarily vulnerable the United States, and the industrial world with it, is to events that at any other time might not prove catastrophic. The simple reason is that everyone is tapped out. Countries racked up enormous deficits attempting to borrow and spend through the recessionary cratering of consumer demand. In the same pursuit, central bankers cut interest rates to near (or, effectively, below) zero. So not much fiscal or monetary stimulus will be available if another crisis hits in the near future. Instead, loose money and large deficits could spark a stagflation cycle of negative growth and rapid price increases.

By far the most talked-about crisis risk in Washington is the possibility that mounting debt will sink the U.S. economy. That risk is priced by what appears to be a fair and transparent market in sovereign debt and credit-default swaps, where investors continue to regard U.S. debt as safer than almost any other country’s. But some analysts worry that markets are underestimating the risks of a debt crisis. By any measure, America’s mounting debts would almost certainly make another crisis much tougher for governments to handle.

If this sounds disheartening, it is. Americans don’t have to bear the burden of underpriced risk forever, though.

First, the country must tackle its moral-hazard problem. That means, economist say, spelling out, in iron-clad terms, the limits of government intervention in the economy. Jane’s neighbors must tell the bank that they will let her lose her house, no matter what, if she defaults. That tough love is easier said than done, of course, and it’s not always popular.