Wednesday, September 13, 2006

Expensive is the New Cheap

As gasoline prices were going up, a number of vocal economists told us we shouldn't worry. They said the U.S. economy could weather much higher prices. They said consumer spending wouldn't take a hit.

For the most part they were right. Gasoline hit $1.80 per gallon, then $2 per gallon, eventually rising to more than $3 per gallon. We didn't really see a slowdown in consumer spending until prices hit those highest levels.

Yet I have to laugh at today's article in the Wall Street Journal. It argues that the recent drop in gasoline prices bodes well for consumers. There is no question that consumers are better off paying lower prices. But if we are to believe that rising gasoline prices won't hurt consumer spending, why should we believe that falling prices will give spending a boost?

The bottom line is that the price of gasoline has to move considerably before consumers take notice. That's because, contrary to popular belief, gasoline represents only a small component of the overall cost of driving. It is dwarfed by the cost of other things, such as the cost of buying or leasing the vehicle, the cost of maintaining the vehicle, and the cost of insuring it.

Look at this way. If you drive 12,000 miles in a year, and you get 18 miles per gallon, you need to purchase 667 gallons of gasoline. If the price of gasoline falls by 50 cents per gallon, you save just $333 dollars, or $28 per month--about the cost of one meal in a decent restaurant.

Let's not forget that despite the recent price drop, gasoline prices remain much higher than they were just a few years ago. John Gibson who anchors "The Big Story" on Fox News, asked me back then if people should think about canceling their vacation plans. At the time, gasoline prices had inched up to $1.80 per gallon and the media were in a frenzy about painfully high prices. Today, with the national average price at $2.60 per gallon, we're supposed to believe gasoline is cheap?