July 25, 2008 | posted by Michael Baxter in Automobiles, Oil |

Honda put its headlights on full yesterday. And in the brilliance of their light, we saw the oil market for what it really is, an unsustainable bubble.

Meanwhile, the National Institute of Economic and Social Research (NIESR) put its fears on the price of oil into gear. And warned we have got to pay for expensive oil through lower wages.

But maybe though, that thinking is wrong. Maybe we need to put our thinking on oil into reverse gear.

While all around, car makers are raiding their Thesaurus looking for alternative words to awful, Honda has just announced an 8.1 per cent jump in quarterly profits. It is yet more evidence of how we are adjusting to the high price of oil through changing our behaviour.

In the US, the company showed just how fit for purpose its strategy is, literally so, because it was Honda’s Fit, and Civic, that topped sales.

So far this year, Honda is the only car maker to see sales increase. In both May and June the company enjoyed higher sales than Chrysler, making it number four in the US.

Honda is also benefiting from surging sales from ventures in China and other Asia countries – so, all in all, it is just about doing things right at the moment.

But the Honda performance is an indication of something deeper too.

As has been argued here before, in the long-term demand for oil does fluctuate with price. To put it in economics speak, in the longer-term the price elasticity of demand for oil is quite high.

That’s why demand for oil is set to plunge – and why it has been predicted here that the black stuff will fall back to $70 by the end of 2010.

Still on the subject of oil, yesterday, the National Institute of Economicsand Social Research (NIESR) said that at current prices oil knocks around ¼ per cent off GDP each year.

But that is without taking into account the effect the cost of transporting goods must be having on international trade during this modern era.

The NIESR went on to announce some intriguing figures on the makeup of energy costs to the economy overall.

It said: “Real wages will have to grow ½ per cent less for next three years in Europe in order to compensate for the changing terms of trade caused by rising oil prices.” And looking across the pond, it said: “High US oil dependency means real wage growth has to slow 1 per cent.”

But is that really right?

At current prices, the cost of fuel is making life very difficult for some of us. Those who drive to work are really feeling the pinch – and public transport is not always a sensible option.

Do you remember when Margaret Thatcher’s government upped VAT when it got into power? The move was considered by many economists to be suicidal at a time of inflation. But they were wrong.

Inflation is not caused by rising costs. Rising costs are a symptom of another problem. Inflation is caused by demand exceeding supply. And for many people, oil at current levels means their spending on other goods and services is falling, and falling fast. This is deflationary.

As for trade – the falls in the dollar and pound will be making it much easier for exports in these economies. The real issue regarding trade relates to the value of the yuan, and the yen, both of which are rising.