These protests have blunted the effort of US and other developed-country governments to respond to rising oil prices with a strategy of dividing OPEC and forcing it to increase supplies to an extent where prices decline and risk setting themselves on a downward trend that could take them once again to historic lows. Advocates of that strategy were clearly against the alternatives to a return to a situation where oil prices registered a free fall. Why should the US Federal Reserve push up interest rates to hold back growth in an overheated economy and in the process risk a sudden slowdown in US growth? Why should European government lose revenues through cuts in fuel taxes and reduce expenditures to meet deficit targets specified as part of the effort at monetary union? These questions emanate from those who believe that the appropriate response to the current situation consists not of demand-side adjustments that slow growth in the developed countries, but supply-side adjustments by OPEC members that risk a return to the $10 a barrel era and slow growth in the OPEC-bloc. Needless to say, these arguments emanate from precisely those countries which are at the winning end of the current combination high growth and low inflation.
 
The explanation for this aggressive and divisive stance is not difficult to find. It lies in the fear of a repeat of the scenario of the 1970s and early 1980s, where oil price increases triggered a recession. Those fears stem from the realisation that price stability does not imply that high growth in the US in recent times had no inflationary consequences. It was just that those consequences rather than being reflected in higher prices had been visible in large and widening trade deficits. The monthly trade deficit, or the difference between what the US buys from and sells to the world, touched a record $31.9 billion in July, up from $29.8 billion in June. This situation where every day the US imports goods worth about a billion dollars has been the result of a continuous widening of the size of the US trade deficit. Those imports included a range of primary commodities whose prices were collapsing, which contributed in no small way to low inflation in the US.
 
The rising trade deficit had not bothered either the Fed or the US government because the US still serves as a safe haven for capital from across the world. Investments in financial assets in the US by investors abroad brought in enough money to finance the deficit, allowing the US to continue to enjoy the benefit of high growth and low inflation. But for those capital flows the dollar would have weakened and forced the Federal reserve to raise interest rates and slow demand growth. Those capital inflows also directly contributed to US growth. By sustaining high stock values in the capital markets, they substantially increased the wealth of US citizens, encouraging them to reduce their savings and spend more from current incomes.
 
These are the factors which are being ignored when analysts argue that technological change and efforts at conservation are responsible for the fact that, unlike in 1974, 1980 and 1990, when oil price increases led to recessions in the world economy, there are no such signs at present. There are at least two ways in which oil prices are threatening to adversely affect growth in the developed countries. First, as mentioned earlier, higher oil prices, are worsening the already large trade deficits on the US balance of payments, raising the possibility of reduced confidence in the dollar, that could reduce capital flows, set off a stockmarket decline and wipe out wealth with damaging consequences for consumer confidence and spending. The principal stimulus to US and thereby world economic growth in recent times can be foiled. Second, higher oil prices can soon start influencing the rate of inflation in the developed industrial economies, forcing their central banks to raise interest rates and slow growth. This is already happening in Europe where the European Central Bank has raised interest rates in response to the rising headline inflation rate. In the US the Fed has been less responsive, possibly partly because of the danger that an effort to apply the brakes and ensure a "soft landing" onto a slower growth path may spur a collapse in financial markets and of demand. But at some point it would be forced to intervene.
 
With no immediate signs of a reversal of the upward climb of oil prices, despite OPEC efforts to raise supplies and promises by oil companies and governments to release part of their stocks, these possibilities are threatening to realise themselves. If they do, the story of oil price increases leading to recessions could be repeated once again, with much greater severity given the fragile foundations on which the US boom rests. It was this prospect which was defining the mood at the Fund-Bank meetings at Prague, where even news of a persisting boom could not clear the gloom.