Think Again

Think Again: The Eurocrisis

Markets are crashing. The euro is hurting. Here's why the continent's financial crisis is even messier than it appears, and how the blowback could hit the United States in the face.

"The Euro Is Heading for a Crackup."

Don't bet on it. Sure, things look bad. The crisis, well into its third year, has forced Greece, Ireland, Portugal, Spain, and now Cyprus into various forms of international financial rescue programs, and it shows no signs of abating. After two years of denial and half-measures, market participants have little faith in the ability of Europe's policymakers to reach a solution. Spanish bond yields are frighteningly wide and those of Italy, the continent's most prolific borrower, are following closely behind. This summer's announcement a fuzzy-at-best plan to recapitalize Spanish banks and create new mechanisms to channel pan-European resources to Europe's stricken financial sector relieved market pressure for all of a few hours. Perhaps most alarmingly, no one seems to have a plan, with British Prime Minister David Cameron warning that the eurozone must either "make up or break up" -- with the implicit threat that the latter is increasingly likely.

But before writing the euro's obituary, let's remember: The driving force behind a European currency union was never purely or even principally financial. It was political -- and these binding forces remain strong. After centuries of bloodshed on the continent culminating in the last century's two world wars, the European Union (EU) and ultimately the euro arose from a deep-seated desire to abolish the risk of state-to-state conflict. A slide back to nationalism is a constant fear in the minds of European political leaders and peoples. And so, in spite of growing concerns about the benefits of sharing a single currency across 17 countries, member states and their publics remain highly supportive of the European project and the euro. While the crisis has caused this support to decline a bit, studies consistently show that Germans, French, and Spaniards favor remaining in the euro. Even upwards of 70 percent of Greeks, who are in their fifth year of recession and looking forward to a decade of grinding austerity, claim that they want to stay in the currency union. They may not get their wish (boundless hope can overcome an awful lot, but not the cold mathematics of Greece's debt burden) but their robust support illustrates the basic fact that the political will to maintain the euro remains strong.

It's true that Europe doesn't yet have a comprehensive plan to balance sensitive and increasingly difficult issues of national sovereignty, financial resources, and disparate economic models and strength among eurozone members. It's also true that this marks a decisive break from the post-World War II trajectory of European integration, which was built on grand visions both successful (the common market and common currency) and less so (the Lisbon Treaty that set the foundation for today's host of supranational European political institutions).

What Europe does have, though, beyond sheer will, is a process, however tortured and painful it may look to those on the outside, to ensure that the euro and the EU hold together. The political and economic costs of a eurozone implosion remain too high and the benefits of maintaining the common currency too real for the countries involved, as self-defeating as they appear at times, to allow a crack up. Europe will likely make steady, halting, and at times apparently counterproductive steps toward a banking union, limited fiscal federalism, and a path to political union. The path from here to there won't be smooth, just as the past two years haven't been -- but it will likely be enough to keep the currency union.

To be clear: We could very well be heading for a deep crisis, and we might even see the exit of one or more member states, with Greece the most likely. But other peripherals won't see a Greek exit as a signal to leave themselves; in fact, measures taken as a consequence may well strengthen their own prospects within the currency union. The likelihood of the eurozone imploding and the reintroduction of national currencies across a broad swath of Europe thus remains exceptionally small.

"It's All Greece's Fault."

Nope. Greece definitely shares a great deal of blame for Europe's current predicament (and, of course, its own). Athens lied about its budget and finances to get into the euro back in 1999, lied about them to stay in the euro in the decade since, and continues to bob and weave as it pretends to comply with the terms of its bailouts, agreeing to absurdly high projections for anticipated growth rates, tax revenues, and privatization revenues. Greece took Europe for a ride, and now both are paying the price.

But Greece's seemingly miraculous overnight transformation from profligate to responsible required willful blindness from European authorities. And the reason that dissimulation was even available to Greece in the first place lay in the faulty construction of the euro itself, in which all eurozone sovereign risk was made to be a thing of the past.

In the pre-euro 1990s, markets widely and correctly assessed Greece as a poor credit risk. As a result, Athens was able to borrow only infrequently, and had to pay high rates to do so. Over the years, when Greece had problems paying back its highly priced debt, it defaulted, devalued, borrowed more, and the cycle continued.

Joining the common currency was assumed to eliminate both Greece's credit risk (that it wouldn't pay back its creditors) and currency risk (that it would pay them back in a different currency worth far less than the one in which they borrowed). These may have been noble aims, but the economic logic rested on assumptions that were faulty at best. Milton Friedman cited these flaws, among others, when he predicted that the euro would be lucky to survive the decade. As he and others warned at the time and is all too apparent now, adopting the euro didn't magically transform countries like Greece into paragons of financial probity. Yet European banks took the elimination of sovereign credit risk at face value and lent Greece huge sums at historically low interest rates, comfortable in the knowledge that the European Central Bank (ECB) would provide virtually instant liquidity for newly issued Greek bonds, so that the lenders could start the whole process again shortly thereafter. And not only did the process continue, but it grew over a decade until the amounts involved became unsustainable, and the crisis as we now know it hit.

The flow of cheap funds was supposed to lead to investment and commerce in Greece and other "peripheral" European countries, which would eventually lead to an economic convergence with the eurozone core. When Greece borrowed money by the truckload, it was doing precisely what the eurozone architects and the ECB intended. Greece undeniably spent its windfall poorly -- taking few steps to fix systemic problems like tax evasion, corruption, and public sector bloat. But the only reason it had money to spend so poorly was due to the overly optimistic (and at times inherently delusional) assumptions that underlay the common currency system. Polonius had it right: "neither a borrower nor a lender be." In Europe, both parties share the blame for ignoring that advice.

"It's all Germany's Fault."

Wrong again. It's easy to blame German stubbornness in preaching austerity, reform, discipline, and penance for the continued metastasis of the crisis. Many fault Germany for helping to create the crisis in the first place, as the ECB was modeled on the Bundesbank and the euro, in effect on the Deutsche mark. German policymakers accepted the single currency zone's incomplete construction and many willingly turned a blind eye to its first decade of tinkered budget numbers in the periphery, which helped them capitalize on a captive export market that benefited German firms enormously. Rhetoric from German politicians about the distressed peripherals too often has been ugly, with some calling for the sale of Greek islands and the Acropolis to help them pay their international debts; even German Finance Minister Wolfgang Schaeuble pointedly reminded the Greeks that "membership in the EU is not compulsory." Perhaps most daunting has been Chancellor Angela Merkel's seeming inability to grasp the direness of the Europe's predicament -- she acknowledges that the eurozone is "in a race with the markets," and then limits how fast Germany will run -- frustrating friends and foes alike.

The truth is, though, that Germany has made an enormous commitment to the European project, and one that has not wavered. From the creation of the European Coal and Steel Community (the EU's forerunner) less than a decade after World War II to the present day, Germany has staunchly supported and even driven a series of steps that have had the net effect of subordinating German power to broader pan-European ends. The EU's godfather Robert Schuman was French, but no country has embraced the spirit of his eponymous declaration more than Germany, and that hasn't changed.

What's more, Germany has over the past year undergone an unbelievably rapid shift in its role in Europe. Casting aside reluctance rooted in its fraught 20th-century history to assert control in Europe, Berlin has assumed the mantle of leadership at a time when it is the only European entity seemingly willing or capable of doing so. To its credit, Germany has shown unforeseen flexibility on a wide array of ideas and initiatives that only a short time ago were completely verboten: multiple relaxation and renegotiation of the conditions required for Greece to receive its rescue funds, direct recapitalization of the Spanish banking system, the creation of European bailout mechanisms like the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), consideration of common eurobonds, banking union, fiscal union, and tacit approval of the ECB's unorthodox market interventions.

Germany receives blame largely because many, in the United States in particular, look to Berlin to play a role akin to the one Washington played in financial crises past: formulating a comprehensive crisis-response plan and committing a substantial amount of money to implement it. Germany can't and won't do this, and its inclination to move incrementally, and only after distressed countries agree to significant reform measures, remains dangerous as the crisis moves exponentially. Overall, however, Germany and Merkel have been far more pragmatic and effective as crisis managers than has been generally acknowledged.

"The Eurozone Crisis Is One Crisis."

Hardly. It's at least four, and possibly more depending on how one counts. Europe's peripheral states have a host of problems, and to some degree demand similar short-term responses. But seeking a one-stop solution by lumping them together (as the "PIIGS," a common acronym for Portugal, Ireland, Italy, Greece, and Spain) ignores the very real differences that separate them and that will over the longer term require different policy interventions. Even referring to a singular eurozone "crisis" is something of a misnomer; the label actually encompasses sovereign debt, banking, growth and competitiveness, and structural crises -- all of which, unfortunately, feed on one another.

Take Ireland, for example, which suffered from a banking crisis in 2010 that became a sovereign-debt crisis. Irish banks financed a real-estate-driven domestic bubble, and when the bubble burst the Irish government moved quickly to nationalize some banks and take the financial risks of others onto its balance sheet. As a result, the Irish debt-to-GDP ratio ballooned from 34 percent to well over 100 percent, crippling Ireland's ability to borrow.

Spain's problems are somewhat similar to Ireland's, but with a twist. Like Dublin, Madrid finds itself confronted with a banking problem born of a real estate bubble. But the Spanish autonomous communities or regions, which under the devolved Spanish federal structure manage their own budgets, systematically over-borrowed and overspent during the past decade, all while apparently lying about it to the center. When the real-estate bubble popped, the regions felt the pinch as much as the banks, and now the Spanish federal government may have to prop up both.

Portugal, by contrast, had and has a competitiveness problem. Lisbon feasted on cheap euro financing and for a while enjoyed the benefits. But instead of investing in its economic future, it plunged its European windfall into an unsustainable services-sector boom that masked, for a time, the need to undertake structural reforms. When economic reality hit and demand for services fell, Portugal's economy was crippled. Its path to competitiveness remains an enormous question mark, though its banks remain generally healthy.

Italy's current predicament likewise stems from structural and competitiveness issues. Italian growth has declined in an almost directly linear fashion for 60 years, from 5 percent in the decade after World War II to a virtual flat line in the 21st century. Corruption is endemic, higher education is mediocre, and antipathy toward reform is high. In spite of its strong and industrious north, Italy's growth prospects as a whole are bleak without structural reforms. The country was the largest issuer of euro-denominated sovereign debt, with total indebtedness of 2 trillion euros placing it at the very edge of what the IMF deems "sustainability." Although the country's annual budget deficit is relatively healthy, without reform the country could find itself unable to fund itself and spiral downwards quickly.

Greece is the closest to a perfect storm of the various gales lashing Europe. It has structural and competitiveness issues, and Athens's serial dishonesty over the state of its finances remains in a class of its own. The country has already undertaken one messy and painful debt exchange and with its second troika program at risk, another may follow. Greek financial institutions only became an issue, however, once the value of their holdings of Greek government bonds was slashed and the downturn crushed economic activity in the country, so much so that recent projections see a nearly 7 percent contraction in GDP this year. In some ways, Greece is a reverse of the Irish situation: a sovereign-debt crisis begat a banking crisis, rather than vice versa. Add to that the ongoing risk that Greece may be the one country that really might be forced to leave the euro, and the country and its banks suffer from almost all that ails the eurozone.

The crises of the eurozone's peripheral countries undoubtedly share commonalities, but that doesn't mean that their causes or potential solutions are the same. What it does mean is that Europe's way out of this morass promises to be even more complicated than it appears.

"The Europeans Have Finally Thrown Big Money at the Problem."

Not if you look closely. Proponents of Europe's response to the crisis point to two acronym-laden rescue funds, the EFSF and the ESM, with combined financial firepower well in excess of $1 trillion -- far more than the U.S. Troubled Asset Relief Program (TARP). These rescue vehicles, they say, represent serious commitments of cold hard cash to eliminate the systemic risk in the European banking system. Sadly, there's relatively little real money being ponied up and the actions of Europe's central bank, the ECB, may have only made things worse.

The EFSF has no actual money. Zero. It's really nothing more than a pool of promises from eurozone countries to pay creditors sometime in the future if there's still no cash in the till. Relying on these promises, the EFSF was supposed to raise its entire funding on capital markets, but it doesn't have a great track record in doing so. As a result, though the EFSF is authorized to borrow up to 440 billion euros, it has only raised around 30 billion euros so far.

With no actual cash and limited investor appetite for their bonds, the EFSF simply declared its own bonds to be as good as cash, and provided them to recipient countries, banks, and investors instead of the real money they couldn't actually raise in the markets. It's anyone's guess how the bonds will ultimately be repaid in the end.

The second vehicle, the supposedly new and improved ESM, is a similar story. For starters, while its money is already being committed, the treaty authorizing it has yet to be ratified in several member states. The all-important German courts have even raised serious questions about its legality. But even assuming the ESM is found to be legal and is ratified, its ostensible 500 billion euros in funding will be mostly a mirage. The ESM is structured so that 80 billion euros will be contributed by eurozone countries over 30 months. The remaining 420 billion euros is supposed to be raised in the capital markets, with investors expected to buy bonds relying on guarantees provided by eurozone countries -- several of which themselves may end up being the recipients of any money that the fund actually ends up raising.

On top of all this, market investors are increasingly concerned that the one entity seen by many observers as the ultimate savior, the ECB, is part of the problem. They fear that the ECB will be able to ensure that it has repayment priority, therefore limiting the prospects for other investors if a country runs into trouble and can't pay on time -- or at all. These concerns are well-founded: that's just what happened in Greece last spring.

So Europe's "rescue" funds are largely unfunded. They are based on hopes that markets will provide enormous amounts of cash on the back of financially engineered government promises not recognized on their sovereign balance sheets, with investors' wariness about their treatment at the hands of the ECB only making matters worse. In an already difficult funding environment, it is hard not to be just a little skeptical that the rescue funds won't necessarily have all the money they need exactly when they need it.

"The U.S. Response to the Crisis Has Been a Failure."

It's complicated. Washington's reaction to the eurozone crisis was almost certainly too slow, too small, and too stove-piped. Not only did U.S. policymakers fail to initially recognize the severity of the crisis, but they focused for far too long solely on purely financial, not strategic considerations. With Treasury taking the lead under Timothy Geithner and in spite of Secretary of State Hillary Clinton's laudable efforts to include economic tools in our foreign policy toolkit, the U.S. approach was purely "economic" without the "statecraft." Some U.S. officials seemed complacent, assuming that the European crisis was not of their making and the impacts likely to remain largely localized on the continent. The Europeans would, as they themselves insisted, figure things out for themselves at the end of the day. As a result, President Obama's personal involvement was not seriously sought until the summer of 2011, and when it did come, it was largely limited to high-level political efforts to cajole his European counterparts to reach a solution. The crisis had by this time evolved, and his interventions were neither universally welcomed nor terribly effective.

But there are mitigating factors that explain, though don't fully excuse, U.S. failures to play a more constructive role in solving the crisis. For one thing, the size of Europe's mess is far larger than anything we have had to help clean up before, and the United States alone simply does not have enough money to lead a robust international response with the vast sums of cash required to backstop Europe. With the U.S. economy recovering slowly from the 2008 financial crisis, the government deeply in debt, and some in Washington increasingly skeptical about U.S. support for international financial institutions, the Obama administration's ability to intervene decisively was hamstrung from the inception of the crisis. That hasn't changed, and in an era of fiscal retrenchment, it won't.

When the Europeans finally dropped their opposition to IMF involvement in May 2010 and agreed to allow the Fund to play a central role in the crisis response, the United States made it clear that it would not be providing more funding to the IMF to boost its war chest. Earlier this year, when the IMF announced an increase in its emergency funding to the tune of some $450 billion, the United States was conspicuous in its absence, arguing both that Europe should use its own resources to solve its own crisis and that the U.S. Federal Reserve has been quietly providing enormous amounts of dollar liquidity to the European financial sector, averting a much worse crisis. All true, but U.S. absence was glaring.

But let's be honest -- the Europeans have been less than eager to accept any U.S help. Certain that their collective wisdom, processes, and minimal financial commitments would be sufficient and mindful of the stigma that supplicant status would bring, Europe has kept Washington at arm's length for most of the last two years. When the United States did finally move publicly and decisively to help broker a solution, at the eurozone finance ministers' meeting in Poland in September 2011, Secretary Geithner was greeted with dismissal (Eurogroup President Jean-Claude Juncker huffily sniffing that Europe would not "[discuss] the increase of expansion of the EFSF with a non-member of the euro area"), ridicule (Austrian Finance Minister Maria Fekter: "I found it peculiar that, even though the Americans have significantly worse fundamental data than the eurozone, that they tell us what we should do") and outright rejection (Belgian Finance Minister Didier Reynders said Geithner should "listen rather than talk"). In private discussions, European ministers were more receptive than the heated rhetoric suggested, but their public rejection sent a clear message: Washington should butt out.

In past financial crises, such as the 1994 Mexican peso crisis, the United States kept publicly quiet and worked behind the scenes to provide necessary financial backstops, while building global coalitions to address the situation at hand. But when Europe began to come apart at the seams, Washington adopted a new strategy: speaking a bit more loudly and hoping that the markets would carry the stick. The United States, perhaps a bit wishfully, believed that expressing public concerns would drive market activity to increase pressure on European leaders for speedier and expeditious action. Europe wanted a quiet and quiescent America that would offer funds; what it got was an America offering lectures. But while it's tempting to pin the ineffectiveness of this approach on U.S. policymakers, they had few other choices; it's a more a sign of the times and the size of the crisis than an outright policy failure.

"The Eurozone Crisis Is a Disaster for the U.S. Economy."

Not yet. The eurozone crisis has undeniably damped economic growth across the globe and helped slow the U.S. recovery. And yes, if the crisis worsens, it could do severe damage to the U.S. economy and President Obama's re-election chances. From early 2010, when Greece shattered the façade of the euro's unshakeable foundations, European instability has driven down U.S. consumer and investor sentiment, reduced spending, and heightened uncertainty for firms, reducing investment. The risks of financial contagion have reduced credit and posed new threats to U.S. banks and other financial actors with significant exposures to Europe. The EU and the United States have the world's largest bilateral trade relationship, and as the continent stagnates or contracts, U.S. exporters may be hit especially hard. This summer's domestic corporate earnings testify to the drag that Europe is exerting on the U.S. private sector.

It's not all bad news, though. First, reduced consumer sentiment and decreased economic activity exerts downward pressure on commodity prices, particularly gasoline. With summer typically the season of peak U.S. energy demand and with the sheer number of geopolitical developments buffeting energy markets -- from U.S. and EU sanctions on Iran to chaos in Syria to instability in Libya and pipeline disputes in Sudan -- the gasoline market could use a little slack. While many analysts predicted prices at the pump to exceed $5 per gallon this summer, prices have dropped to below $3.40 nationwide, and may fall still farther.

Second, Europe's financial turmoil reinforces America's safe-haven status. A lack of alternatives means that investors looking for assets to stuff under the proverbial mattress still outbid one other for blue-chip U.S. Treasuries, keeping interest rates low (even negative in real terms) and inflation manageable. Those same low rates translate into lower borrowing costs for businesses and homeowners.

Finally, as long as Europe appears near (or in) crisis, the United States won't face sustained market pressure over its shaky fiscal trajectory, and thus there's not likely to be market pressure to force action by Congress and the president on difficult decisions like the extension of the Bush tax cuts or softening the automatic spending reductions that hit at year's end -- thus preventing a self-induced hit to the U.S. economy before it is able to recover. While it is obviously necessary that we grapple with our very real fiscal challenges, it is certainly nicer to do so on a timetable of our own, and not one set by markets forcing our hands and risking the onset of a double-dip recession.

RAINER JENSEN/AFP/GettyImages

Think Again

Think Again: The American
Energy Boom

Yes, oil and gas made in the USA is surging. But does that really liberate us from the Middle East?

Click here for FP's survey on how energy is remaking the world.

"The United States Is the Next Saudi Arabia of Energy."

Yes and no. American oil production, once thought to be in terminal decline, is up strongly for the first time in a quarter-century. Natural gas output, largely flat since the mid-1990s, has grown rapidly for the last five years. These trends look poised to continue, and observers are predicting major geopolitical consequences to follow. Ed Morse, an influential Citigroup analyst and former U.S. official, asserts, "North America is becoming the new Middle East." Robin West, another perceptive industry observer, predicts that by 2020, the United States will become the world's largest producer of oil and gas -- "the energy equivalent of the Berlin Wall coming down."

These sorts of views are quickly becoming conventional wisdom. But it takes more than sheer volume of oil and gas production to dominate world energy markets.

No doubt, the renaissance in U.S. oil and gas is really happening, fueled by new technology and high oil prices. About a decade ago, innovators aggressively began to marry horizontal drilling, which allows producers to access large swaths of an underground resource from a single well, with hydraulic fracturing -- better known as fracking -- which uses high-pressure fluids to crack dense rock and allow oil and gas to flow. The combination has unlocked vast quantities of oil and gas buried in shale rock deep underground. Technology has also allowed producers to tap resources far beneath the sea in a way that wasn't possible before; just two years after the Deepwater Horizon oil spill in the Gulf of Mexico, offshore production has recovered, helping spur U.S. oil production upward.

It's no coincidence that these technologies have flourished amid record-high oil prices. Extreme offshore production makes little sense unless oil prices are above $50 or $60 a barrel. The economics of extracting oil from shale are murkier, but most think that $70 or $80 a barrel is necessary. Ten years ago, most analysts were projecting $20 crude for as far as the eye could see. In that world, the current boom would have been impossible. Oil prices have shifted decidedly higher, however, making new production possible along with them.

As a mere matter of scale, projections that the United States will reclaim the title of world's largest oil producer are entirely plausible, though hardly guaranteed. Saudi Arabia produces around 10 million barrels of crude oil each day, versus about 6 million for the United States. Surging production of natural gas liquids (NGLs) -- crude-like hydrocarbons produced alongside natural gas -- effectively takes that figure up to about 8 million barrels a day. Morse claims that total U.S. production could exceed 10 million daily barrels by 2015, and even the cautious U.S. Energy Information Administration (EIA) sees combined crude and NGLs production coming close to 10 million barrels a day by 2020.

But what makes Saudi Arabia such a dominant global player isn't merely the scale of its energy production. It's that it actively attempts to influence the price of oil and often does so for explicitly political reasons, whether currying favor with Washington or trying to hurt Tehran. By restraining long-term investment in oil production capacity -- manufacturing scarcity -- the desert kingdom is able to prop up the average price of crude. What's more, by keeping some of its production capacity in reserve, to be swung on and off the market at will, Saudi Arabia is able to moderate short-term price swings. It's not because they love the Saudi royal family that world leaders are so solicitous when they visit Riyadh.

Nothing about the U.S. oil and gas boom suggests that Washington can or will step into this role. No U.S. government would -- or could -- attempt to prop up world prices by restraining U.S. supplies. Besides, America's oil boom is being driven by supplies that cost huge sums of money to develop. Once new wells are drilled (at a cost of about $100 million each for offshore development), owners will produce flat out to recoup their investments; there's no way they'll leave untapped production capacity just waiting for a political crisis or global market swing.

Joe Raedle/Getty Images

"The United States Could Be Energy Independent."

No. This massive new U.S. oil and gas output has brought talk of American energy independence back into vogue. Energy economist Adam Sieminski, the new EIA administrator, captured the shift in a February interview: "For 40 years, only politicians and the occasional author in Popular Mechanics magazine talked about achieving energy independence," he observed. "Now it doesn't seem such an outlandish idea." The numbers would appear to back up this sentiment.

Just five years ago, the experts were bracing for the United States to become dependent on imported liquefied natural gas, with uncertain geopolitical consequences, such as dependence on vulnerable Middle Eastern suppliers and entanglement in a global gas market in which Moscow plays a troubling role. That now seems like ancient history, as record gas production has spared the United States the need for large-scale imports. According to one only somewhat hyperbolic headline, "We've Fracked So Much Gas We've Got No Place to Put It."

The math is shakier when it comes to oil. The most bullish projections foresee around 15 million barrels a day of U.S. liquid fuels production by 2020, while the consultancy Wood MacKenzie claims that U.S. production could rise to about 10 million barrels a day by the close of this decade and 15 million before the end of the next. In any case, U.S. consumption is vastly greater. As of 2009, Americans burned through nearly 19 million barrels of oil-based liquid fuels each day to power their cars, trucks, and factories, and although that figure has edged down over the past couple of years, domestic supply is still a long way from matching U.S. demand.

That said, U.S. demand for oil appears to have peaked. While part of the recent fall can be chalked up to slow economic growth, sustained high oil prices and improving automobile technology are also at work. New fuel- economy standards, if they stick, could drive U.S. consumption down much further. Ultimately, though, it's a massive stretch to think the United States will eliminate the gap between oil supply and demand anytime soon.

In any case, energy independence requires more than impressive arithmetic. As long as the United States is fully integrated into the world oil market, U.S. fuel prices will rise and fall along with events on the other side of the globe -- say, a war with Iran. Greater domestic production will blunt the economic shock of rapidly rising prices -- better to suddenly be sending massive sums to North Dakota than to Saudi Arabia -- but because oil producers everywhere are relatively slow to spend their windfalls, skyrocketing prices could still knock the economy on its back.

"We Can Drill Our Way Out of High Prices."

Don't bet on it. Some people claim that unleashing U.S. oil and gas resources would slash the price of crude. Who can forget the cries of "Drill, Baby, Drill!" that saturated airwaves during the 2008 presidential campaign? Others insist that, because oil is priced on a global market, increased U.S. output wouldn't move the needle. Even Douglas Holtz-Eakin, the top economist for John McCain's 2008 presidential campaign, has written, "Domestic action to increase production will not lower gas prices set on a global market."

The precise truth lies somewhere in between. If U.S. producers were able to massively ramp up output, the ultimate impact would mostly boil down to one big question: How would other big oil producers (mainly the Saudis and the rest of OPEC) respond to a surge in U.S. supplies?

To stop prices from falling, they could cut back their output in response to new U.S. production, much as they've tried to in the past. That's essentially what happens in the much-cited projections by the Energy Information Administration. In one recent exercise, for example, it looked at what would happen to gasoline prices if U.S. oil production grew by about a million barrels a day. The net impact was a mere 4 cents a gallon fall. Why? All but a sliver of the increase in U.S. output was matched by cutbacks in the Middle East, leaving oil prices barely changed.

Predicting OPEC's behavior, though, is notoriously difficult. No one country wants to bear the burden of selling less oil. In good times -- when demand is high and supplies from outside OPEC are weak -- the market is big enough for everyone to have a piece. That's what happened in the early 1970s: Rising demand for crude combined with declining supply in the United States to give OPEC unusual power. The result was a decade of historically high prices.

In leaner times, though, when demand is less robust and supplies from outside OPEC are strong, restraint can be difficult. Left with a smaller market to divide among themselves, OPEC producers can end up battling for market share, ultimately pumping far more crude than expected. This is in part what happened in the 1980s: High prices spurred new supplies and restrained demand, making coordinated OPEC action to prop up prices almost impossible.

Which pattern will we see in the face of rising U.S. supplies, combined with new production from Brazil, Canada, Iraq, and beyond? Given the growing demand for oil in China, India, and elsewhere, the safest bet is on continued high prices, though slightly lower ones than would prevail without the new supplies. As a senior OPEC official told me this year, "There is plenty of room for everyone." Yet new crude -- particularly if it collides with strong restraints on demand -- could change the equation. It would be foolish to rule out a crash.

FREDERIC J. BROWN/AFP/Getty Images

"The U.S. Energy Boom Will Create
Millions of New Jobs."

Overstated. The U.S. oil and gas boom has come at an auspicious time. With record numbers of Americans out of work, hydrocarbon production is helping create much-needed jobs in communities from Pennsylvania to North Dakota. Shale gas production alone accounted for an estimated 600,000 U.S. jobs as of 2010, according to the consultancy IHS CERA.

It's much harder, though, to extrapolate into the future. In a deeply depressed economy, new development can put people to work without reducing employment elsewhere. That's why boom states have benefited massively in recent years. The same is not true, though, in a more normal economy. Unemployment rates are typically determined by fundamental factors such as the ease of hiring and firing and the match between skills that employers need and that workers have. The oil and gas boom won't change these much.

That's why we should be skeptical about rosy projections of millions of new jobs. Wood MacKenzie, for example, claims that the energy boom could deliver as many as 1.1 million jobs by 2020, while Citigroup forecasts a whopping 3.6 million. Unless the U.S. economy remains deep in the doldrums for another decade, these will mostly come at the expense of jobs elsewhere.

That hardly means all the new oil and gas coming online is worthless. In the near term, it can support hundreds of thousands of workers who would otherwise be unemployed. In the long term, it should deliver a boost to the overall U.S. economy, raising GDP by as much as three percentage points, according to my colleague, Citigroup's Daniel Ahn. But we can't drill our way out of America's job crisis. The numbers just don't add up.

FILIPPO MONTEFORTE/AFP/Getty Images

"Strong Regulations Would Kill the Boom."

Dead wrong. The technology at the heart of the U.S. oil and gas boom has become central to the battle between the environmental community and the oil and gas industry. Drillers and their allies have often resisted new regulation, insisting that the industry is already heavily regulated at the state level and that fears of fracking are overblown. Barry Smitherman, chairman of the Texas Railroad Commission, captures the sentiment well, warning that more regulation could "kill the technology that's taking us to energy independence." Green groups have hit back with demands for stricter oversight of fracking, highlighting threats to air and water and disruptions to local communities. The Sierra Club has gone so far as to launch a "Beyond Natural Gas" campaign to accompany its efforts to move "Beyond Coal" and "Beyond Oil."

Some warnings, like an alarm in early 2011 that Pittsburgh's tap water was radioactive, have been over the top. Executed properly, development of shale gas and oil can be done in ways that safeguard the environment and protect communities. But there are always bad apples and sloppy operators. They require not only solid regulation, which often exists at the state level, but also strong enforcement and penalties to deter and punish violators, which too often do not exist.

This is not only about preventing bad behavior -- it's a matter of building public trust. Operators that refuse, for example, to support mandatory disclosure of the chemicals they use in fracking inevitably raise suspicions. That's true regardless of whether those chemicals actually endanger public health. Industry is at its best when it helps craft regulations that protect people and the environment while allowing robust development to proceed apace. But those who instinctively oppose stricter rules are sowing the seeds of their own misfortune: Robust regulation might add a few percentage points to the cost of producing natural gas, but weak regulation will sap confidence, and if communities shut down drilling, the price of natural gas will rise a lot more.

"The Energy Boom Is Bad for Climate Change."

It doesn't have to be. If there's one thing that critics of oil and gas development on the left have right, it's that we've done far too little to combat climate change. Serious action to mitigate the problem will require moving close to zero carbon emissions over the long run. That's right, zero. That will eventually mean little or no coal, oil, or gas consumption, unless the emissions produced by burning those fuels are captured and buried deep underground. Nor can we wait to start taking action: Because investments today can last decades, a meaningful strategy to curb U.S. emissions must begin, well, yesterday.

So is more oil and gas production fundamentally at odds with confronting climate change? It's not that simple. New natural gas production is actually great news for climate change. Gas is largely displacing coal, and it produces only half as much carbon dioxide when burned. Furthermore, while new coal-fired power plants are expensive and thus tough to displace later, gas-fired facilities are much cheaper. That makes it easier to replace them as lower-carbon options, such as nuclear energy, solar power, or coal or gas plants that capture their carbon dioxide emissions, become more attractive. All of this means gas is better for the climate.

Oil presents a tougher problem. New U.S. production doesn't displace dirtier fuels; indeed, insofar as it lowers gasoline and diesel prices, it feeds higher demand for crude. Yet unless massive U.S. production fundamentally overturns world oil market dynamics, the impact of new supplies on world prices (and hence emissions) will be modest. Instead, new U.S. output will largely displace production overseas, particularly from OPEC members. Not only will the scale of additional emissions be limited, but the gains to the U.S. economy will be larger than the accompanying climate damage.

Ultimately, U.S. efforts to combat climate change should focus mostly on the demand side of the equation. Curbs on fossil fuel usage, through steps like fuel-economy standards, carbon pricing, power plant regulation, and targeted incentives for clean energy, are far less likely to lead to additional emissions elsewhere than restraints on fossil fuel production. If U.S. policy aimed at oil demand ends up crashing crude prices, and that in turn reduces domestic production, the net result will still be good for the United States. But if the United States goes after the drillers without cutting back on demand, it'll just be shifting production to other countries.

"Barack Obama Is Bad for the Oil and Gas Industry."

False. The oil and gas industry does not exactly love President Obama. Many of the industry's most prominent members rail against his "job-killing tax hikes," bankroll his opponents, and assert that his claims about oil production "couldn't be farther from the truth." Some of this frustration stems from real policy disagreements. Many oil and gas producers scoff at efforts to promote clean energy. They chafe at the drilling restrictions put in place in the aftermath of the Deepwater Horizon oil spill and are apoplectic about the president's denial of a permit for the Keystone XL pipeline.

Yet Obama has presided over an extraordinary boom in oil and gas production. That fact alone suggests he isn't out to wreck the industry. So why the hostility? Bennett Johnston, then a Democratic senator from Louisiana, put the dynamic well, though he was talking about another president and another energy boom 30 years ago: "When I go down in my state, I see virtually none of the independent oil producers for Carter.… We've gotten higher drilling rig counts, more dollars being spent, more activity, more profits being made by oil people than ever before. But do they like Carter? Oh no, they hate him because of his rhetoric."

So let's get real: Obama may criticize the energy industry, but he has been pretty damn good for business. Washington under his watch may not be turning into Riyadh on the Potomac, but these are happy days for oil and gas producers. Even the president's efforts to remove industry tax breaks would amount to an additional burden of around $4 billion a year for an industry that posted more than $100 billion in profits (and far more in revenues) last year. And far from shutting down business with draconian new rules, his administration has worked to craft regulations that keep production going while also protecting the public. After pausing to improve safety provisions in the wake of the Deepwater Horizon oil spill, Obama has allowed new offshore oil drilling and production to resume. No president has a perfect record on energy. Yet if America's energy industry and its supporters set aside rhetoric, they'll find quite a lot to gush about.