"The US Dollar Hits an Oil Slick"

Martin Feldstein says to expect more rapid dollar depreciation in coming years:

The US dollar hits an oil slick, by Martin Feldstein, Project Syndicate [alt]: The rapid rise in the price of oil and the sharp depreciation of the dollar are two of the most noteworthy developments of the past year. ... To many observers, the combination of a falling dollar and a rise in oil prices appears to be more than a coincidence.

But what is the link between the two? Would the price of oil have increased less if oil were priced in euros instead of dollars? Did the dollars fall cause the price of oil to rise? And how did the rise in the price of oil affect the dollars movement? ...

The thinking behind the question of whether oil would cost less today if it were priced in euros seems to be that, since the dollar has fallen relative to the euro, this would have contained the rise in the price of oil.

In reality, the currency in which oil is priced would have no significant or sustained effect on the price of oil when translated into dollars, euros, yen, or any other currency.

Here is why. The market is now in equilibrium with the price of oil at US$120. That translates into 75 euros at the current exchange rate of around US$1.60 per euro. If it were agreed that oil would instead be priced in euros, the quoted market-equilibrating price would still be 75 euros and therefore US$120. ...

Of course, the rate of increase of the price of oil in euros during the past year was lower than the rate of increase in dollars. ... But that would be true even if oil had been priced in euros. ...

The key point here is that the euro price of oil would be the same as it is today. ... The only effect of the dollars decline is to change the price in dollars relative to the price in euros and other currencies.

The high and rising price of oil does, however, contribute to the decline of the dollar, because the increasing cost of oil imports widens the US trade deficit. ...

The dollar is declining because only a more competitive dollar can shrink the US trade deficit to a sustainable level.

Thus, as rising global demand pushes oil prices higher in the years ahead, it will become more difficult to shrink the US trade deficit, inducing more rapid dollar depreciation.

Comments

says...

The US is currently importing 9.24 Million barrels of oil per d

or 3.372 BB of oil per year.

At $130 per barrel, the cost is $438 Billion per year.

That is 3.2 % of our $13.6 Trillion economy.

Oil was only about $60 / barrel at the beginning of 2007, so oil is contributing an additional $230 Billion per year to our trade deficit. This is an unsustainable spiral that is best broken by reduced demand for oil. The easiest way to reduce oil use is to increase efficiency.

[Rajesh Raut]

The rising price of oil may be increasing the U.S. trade deficit but what about the dollar-zone trade deficit? Imports from countries that use the dollar as its currency have no effect on the trade value of the dollar. Similarly, trade with countries that use currencies that are fixed against the dollar have no effect on the trade value of the dollar. The dollars are simply added to the foreign reserves and the local money supply expands to accommodate it.

Conversely, when a oil producing country with a fixed value to the dollar exports to a country that does use the dollar; it pushes up the value of the dollar.

[Peter]

>The easiest way to reduce oil use is to increase efficiency.

the destruction of manufacturing doesn't leave us with
many opportunities to increase efficiency...at some point
we will have to, as a nation, accept 7-8 $/gallon gas and
plan accordingly.

[2slugbaits]

Hmmmmm. If oil were priced in euros rather than dollars, then this would suggest that the dollar was no longer the world's reserve currency. If that were true, then I suspect a lot of things would cost more, not just oil. So I think Feldstein is right as long as he stays within the narrow lane of an even narrower argument, but given what euro priced oil woulf say about other things concerning the dollar's status, I find his broad conclusion a little hard to swallow.

[Deficit]

The consumer goods trade deficit is one factor. Also relative internal inflation rates. Ours has been higher than most advanced nations for some time.

With no net internal savings, net borrowed capital for business expansion must be imported. Even if consumers dramatically slowed their buying of imports today, the business need for capital alone would still create a deficit. Then there is the chronic fiscal deficit that is too large to be monetized without hyper inflation... Martin is probably correct, the dollar is likely fall for awhile yet. Albeit in a zig zag fashion.

[Bruce Wilder]

Martin Feldstein: Of course, the rate of increase of the price of oil in euros during the past year was lower than the rate of increase in dollars. ...

The high and rising price of oil does, however, contribute to the decline of the dollar, because the increasing cost of oil imports widens the US trade deficit. ...

The dollar is declining because only a more competitive dollar can shrink the US trade deficit to a sustainable level.

Thus, as rising global demand pushes oil prices higher in the years ahead, it will become more difficult to shrink the US trade deficit, inducing more rapid dollar depreciation.

Is it just me, or did Feldstein just spin himself dizzy?

Of course, the decline of the dollar and the rise in oil prices reinforce one another, and both are part of the process of the forced reduction in U.S. overconsumption. Duh.

Memo to Marty: Counterfactuals are not evidence. Try not to be an idiot.

[Why Now?]

"The dollar is declining because only a more competitive dollar can shrink the US trade deficit to a sustainable level."

Nothing says the trade deficit has to shrink at any particular time. Deficits can abide as long as other nations are willing to send products to us in return for the promise of future repayment, or buy ownership positions. The dollar has begun declining now, rather than later, because other nations have become less willing to loan to us. Loan default rates have shocked foreign savers, and they withdrew somewhat from everything not guaranteed.

Transfer of ownership to foreign savers has been taking place at about 1% per year. They no longer want non guaranteed debt, and have been partially blocked from speeding up transfer of ownership. Net result, foreign savers don't want as many dollars at a time that the supply of dollars has been expanding faster. We have to send more steel and autos overseas to entice more foreigners to accept the flood of newly created dollars.

Everyone works, but the standard of living gradually falls.

[hari]

I've difficulty understanding exactly what Marty is trying to say or argue here taking into account the gallapoing US trade deficit and unit oil prices (in US$).

May be he's concerned about the devaluation of the dollar compared to rising euro - resulting in still higher unit price of oil.

Why can't he deal with role of Feds current rate policy decisions and its global consequences on commodity markets including oil?