The Dollar and Oil

Here is a further discussion of oil prices, which I had began in a post last week.

I had pointed out that domestic oil production would decrease our trade deficit. The mechanism has feedback--which can be good for us or bad depending on which side of the curve we are on. Currently we are on the wrong side of the curve.

When there is pressure for oil prices to rise, say by India and China rapidly growing, this causes the price of oil to rise. Now even if we import the same volume, it costs us more, so our trade deficit grows, the dollar falls. The result is that oil costs even more for us; it is a vicious cycle. It can be a virtuous cycle though. If we produce more oil, we will purchase less, the dollar will rise and then it will cost even less for what we import.

It is all econ 101, but you don't have to believe me--only an MBA. Believe the guy below, he is saying the same thing.

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. Last year, the US spent US$331 billion on oil imports, which was 47 percent of the US trade deficit of US$708 billion. If the price of oil had remained at US$65 a barrel, the cost of the same volume of imports would have been only US$179 billion, and the trade deficit would have been one-fifth lower. 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.

Martin Feldstein is Professor of Economics at Harvard and President of the National Bureau for Economic Research.