Friday, June 13, 2008

Falling dollar, high oil prices, and trade deficits

The Falling Dollar, High Oil Prices, and Trade Deficits

Raymond L. Richman, Howard B. Richman, and Jesse T. Richman

Why have crude oil prices escalated during the past three years? Most economists attribute the rise to increased demand and the failure of supply to keep pace. And some believe the bubble has been caused by speculators, betting on the fact that the U.S. will continue to do nothing about it. According to other observers, the immediate cause of what appears to be a “bubble” in the price of oil during the past three years was the fall of the dollar relative to the Euro and other currencies during the past three years. Oil contracts are typically expressed in dollars. Measured in Euros which have appreciated about fifty percent against the dollar, the price of oil has increased hardly at all during the past half decade. While high oil prices have created a serious problem for the U.S., countries enjoying strong currencies have felt little pain at all.

We believe that the basic cause of the decline in the value of the dollar was our huge trade deficits which grew to a shocking $760 billion in 2006, falling in 2007 to $708 billion and rising again in 2008. The rising price of oil in dollars merely exacerbated the trade deficit and the dollar’s decline. The fall of the dollar against the Euro made American goods less expensive to foreigners and accounted for most of the reduced trade deficit observed in 2007.

For many years trade surplus countries like Japan, China and the oil-exporting countries invested their surplus dollars in American assets such as U.S. Treasury bonds. The flow of these funds to the U.S. prevented any downward pressure on the dollar but as the dollar began to show weakness, they reduced their purchases of U.S. assets and increased their purchases of Euro assets and assets in other countries. This strengthened the Euro and precipitated the decline in the dollar. The trade deficits are the real cause of the weak dollar. The falling dollar is the result of the fact that the trade surplus countries did not use the dollars they earned to buy U.S. goods or services but used them to buy financial assets here and increasingly abroad.

Later they diversified into corporate securities. The latest manifestation is the so-called Sovereign Wealth Funds. Wall Street says this shows the confidence foreigners have in the U.S. economy! Well, that confidence has been waning; they have been using their ever-larger supply of dollars to buy Euro assets which strengthens the Euro and explains the collapse of the dollar relative to the Euro.

The U.S. government in the person of Treasury Secretary Henry Paulson, has been trying to bring down the price of oil by treating its symptom, the low value of the dollar relative to the Euro, trying to get foreign central banks to support the dollar. That would do nothing to correct the cause of the dollar’s decline. The cause of the collapse of the dollar is the trade deficit.

The administration’s economists denounce any action to restrict imports as protectionism. They sat, and continue to sit and pontificate in their ivory towers on the benefits of free trade while the trade deficits accelerated America’s de-industrialization causing the loss of U.S. factory jobs, wage stagnation, a worsening distribution of income, soaring commodity prices, and economic stagnation, as well as a depreciating dollar.

Unfortunately, neither the Fed nor the Treasury has any solution to the problem of the falling dollar and its cause, the trade deficits. Dr. Bernanke himself said in a speech while he was Chairman of the Council of Economic Advisors that market forces cannot be relied upon to get the trade deficits under control because of the foreign governments’ manipulation of flow of foreign savings to the U.S. The collapse of the dollar stimulated U.S. exports in 2007 but by April, 2008, the deficit was as great as ever thanks to higher prices of crude oil imports.

We do not need to submit passively to the high price of imported oil or a falling dollar. For thirty-five years we have been on notice that our dependency on imported oil endangers our economy and our security. Nevertheless, our government has prohibited drilling for oil on public lands like the ANWR and exploiting our huge resources of shale oil just as Canada began expoiting its oil sands. Congress should announce that drilling will be permitted in the Arctic National Wildlife Refuge (ANWR) and other public lands and offshore. How much oil is there in the ANWR? A U.S. geology mission in 1998 estimated 4.25 billion to 11.8 billion barrels. Just announcing that we would authorize drilling in the ANWR would cause the price of oil to fall substantially as speculators run for cover.

Drilling in the ANWR would have few social costs, environmental or otherwise. There is no evidence that drilling has had any effect on wildlife anywhere. Environmental concerns are sometimes legitimate. But this one is not. Drilling in Alaska has proven to be environmentally neutral. What better place to drill that an area devoid of humans. In any case the benefits would be considerably greater than costs. The oil that is foregone by the current restrictions on drilling has a market value of many hundreds of billions of dollars and the exploration, drilling, and pipelines would provide many thousands of good jobs directly and indirectly. And longer-term, we should continue to seek alternative sources of energy for transportation uses. The hybrid cars and projected use of electricity as a substitute source of power is already having an impact.

More can be done in the short-run. We can easily reduce the trade deficits. As we show in our recently published book, Trading Away Our Future, we need to inform all of our trading partners with whom we have chronic trade deficits that they must purchase as much from us as we purchase from them or we will enforce a trade balance by reducing our imports from them. If necessary, we may have to ration some oil uses, particularly gasoline.

A reduction of our imports of oil by ten percent would require the reduction of imports from current levels of 9.3 million barrels to 8.4 million per day. Only our imports from OPEC countries would need to be affected. Our imports of crude oil from OPEC in 2007 were about 38 percent of our total imports and Saudi Arabia and Venezuela alone accounted for 28 percent. Canada and Mexico are the other principal suppliers and balancing trade with them is not a great problem because our NAFTA partners are not imposing barriers to trade.

Reducing our oil imports ten per cent would cause a dramatic fall in world oil prices as soon as it were announced. A similar response could be expected when the U.S. simply announces that we will authorize drilling on public lands. The world price could be expected to fall by 20 percent or more. Americans will have to adjust to the reduced quantity of fuel available by making greater use of public transportation, sharing rides, using hybrid vehicles, etc. etc. The U.S. Department of Commerce has a stand-by plan for gasoline rationing and it, or a simpler version, could be implemented quickly.

The high price of gasoline is equivalent to a regressive tax, weighing most heavily on low income households. It is almost as regressive as a poll or head tax. It has the effect of causing low income families to reduce their consumption of other goods and services while middle and upper income families could care less whether a fill-up costs $30 or $60. Rationing would have the effect of reducing the price of oil and gasoline and all households would benefit thereby. Households willing to forego their entire ration should be authorized to sell them. It would be simple to create a market for them. (Just this sort of rationing plan was suggested by Prof. Martin Feldstein in a 2001 paper. (See

The Democrats will probably control the next Congress and administration. To date they have been subservient to the environmental lobby. It was Pres. Bill Clinton who vetoed in 1995 the authority to drill in the ANWR. And Senators Obama, Clinton, and McCain are all on record as opposing drilling in the ANWR. It is laughable that they and the President have enacted a law requiring the substitution of mercury-filled fluorescent lamps for incandescent lamps. There is not now nor does there ever need to be a shortage of electricity in the U.S. Prospective shortages of electricity can be blamed on opposition to new coal-powered and new nuclear plants. The high price of motor fuel and the trade deficits are the problem. What we need is a lobby as powerful as the environmental lobby that will advance, not diminish, the welfare of the American people.

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Dr. Raymond L.Richman is Professor Emeritus of Public and International Affairs at the University of Pittsburgh; Dr. Howard B. Richman teaches economics on the Internet, and Dr. Jesse T. Richman is Asst. Professor of political science at Old Dominion Uniersity. Their book Trading Away Our Future, published by the Ideal Taxes Association ( deals with many of the above issues.

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