The front page story on today's Houston Chronicle bespoke of the travails of $100 per barrel petroleum to modern day society. It was a good article, underlying the fact that the oil and gas industry does not waste one drop of a barrel of petroleum, but instead finds a way to use all of it. I write here because there was one aspect of the price rise of petroleum in recent years that was not covered by the story and that is the weakening of the United States dollar as a currency. This matters because petroleum is denominated in U.S. dollars when it is traded on world markets.
To give gentle readers a sample of how much the U.S. dollar has weakened in value over the past 5 years, I point you in the direction of the excellent Yahoo Finance and world currency website. What is really great about the Yahoo finance pages is that a reader can easily compare how the dollar has fared in world currency markets and what effect this can have on tradable goods.
Examples of how much the dollar has weakened include:
1) The dollar verses the euro. The dollar has gone from being worth 1.20 euros in 1999 to 0.96 euros in January 2003, all the way down to a petty 0.678 euros in January 2008. Put it another way, the euro was worth some 85 cents when it was created. Now a euro is worth about $1.50. The dollar has effectively lost some 44 percent of all of its value against the euro in the past 9 years.
2) The dollar verses the Brazilian real. I went to Brazil in 2003 on vacation. The real, (pronounced "hey ais"), was trading at 2.8 to 1 dollar when I went there. As one can see from the chart, the real has gone from 3.5 reals to 1 dollar in January 2003 to 1.76 reals to 1 dollar in January 2008. That's right folks. The Brazilians, who possessed currencies which suffered massive hyperinflation during long stretches of the 20th century, are now in possession of a currency which has doubled in value against the dollar in the past 5 years.
3) The Canadian dollar verses the U.S. dollar. The loonie has gained 1:1 parity on the dollar for the first time in some 30-40 years, having been worth only 64 cents in January 2003. So the loonie has also gained 55 percent in value against the dollar.
4) The U.K. pound verses the U.S. dollar. When I first went to the U.K. on holiday in May 2002, the Queen's money was worth $1.50. Now the pound, which hit $2 earlier this year, is just under, currently trading at $1.97. The dollar has lost 30 percent of its value against the pound in the past 5 1/2 years.
5) The Thai baht verses the dollar. The baht was trading at 43 to the dollar in January 2003, but now it only takes 30 baht to buy a George Washington note. The dollar has slid some 31 percent in value against the baht in the past 5 years.
6) The Russian rouble has gone from 32 to the dollar in January 2003 to 25 to the dollar in January 2008.
But then we compare these numbers against some of America's big trading partners, including Mexico, Japan, and China.
7) The Mexican peso has held steady against the dollar, losing only 8 percent of its value since January 2003.
8) The Japanese yen continues to bounce around the 110-120 yen to the dollar mark, a range it has done with some exception of the endaka period of the Clinton years.
9) Even the Chinese yuan, which traded at 5.2 to the dollar when I was in China, and which was revalued at 8.28 o the dollar in the 1990's, has been gaining strength and is now at 7.4 to the dollar.
As is well known, the Asian and Middle Eastern countries have routinely purchased untold amounts of U.S. Treasuries, both to help buoy their own currencies so as to continue to be able to sell something to America on terms helpful to themselves, and as a hedge in case markets lose faith in their own currencies. They also need a place in which to invest which is relatively safe and where their money will be put to productive use. They find all of these when they buy American treasury notes. In contrast, countries which have done little to interfere with currency markets have seen their currencies strengthen considerably against the dollar.
The Wizard thinks that what we are seeing is a long slow correction in the world's terms of trade with America. The United States has been running astronomically large current account deficits for 25 years now, and we have run up trillions of dollars of debts on our federal treasuries. Americans have essentially stopped saving money. Moreover, we will see in the next decade the retirement of the Baby Boomers en masse, which will per force require the United States to either raise taxes to meet the political demands of the Baby Boomer cohort retirements, cut their benefits, or continue to let things stay as they are and run up deficits and inflate them away through a punitive devaluation of the U.S. dollar.
The logical conclusion here is that world currency markets have spoken and have decided that the United States will not put its financial house in order, hence world markets will force America to put its house in order via the devaluation of the dollar. This of course revalues the terms of trade in all tradable foreign goods. As the Chronicle article notes, Americans will find foreign travel much more expensive, but we know that petroleum is also one of those traded goods. The Wizard postulates that had the dollar retained its strength, then we would be seeing oil prices at $60-$70 per barrel and not $100. That of course still means that the price of a barrel of oil has gone up 2-3 times since 2000, but that is different from a 5 fold increase in prices. What is interesting though is that a continuing slide in the value of the dollar would presumably improve terms of trade vis-a-vis the rest of the world, but it would also continue to push up the cost of petroleum imports which in turn would offset the improvements of the balance of America's terms of trade.
It is hard to tell how much of a correction would be required for America to come back to an equilibrium. The Wizard supposes that the Chinese, Japanese, and the Middle Eastern countries would need to be convinced that the dollar would continue to erode in value to the point where they would quit buying them. That in turn would send the dollar into a fully corrective tailspin. Maybe the dollar needs to lose another 50-75 percent of its value, on top of what it has lost already, before our current accounts finally balance out once again. On the bright side, manufacturing and other aspects of the economy which are not stuck in country would find it more preferrable to stay in America rather than to flee offshore. Jobs would be more likely to stay in country, indeed some of them might come back here.
As for what that would do to the price of a barrel of oil? Well, are you prepared for oil selling at $200 - $300 per barrel? Hold on to your seat folks. That would be a great reason for those jobs to come back here if we see prices like that. Prices like that also might finally make alternatives like cellulose ethanol a viable competitor to conventional petroleum. Hmmm. Now is that another reason why those Middle Eastern governments buy up our treasury bills? Think about it.
Wizard