Weak Dollar Fallout

Wednesday evening I was interviewed by a news radio station in Kingston, Jamaica. Unfortunately, it took place by telephone, rather than on location. Most of the host's questions concerned the likely course of oil prices, and she was particularly interested in the role played by the depreciation of the US dollar. Today's Washington Post includes a helpful set of graphs charting oil's rise over the last year in US and Canadian dollars, Sterling, Euros and Yen. Compared to the currencies of our major trading partners, the dollar's weakness explains about a third of the one-year change in what we pay for oil. Even if market fundamentals drive oil prices somewhat lower over the next year, as seems likely, the US and countries with currencies linked to ours might not get much relief, if the dollar continues its slide.

The article accompanying today's graphs mentions the usual factors spurring on oil prices: geopolitics, OPEC, and the weak dollar. The influx of portfolio investment into oil markets--a.k.a. "speculation"--is directly related to the decline in equity markets, and to inflationary expectations caused by spikes in consumer and producer prices and the general consensus that the Federal Reserve will focus on lubricating the economy, rather than fighting inflation. So investors seek stable value and positive returns in commodities, and the prophecy becomes self-fulfilling, for now, worsening the trade and fiscal imbalances contributing to a weak dollar. As bad as that cycle is for Americans coping with rising food prices, resetting adjustable-rate mortgages, and high fuel prices, it is disastrous for small developing countries.

Since January 2007, oil prices have gone up by about $40 per barrel, adding roughly $14 billion to our monthly oil import bill--$170 billion on an annualized basis. As painful as that has been for our $14 trillion economy, imagine what it has done to countries such as Jamaica, with a $13 billion GDP that relies on imported oil for most of its energy needs, and with a currency that has actually declined slightly against the US dollar. A $1 billion increase in their oil import tab isn't just an extra burden; it's a crisis.

The primary focus of the Jamaican radio discussion in which I participated was on the estimated oil price that should go into their national budget. Given their reliance on imported oil, that figure will largely determine how much is left over for all other consumption and investment, public and private. Guess too low, and programs and projects will be slashed later, or more money borrowed. Guess too high, and necessary programs get cut now, causing hardships and squandering political capital. $80 per barrel might look right based on the fundamentals, but can they afford to bet that the dollar won't drop another 10%, or that Venezuela--their main oil supplier--won't finally follow through on one of its unpredictable leader's threats? Many other resource-poor countries are in a similar bind, with a lot less control over the outcome than we have.