Clarification: Weak Dollar Is Not Driving Oil Up But High Oil Is Driving Down The Dollar

The President of the National Bureau of Economic Research (NBER), Martin Feldstein, gave everyone an economics lesson today and explained why it is incorrect to claim the weak dollar is responsible for high oil prices. Instead, the Harvard economics professor says, it is in fact high oil that is driving down the dollar.

Glad we got that straight. Here are the details:

The weak dollar is not driving up the global 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 [or thereabouts]. 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.

Any lower price in euros would cause an excess of global demand for oil, while a price above 75 euros would not create enough demand to absorb all of the oil that producers wanted to sell at that price.

However, while the weak dollar is not responsible for sky-high oil, it is making oil more expensive for us:

The only effect of the dollar’s decline is to change the price in dollars relative to the price in euros and other currencies.

More Importantly, high oil prices will keep the dollar weak:

If the price of oil had remained at US$65 a barrel…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.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.