Krugman

In the NYTimes today, behind their paywall:

We shouldn't read too much into a couple of days' movements in stock prices. But it seems that investors are suddenly feeling uneasy about the state of the economy. They should be; the puzzle is why they haven't been uneasy all along.

The rise in stock prices that began last fall was essentially based on the belief that the U.S. economy can defy gravity -- that both individuals and the nation as a whole can spend more than their income, not on a temporary basis, but more or less indefinitely....

As I summarized it awhile back, we became a nation in which people make a living by selling one another houses, and they pay for the houses with money borrowed from China.

Now that game seems to be coming to an end. We're going to have to find other ways to make a living -- in particular, we're going to have to start selling goods and services, not just I.O.U.'s, to the rest of the world, and/or replace imports with domestic production. And adjusting to that new way of making a living will take time.

One of the more common conspiracy theories re: Iraq & Iran is that the US attacked because Saddam started denominating oil sales in Euros, and Iran is next because of the opening of their oil bourse. Paul Krugman dismissed this theory before the Iraq War began, and on matters economic I happily defer to him. However, one of the definite advantages the US gains from oil denominated in dollars is that the when the value of the dollar goes down, the price of oil does not go up for the US as it would for any other country. This isn't conspiratorial at all. While the price of oil isn't "pegged" to the dollar the way the Yuan is, the US is insulated from its own deficits in a way that no other country is in relation to oil.

Brief illustration: If the price of oil is US$50/bbl and the Canadian dollar declines to C$0.75/US$, then the price of oil in Canadian dollars is more than C$65. If the Loonie climbs to parity, then we pay $50/bbl. But if the US dollar declines in value relative to the Euro, or Yuan, or whatever, America still pays the same $50. This is good for OPEC when the dollar is high (when Democrats run things) and bad for OPEC when the dollar is low (Bush.) It's less important when the price of oil is going up generally, but it's really bad for OPEC when the price of oil goes up while the dollar sinks.

This amounts to a subsidy from the OPEC nations to the US. As you might imagine, some in OPEC aren't particularly happy with subsidizing the Great Satan. There's been some musing by OPEC members to switch to a basket of currencies, or to stop denominating the price of oil in any currency whatsoever and let it float relative to all currencies. None of this talk has (officially) been aimed at bringing the Zionist lackey to its knees. As recently as 2002, the Venezuelan oil minister was saying that the system worked fine and there was no reason to change.

We can see that the scenario some people see - OPEC switches to Euros, world ends - is unlikely. In fact, it's probably reversed. OPEC is only going to jump currencies after there's a serious decline in the dollar, one they can't ignore. (Not saying it's going to happen at all, but if it is a decline in the dollar is a necessary precondition.) This will finally expose American consumption to the kind of discipline that other countries have been exposed to. The next step will be for China to unlock the Yuan, and the global economy might finally be able to find a balance again.

One interesting point to note: Two major chunks of US imports - oil and Chinese goods - have been insulated from changes in the value of the US dollar because of OPEC and Chinese policy. Meanwhile, China has been propping up the US dollar (and maintaining its peg) by buying massive amounts of US debt. So three of the largest impacts on the US economy - Bush's deficit, oil consumption, and Chinese imports - are effectively being maintained artificially by policies of the Chinese, American, and Saudi governments. Without Chinese lending, American interest rates would be higher and the housing bubble couldn't be sustained. Without Chinese goods, most Americans couldn't afford their lifestyle. They certainly couldn't do so without the easy money of home financing, again made possible by low interest rates via Beijing.

And finally, the US economy, already troubled with oil at $70/bbl, could very well fall into recession if Americans have to pay the full price of oil. I've heard Brad Delong say that the US$ may need to decline by as much as 30% to restore balance. If that's the case, then a US$70 barrel of oil may suddenly cost close to $100/barrel, even assuming the price of oil doesn't increase. $100/barrel would be 25% over the 1980 peak price of oil.

So even if the global economy reaches a "balance" of a higher Yuan, lower dollar, and controls the US deficit, we can see that it might still be quite... unbalancing.