Sunday, February 26, 2012

The dollar and the new oil production in the US

There is a key theme in dollar forecasting over the last 20+ years.

There is a negative correlation between oil and the dollar.

Higher oil prices will cause a dollar drop because the trade deficit will increase given the strong dependency by the US on oil.  What happens if the  US becomes less oil dependent? The negative correlation that we have generally expected over the last two decades will no longer exist or will be muted. In fact, if the US is less oil dependent, then the value of the dollar will actually increase during an oil crisis because the safety effect will become more important. Clearly the doomsday forecasters concerning the trade deficit will have to adjust their rhetoric because the numbers are looking much more attractive. Current account deficits of 3% are more normal. The flow of oil to different countries has also changed so the dependency on the Middle East has declined. The oil market pricing is now more determined by emerging market demand which will have an effect on the dollar but again we can see more muted effects over the next few years.

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