Solving the trade deficit – more than increased manufacturing

The trade deficit has declined and there has been a closing of the current deficit. Some of this closing has been associated with the declining dollar. Imports are getting more expensive and exports are finding new markets because they are cheaper. We have talked about the added benefit of a decoupled global economy. A slowdown in US growth will cut imports while the fact that the rest of the world is still growing is good for US exports. This is basic trade theory at work. However a decline in oil prices will have a quick benefit.

Crude oil imports are now at $26 billion per month. While goods exports is still higher, crude oil imports have increase fivefold since 2000. Higher oil prices have not been good for the dollar. The increase in oil has matched the decline in the dollar since 2000.

A decline in oil prices, given the current relationship will lead to a strengthening dollar and further improvement in the trade balance. Of course, the sensitivity to a crude oil price decline is not high. The dollar has declined by 30% since the beginning of 2002 while oil prices increased by 300+% over the same time period. A decline in oil prices from current levels of $95 per barrel to $85 per barrel will only lead to a possible 1% increase in the dollar. The impact on the trade balance will be a decrease in imports of about $2.5 billion.

Crude oil prices will be a key driver for the dollar over the next few months.