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Tuesday, July 15, 2008

Are US Purchases of Foreign Oil a Transfer of US Wealth Abroad?

While prof bug has been looking around in google for a good graphic display of the Pareto optimal --- essential before he posts the ready-to-publish commentary that completes the two-part analysis of growing American economic pessimism the last year or so --- he took some time off today to post two lengthy replies at Carpe Diem to a posted commentary left there by Mark Perry, the University of Michigan libertarian economist who runs that praiseoworthy site . . . full of illuminating, data-driven charts. 

The Claim Contestged by Perry: Unprecedented Transfers of US Wealth Abroad to Oil Producing States

In his new commentary, Mark Perry contested the claim of T. Boone Pickens, a billionaire Texas oil guy, who argued that the purchase of foreign oil by the US amounts to the largest transfer of wealth in world history.  Specifically, according to Boone Pickens,

"In 1970, we imported 24% of our oil. Today it's nearly 70% and growing.

"As imports grow and world prices rise, the amount of money we send to foreign nations every year is soaring. At current oil   prices, we will send $700 billion dollars out of the country this year alone - that's four times the annual cost of the Iraq war. Projected over the next 10 years the cost will be $10 trillion - it will be the greatest transfer of wealth in the history of mankind. America uses a lot of oil. Every day 85 million barrels of oil are produced around the world. And 21 million of those are used here in the United States.That's 25% of the world's oil demand. Used by just 4% of the world's population.

"Can't we just produce more oil? World oil production peaked in 2005 . . . "

Perry's Criticism 

Now let's see here. Foreign oil producers like Canada, Saudi Arabia, Mexico (top three countries for U.S. imports) send us their oil, and we send them "green pieces of paper with dead presidents' pictures," aka as USDs. That imported oil helps to fuel our economy, cars and factories, raising our standard of living.

Oil producers in Canada, Saudi Arabia and Mexico now have US dollars, which must be spent back in the U.S. on American goods and services, or invested in the U.S. financial markets, either by the oil producers, or by those who buy the USDs from them.

Importing oil certainly involves a transfer, but it's not a transfer of wealth, it's a market transaction involving the exchange of oil for currency.

If' it IS a transfer of wealth, it seems like we got the better end of the deal: Their valuable natural resources get transferred to the U.S., in exchange for paper currency, which gets spent back here eventually.

In T. Boone Pickens' version, it seems like wealth gets transferred overseas with out any benefit to the U.S. But oil imports, like all trade, involves mutually beneficial exchange. Remember trade is win-win, not win-lose (like T. Boone Pickens suggests), or lose-lose (the way the Soviets supposedly described a market exchange- buyers loses their money, and sellers loses their goods).

Update: One dictionary definition of "wealth" is "an abundance of valuable resources." In that case, wouldn't T. Boone Pickens' "greatest transfer of wealth in the history of mankind" be a transfer of wealth in the form of valuable natural resources (oil) TO the United States, and not a transfer of wealth FROM the United States in the form of paper currency?

The First Set of Buggy Comments

A very stimulating commentary, Mark, and so are the posted replies.

1) Your basic claim is true enough: once the dollars we use to buy oil are owned by foreign governments or firms, either these owners or others to whom they sell the dollars  ---at a reduced nominal exchange rate for the US $ --- will eventually invest them back in the US or use them to buy American exports.

If, though, most are used for investment purposes here, then either American taxpayers or American owners of business firms (say, stockholders) will have to pay interest on those invested dollars to foreigners one way or another. In all these cases, there is a transfer of US wealth in the form of ongoing payments to foreigners.  At a minimum if there are Treasury bonds on which the interest is being paid, US taxes on American citizens will have to go up --- either that, or the US government has to start printing dollars and hence cause corresponding rates of inflation. 

2) There's also another wealth effect, the standard one talked about when a country's exchange rate depreciates. If the foreign owners of the oil-dollars sell them to other foreigners, then that will lead, as noted above, to the decline in the nominal dollar exchange rate. That makes the US as a country less rich in the world.

The offsetting compensation is that we will then export more and import less. As some of your other posts note, US GDP growth is being fueled for the first time since the late 1980s and very early 1990s by our rapidly growing export sales.

3) Then there's a distributional effect of ever higher oil prices, whether the oil is produced here or abroad (unless enough future oil supply reaches the US and other countries enough to cause oil.prices to decline . . . something Boone Pickens, rightly or wrongly, says won't happen.   Quite simply, these ever higher oil prices --- whether or not we're dependent on foreign imports or not --- have and will continue to hit harder on low-wage and average-wage Americans, and they will continue to dislike the changes in their household consumption and the decline in their real wages.

And they will continue, as a result, to be pessimistic about the US economy, with the predictable fall-out on the presidential and Congressional elections this fall . . . and very likely into the future.

4) Then there are slightled foreign and security policy fall-outs if we continue to depend, directly or indirectly, on Middle East oil imports.  (Remember, the world oil market is an integrated one.  It doesn't matter if the US itself imports most of our foreign oil from areas like Nigeria, Mexico, Canada, and Nigeria.)  Two  such fall-oouts are worth underscoring. 

  • As foreign governments like those in the Persian Gulf gain more and more financial influence through their dollar holdings --- however invested in the US (Treasury bonds, corporate bonds, the stock market, outright purchases of US firms or real estate) --- they will gain political leverage of sorts, won't they? over US policymaking. Not just, say, in the need of the Federal Reserve to consider monetary policy in the light of what those governments will do with their dollar holdings, but in growing influence over certain aspects of US foreign policy.

  • We are and have been way too enmeshed in the military protection of gangster-Arab regimes in the Middle East because of our oil dependence. That has given them far too much influence in our foreign and security policies as a great power.


Mind you, I'm not saying that we intervened militarily in Iraq mainly because of oil.  After 9/11 terrorist attacks, the US and other like-minded democratic countries like Britain, Australia, Poland, Czech Republic, and Spain--- all of which participated in the military toppling of Saddam in the springof 2003 --- would likely have gone to war out of shared worries that Saddam had WMD programs or stockpiles or both and would likely use them one way or another to support Islamist terrorist organizations like Hezbollah or Hamas or maybe even Al Qaeda at some point.  This key point --- war with Saddamite Iraq was likely inevitable for reasons of national security and US foreign and security policies --- was argued recently by prof bug at length, and with a fair amount of documentation, on this site recently.

Still, if there were no oil in Iraq or the rest of the Persian Gulf (or we were entirely energy independent) I doubt whether we would have been devoting so many resources ---- in US dollars and blood --- in that area of the world.  In fact, on a different plane, Saddam Hussein wouldn't have been able to develop WMD programs and at one point or another chemical and biological weapons without oil revenues to finance them.

5) What can we conclude?

Alas, mainly this: the more we become dependent on Arab oil --- and it makes no difference if the US itself imports mainly from non-Arab oil producing states --- the more we become prisoners of sorts of what ensues in the Middle East, way beyond what otherwise our security interests would require.

And this is a region of the world that is profoundly unstable, with the instability likely to extend way into the future.

The Second Set of Buggy Replies

This Time, To A Fellow Poster Named Craig

"Those pieces of paper are currently being used, among other things, to purchase more pieces of paper known as Treasuries (creating more future debt for US tax payers and more transfer of wealth) and funding terrorists." --- Mark Perry
Those pieces of paper don't create debt, our very own government creates it. Please, let's not confuse a so-called trade deficit with a federal government budget deficit. The former doesn't matter and the latter has nothing to do with it.

Alas, Wrong Craig (Buggy Clarification)

1) In reality, the two deficits --- federal and trade (more accurately a current account) --- are causally related.

You see, by definition, a current account deficit --- trade in goods and services (plus unilateral transfers like foreign aid or Mexican workers in the US sending dollars home) --- exactly equals the gap between US investment at home and abroad and US savings. The gap is filled by foreigners using their savings to buy US financial assets . . . including Treasury bonds. 

2) The US savings-investment gap: though there is no direct measure of US savings --- and some contest the stress on "net" vs. "gross" savings and whether average individuals are wrong to consider their investments in pensions and others as "savings" --- those savings do, by definitional use, equal net investment.

And if the federal government is running a deficit, it reduces private US savings by selling Treasury bonds (and bills) and hence increases the gap between savings and investment. The greater the federal deficit, the greater the gap (unless, of course, which is not the case, US private savings were large enough to cover both federal deficits and private and public investment.)

3) Oppositely, countries with excess savings over total investment will run current account surpluses and export the excess capital abroad to balance their overall balance-of-payments.

4) All this is definitional, please note.

The causal influences and direction are more controversial: for instance, there are lots of foreign investors who send their capital to the US. This raises the US$ nominal exchange rate, and that in turn reduces US exports and increases US imports, possibly creating the current account deficit that balances the capital account surplus (short- and long-term capital inflows and outflows). 

More concretely:  If it helps, think how the inflow of foreign savings each year --- used to buy American Treasury bonds, corporate bonds, corporate stocks, or real estate or start a foreign multinational business from scratch --- requires that Middle Eastern currencies or Russian rubles or euros or yen or Chinese yuan have to be exchanged for dollars.  The result is to keep the dollar from falling as the annual US current account deficit begins to emerge and continue over each 12 months, and hence to keep US exports down and imports up.  (A large part of the inflow of dollars into the US comes from countries like China or Japan, heavily dependent on export-led growth, and hence seeking to exchange yuan or yen for US$ to keep the $ from depreciating steadily against their currencies.  For the oil-rich Persian Gulf countries, they can't possibly absorb all their surplus dollars by spending their equivalent in their local currencies at home, and so they need to place their dollars in financial assets in the US --- which has a stable and rich country with a huge diversity of financial assets --- or in the EU or Japan, where they can earn fairly predictable interest or capital gains on those investments.)

5) Note one other thing.

Contrary to man-in-the-street economics, the industrial countries with the largest current accounts as a percentage of GDP --- leaving aside Norway, the third or fourth largest oil exporter in the world --- are Japan and Germany, and they have been for decades. And yet the two countries have vied since 1991 to rack up the worst record of real GDP growth since the Great Depression of the 1930s.

By contrast, the US has been running an ever larger current account deficit since 1991 (as it did in the late 1970s and the early 1980s), and yet it has grown far faster in GDP than any other major industrial country.

And capital inflows from abroad have financed the ever larger current account deficit. Can this go on forever? Should it?

6) What can we infer from these last comments just set out in 5)?  Specifically, are we not benefiting now, as long as inflationary pressures are limited in the US economy (so far anyway), from a falling dollar as foreign investors realign their portfolios and sell off some of their US financial assets for euro-based ones? In the process of this falling exchange rate of the $, US exports have been booming . . . their growth well over 15% yearly for several years now?

PS It's a pleasure to read Mark's data-filled posts and his clear, to-the-point commentaries, as well as participate in these exchanges when I get some free time. Thank you everybody.