The Dollar's Decline: Taking Responsibility for the Future

As of 2008Q1, wholly 100% of the increase in the trade deficit since 2001Q4 is accounted for (in a mechanical sense) by the increase in the value of oil imports. And the dollar share of reserves appears to continue its decline.

To the first fact:

Figure 1: Change in the value of petroleum imports since 2001Q4 (blue) and change in trade deficit on a NIPA basis since 2001Q4 (red), in billions of dollars, SAAR. "Lo" and "Hi" denote alternate 2008Q1 levels of petroleum imports under the counterfactual of a $1 gasoline tax, assuming gasoline price elasticity between 0.3 to 1.0 (see text). NBER defined recession dates shaded gray. Source: BEA, GDP release of 26 June 2008, NBER and author's calculations.

One is tempted to ask how different matters would have been if we had enacted a gasoline tax and it had been put into place. Three years ago, I wrote in a Council on Foreign Relations special report [pdf]:

 On the supply side, production is unlikely to rise strongly given the depletion of onshore reserves. In addition, production takes years to put into operation. On efficiency grounds, a gasoline tax would be preferable to higher fuel economy standards (see Congressional Budget Office, The Economic Costs of Fuel Economy: Standards versus a Gasoline Tax (Washington, DC: Congressional Budget Office, December 2003). In addition, a tax acts immediately, while standards would take longer to have an impact on consumption. A back of the envelope calculation can be useful in defining the potential impact of a gasoline tax. In 2004, the United States imported about $180 billion worth of petroleum and petroleum related products, equal to about one third of the trade deficit. Ignoring interaction effects, a $1 per gallon tax on gasoline would reduce annual petroleum imports by $10 to $25 billion dollars, or about 1.6-4 percent of the trade deficit. The calculation relies upon estimates of the gasoline demand elasticity of 0.3-1.0. Specifically, each barrel of oil yields approximately 19.5 gallons, and U.S. consumption was 19.4 billion gallons. Using CBO's preferred elasticity, a twenty-cent tax would save 40.5 million barrels of oil, reducing (at 2004 prices) $2.03 billion worth of oil consumption. There is also an increment to tax receipts, but it is very small -- less than $20 billion per annum initially.

Updating these figures, using the petroleum import deflator obtaining in 2008Q1, the implied reduction in oil imports -- had those taxes been put in place -- was between $24.4 to $61 billion, on an annual basis. The range of low and high import reductions are shown as boxes in Figure 1. Note that the calculation ignores the effect of lower U.S. demand on world oil prices, so the impact on the oil import bill is downward biased.

Of course, that is of little comfort, now that we are where we are. Oh, well. But there are still disasters we can avoid. From the conclusion to the same report:

 The focus of this essay has been on the economic consequences of inaction. The longer we wait, the greater the likelihood of a global financial and economic disruption. Even absent a discrete crisis, hewing to the current course raises the chances of stagnant economic growth, if not recession, in the future. But there may well be other ramifications.

A cautionary note regarding America's current path is provided by Britain's loss of military and political primacy in the 20th century; that development followed a shift from creditor to debtor status. Similarly, a prolonged decline in the dollar's value and increasing indebtedness will erode America's dominance in political and security spheres. These trends threaten the dollar's role as the global currency that facilitates international trade and finance, something the United States has gained immeasurably from over the years. A weaker dollar also reduces American leverage in international financial institutions such as the World Bank and IMF. Finally, a diminished U.S. currency means that each dollar's worth of military and development assistance has less impact at precisely the time when the nation faces the greatest challenges. Those threats we ignore at our own peril.

That quote brings me to the second fact, that measured dollar reserves continue to decline. Now, since measured and actual dollar reserves almost surely differ, this second fact is not as informative as it could be. My estimate of dollar reserves, as a share of total, also appears to be declining.

Figure 2: US dollar as a share of total foreign exchange reserves (blue), estimated US dollar share, assuming 60% of unallocated reserves are in USD (red), and estimated euro share, assuming 40% of unallocated reserves are in EUR. Source: IMF, COFER, accessed July 9, 2008, and author's calculations.

The conclusion I draw from this is that we should eschew the snake oil of extending the Bush tax cuts (and associated Laffer curve fantasies), which would likely exacerbate the dollar's decline, and take responsibility for the future.

Comments

[User 118015]

The housing market and their default securities and financial institutions that support it have the attention of the Fed at the expense of the dollar. But it seems that nothing the Fed does will have any long term effect but increase M3 (inflation) while M1 which is the driver for the whole economy is neglected. Unless the Fed starts increasing interest rates immediately inflations is going to get out of control...it is for energy and food. Continuing with the existing Fed policy for much longer guarantees a long DEPRESSION.
Our political system seems frozen and does not know what to do about energy and other issues but seems to know how to increase the National debt beyond recovery...watch out below.

[Mr. Math]

Menzie Chinn-

Other posters disclose their financial positions. You should disclose your political affiliations, so that readers can understand that your economic commentary is primarily dictated by your politics.

[HARM]

Mr Math is 100% right. It's obvious by disparaging Bush tax cuts for Big Oil and the top 1% as "snake oil" that Mr. Chinn hates America and Our Freedoms. He ought to be sent to Guantanamo and fed a steady diet of Rush Limbaugh, Larry Kudlow and Sean Hannity until he cracks and embraces corporate socialism with open arms.

[AmesTiedeman]

OIL is going up. We bomb Iran and it goes up even faster. Be ready.

[X-15]

No energy policy. No government intervention for the dollar. No end to Iraq War (Vietnam II-desert edition). Strange doins at the FED. Congress inabilty to overcome Sept 11.. and be a force for effective leadership. Republican/ Democrat = no vision. ? Strange Days

[xsuddensam]

We should have added a dollar/gal. tax back in 1978 after the oil embargo. The market would have forced Detroit to build fuel efficient vehicles. Our political leaders didn't have the courage nor the foresight to do the right thing.

I don't see any good news anywhere. High commodity prices, runaway monetary inflation, declining economic growth, sky rocketing public and private debt and a very shakey financial system point to a coming disaster. If there's any good news out there, I'd like to hear it.

[Eehgads]

"Mr.?, May I borrow a hundred bucks for a hamburger? I will gladly pay you, next Tuesday.

[just knockthe hornsoff]

The Council on Foreign Relations speaks for the American taxpayer - the oxen of the New World Order? Yeah. right. More likely for the enslavers of the North American Union, MexiCanUSA, in that order.

Beware the Security and Prosperity Partnership (SPP) and Obama's Global Poverty Act. Read up and wake up, America.

[Tao]

The writer, Menzie Chinn, is just whining.

Phil Grahm, McCain's economic advisor, thinks we are all whiners. Don't you know everything is doing great?

[jlounsbury59]

Prof. Chin, your discussion is very NON-political. Unfortunately, some of the commenters are not (although I love the political satire by HARM).

My conclusion is that the free lunch philosophy that has gripped the American government and people since 1964 (supported by all presidents and congresses of both parties) is coming to an end. The only question is whether the prosess is done BY us or done TO us. No matter which presidential candidate wins and no matter which party controls congress, the fantasy we call the American Dream must be interupted by a wake-up call. After some hard work (and painful to the average American) on energy, long term planning for deficit reduction, and improving the efficiency of social programs the government is involved in, we can return to a regular sleep schedule and dream again.

Can the ostrich (American people) take its (their) head(s) out of the sand and get behind a call for the hard work needed? I'm not sure. We must recognize the world terriorist threat is the number two issue. Returning our economy to a sound footing is number one. Without addressing number one, the number two problem, terrorism, defeats us without doing anything more.

[123z]

Mr. Math states that if people knew the writer's political affiliations, then they would understand how his economic commentary was formed. His econimic commentary should be judged on its merits and his political affiliation is irrelevant to the merits of his discussion. Mr. Math may be unable to judge an econimic discussion on its merits, but others are not so challenged.

[captbob]

The only people I love more than Politicians are College Professors.
It's hard to tell who's ahead in the "Out of touch with the working public" race.
Why not raise the tax on gas to $5 a gal?- that would probably cut consumption and the Trade deficit attributable to it by 50%. Of course a lot of people would no longer be able to get to work, but who cares, look at all the revenue we'll get in taxes.

What he overlooks is -now unemployed--plus the price of gas-- they won't be able to go for their Walmarts "fix" which will result in Impoverishing China which now subsidizes the price of gasoline -(reducing the retail price)- encouraging millions more working comrades to buy cars and consume more gas. They seem to have it backwards???--Maybe a shortage of Economics Professors over there.

Of course there's a case to be made. That with fewer people working we'll become impoverished, use even fewer resources and thereby reduce the costs to the "emerging economies", Nations -(don't-cha love those labels?)- allowing more of them to ride in cars and still eat cake.

After all don't they deserve it after all these years working with hazardous lead based paint on our toys??

What could be a more Noble Cause than have all the World's Peoples economic & living standards EQUAL??
That's a Ivory Tower Socialist goal, shared by Social Idealists and Academics alike!!

[armadillo]

So who is going to be the next world power.....China is just catching up a little, I don't see them founding the next great wave of innovation and productivity. They are just coming out of the dumps for most of their people. Same with India. Brazil is riding the fallacy of ethanol. You tell me who is smarter, more innovative.........

[19Larry42]

1. Higher prices will lead to more efficient use of most anything (oil)
2. A politician’s job is to get re-elected (by pandering to those that will get him there)
3. If the electorate chooses on the basis of pork for the locals, the nation as a whole suffers (ethanol?)
4. The system will only get worse until it collapses, due to all of the above.

[diogenes]

captbob wrote: What could be a more Noble Cause than have all the World's Peoples economic & living standards EQUAL??
That's a Ivory Tower Socialist goal, shared by Social Idealists and Academics alike!!

Bingo! You got it! As one who is currently living the "Peoples Glorius DemoKratic Republic of Chapel Hill, NC" can testify. The tenured and retired professors, the Maserati Marxists and Lambourghni Liberals, here who live in a bubble don't give a rats ass about the peasants...let them eat organic tofu!

[jlounsbury59]

Can't anyone envision what the spending of $800 billion dollars a year in the good old USA (instead of sending it overseas for oil) would do for our country. That amount, about $2,700 per individual or more than $10,000 per year for a family of four, would raise living standards significantly, especially when the velocity of money is considered. That $800 billion might ciculate through the economy more than once per year, possibly a lot more. The resulting tax revenues could substantially reduce our budget deficit.

Bite the bullet, America! Tax gasoline, develop alternative transportation energies (not ethanol, please, except from waste materials), and get economically healthy again. Provide tax credits to the lower middle class and low income workers to cushion their higher cost in getting to work until the transition from gasoline to domestic energy is well underway.

[captbob]

Jl---59: I guess that family of four just has to get penalized for moving to get a decent education for the two, plus leave some "nonworking" criminals behind close to their urban jobs!!.
Have you figured out how they earn the $10,000. before they can save it, if they can't afford to drive to work, no public trans. to far to bike and No medical insurance for winter walking???.

What's the matter with Sugar ethanol-(like Brazil)?? Are you all dentists?? and want more cavities?? or is it just "sour grapes" cause they beat us to something that works??.

Our Corn Farmers gave more to the campaign so of course they come first to the trough--Even though sugar is 5X more efficient and
doesn't take food off anyones table. As an aside there's a $.75 tariff on ethanol imports--wouldn't want any of that cheap stuff sneaking in taking profits out of our Corn Dogs pockets now would we??

[sbenard]

As if no one else has already said what needs to be said, I'll parrot what has been adequately covered by others, just to weigh in. I'm glad other readers "got it".

"Here comes the orator, with his flood of words, and his drop of reason" -- Benjamin Franklin (I would change the word "orator" in this case, to "professor", except when I'm referring to Obama).

Here we go again. More ivory tower liberal university professors who are members of the elitist Council on Foreign Relations who promote one world government, the compulsory religious fraud of global warming, monstrous taxes, and socialism. The government is always the ultimate answer to everything!

Unfortunately for you, professor, in this forum, we don't have to regurgitate -- or believe -- your intellectual garbage to get a good grade. We can think for ourselves, and unlike young students just out of puberty, we aren't all foolish enough to buy your "higher taxes are better" baloney. Most of us have real businesses or real jobs, so we know how the REAL world works. That's why your malarkey falls on few receptive ears.

You are more proof, prof, of the old adage that "those who CAN, DO; those who CAN'T, TEACH!"

[sbenard]

jlounsbury59--

Calling lower taxes cut "snake oil" is hardly "NON-political&qu... Suggesting at least two policy initiatives in a single article -- BOTH of which are that the answer to all are problems are HIGHER taxes -- is hardly NON-political.

What planet are you living on?

[WayneS]

The special treatment that oil companies get is that they pay 2-3 times as much taxes any any other industry. When XOM made $40 billion last years, they paid over $120 billion in taxes. Check the oil company financial reports. Actions speak louder than words. The actions of the drivers around me say, "Gas is cheap and plentiful. I waste 20-40 percent of the gas I buy just to prove this fact."

[runner]

"low taxes" in the USA
-27% Fed tax
-8.5% state ax
-5% city tax
-16 % medicare + social security tax
- 8.75 % sales tax
- $1500 / month property tax
- some 9 taxes on my phone bill


And BTW, you DON'T get health insurance after all these taxes. You still have to pay for it. Comparing "low" US taxes (ie, comparing only Fed taxes), to "high" taxes elsewhere.... very clever - in EU, they get health coverage as part of their tax burden.

[pockyclips2020]

Comments remind me of "The Good, the Bad, and the Ugly", where Ugly didn't know what I D I O _ spelled. Manifest Destiny ended over 100 years ago. It's time to move on. If we insist on sticking with a resource that we do not possess, we are doomed.

When oil went below $20/barrel, independents went bankrupt, and big oil went through their mega-merger phase, that was the time to put an import oil tax in place. Instead, oilmen and politicians were whining about the 4 cent/gallon gas tax that doesn't even cover the minimal port security we have at our oil terminals!

[ohm]

Mr. Chinn: what garbage you spout! What we need at this point is TRIAGE. Stop the bleeding, ease the burden on Americans any way possible. Drill in the easiest places, wind, water, nuclear, clean coal, solar bio etc. etc. Everyone, everywhere has an asset and can help. Stow the politics until we can breath easier...then implement a longer tem solution. Higher taxes now will only drive the last nail in our coffins.

[Britishsteel]

here is your solution not very academic but none the less as true as the day it was written. And mind you what is needed to right this sinking ship known as the USA!

"If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them, will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered." -- Thomas Jefferson, Letter 1802 to Secretary of the Treasury, Albert Gallatin

WE need to abolish the Federal Reserve which is unconstitutional and created this credit crisis in the first place. Central planning is socilaism plain and simple and has no place in a free market society.
We need to get back on the gold standard.

[crowdofcheerleaders]

he's a CFR bootlicker, ergo he is against everything that is in this nation' interest, flat out.

[willynill]

Bob La Follette must be turning over in his grave. Chinn is not just wrong, he is utterly wrong. Do Wisconsin taxpayers know that their tax dollars are paying the salaries of such witless professors?

[ussmls7]

I think most of you missed the damn boat,where Americans ,like sheep, jumped to the great unlawfull act of 1913 & 1933, the Federal Reserve Banking System. You will not demand change, with only a mass out rage, will this be done, or this Nation will suffer like it has never before! It is a ship with no sails,no wind, & all hope is forced upon a few that know, this Nation as great as it is, only with a sound pratice to follow, will it again be the Greatness it as it was! The Constitution, no where is the Federal Reserve a legal or part of this Nations best interest, it has only served Bankers & their interest.
I give the Fed a year or more,before, the mass of Youth are feed up with the crap from DC & the people that are in power! When those that that are rich now, become beggers to us plain folks, for a bite of food from our rual gardens, it will be justice, but I will not turn them away!

[Kunst]

You can have a gas tax that is rebated dollar for dollar back to the taxpayers, for example via a reduction in income or payroll taxes. That means the net effect is zero, but gas becomes relatively more expensive, correctly representing the additional costs and dangers involved in our dependency on imported oil. Those who conserve benefit, those who waste are penalized.

I think SA should have a "respectfulness&q... week, when every post with gratuitous insults would be summarily deleted. For example:

[Kunst]

Well, never mind the example, it'll never happen.

[User 30121]

To Captbob: You keep writing comments like these two gems, and you will make my All-Time Champion List! Keep up the good work...enlightening the masses who JUST DON'T GET IT!

[cal48koho]

excellent post and you sure inspired a lot of comments, some of which were predictably clueless and some amazingly prescient and well written. The key point is that we must reduce demand and a tax does it best right now. The next move is to reduce our budget deficit. IF we and not our children had to pay that 600 bil + the trillion or three we will spend on world policing, we wouldn't be in Iraq or Afghanistan. How do you feel about our lovely GSEs like the fannyfreds. Anybody out there have 5 trillion for that bailout?The dollar is indeed toast and if there is anyone out there who thinks otherwise, please raise your hands.If you are still holding dollar in any account, you must be crazy. If you're using dollars to buy oil, you will see the price going up forever. so stop whining americans.You are watching the beginning of the end of economic and military hegemony, or possibly worse, the end of the beginning.