- Low oil prices means fewer dollars heading into oil exporters’ central bank reserves and more dollars heading into the hands of people with a higher propensity to spend them.
- Most eurozone and Asian economies will see terms of trade improvements supporting economic growth relative to the U.S., which, as a marginal net oil exporter, will not benefit.
- On top of these two natural depreciating forces, the likely policy response from the U.S. Fed and Treasury will also be dollar bearish.
Oil price collapses tend to put temporary upside pressure on the U.S. dollar in the short term as dollar demand rises among oil producers who have dollar denominated debts while dollar credit supply dries up. However, lower oil prices are not fundamentally bullish for the dollar as used to be the case when the U.S. was a major net oil importer. There are three reasons why lower oil prices are actually fundamentally bearish for the dollar.
Fewer Dollars Heading Into Central Bank Reserve
The main reason we believe that lower oil prices are negative for the dollar is that it will mean fewer dollars heading into the reserve stockpiles of oil exporters’ central banks. As explained in ‘Dollar Shortage A Red Herring‘ as oil is traded in U.S. dollars, when prices are high these dollars end up in the reserve holdings of oil exporting central banks. With the recent oil price decline, dollars that were previously spent on oil and hoarded by central banks will increasingly find their way into the hands of people who are more likely to spend them.
We are highly likely to see net dollar sales from the major oil exporting central banks which look to prevent severe currency depreciation. This will unlikely prevent the dollar from strengthening against these countries’ currencies, but it should place downside pressure on the dollar versus oil importing countries’ currencies. Investors seem to be far too complacent about the huge store of potential dollar supply sitting in the world’s reserve stockpiles.
Growth In Other Countries Will Benefit Much More Than In The U.S.
Secondly, the U.S. runs a broadly balanced net oil trade balance, with the latest figures actually showing a sight surplus suggesting that at the macro level the county will not benefit from lower prices. What is gained by industries which depend on oil inputs is offset by the losses to oil producing industries. In contrast, most of the world’s countries are net oil importers, while only a few are net oil exporters.
U.S. Vs Eurozone Terms Of Trade Indices
Source: Bloomberg, Citi
The eurozone and most Asian economies for instance will see the beneficial effects far outweigh the negative effects as far more producers benefit than lose. The collapse in oil prices is an unmitigated benefit for major oil importing countries. Take the example of India where it’s oil import bill equaled an annualized roughly USD150bn at the start of the year and tracks international oil prices. Assuming similar import volumes the country stands to benefit to the tune of around USD100bn, or over 3% of GDP. This will provide significant support to economic growth to the benefit of the rupee.
Indian Oil Imports Vs Brent Crude Oil
Note that we place the emphasis of the impact of lower oil prices on production and not consumption as it is the former that ultimately drives the economy; consumers can only consume what is first produced. An article in the FT recently noted that the oil price drop is unlikely to be as beneficial as during previous occasions because consumers will not spend the windfall savings. This is not how it works. The reasons consumer spending benefits from lower oil prices is that producers which rely directly or indirectly on energy as an input become more profitable and able to expand production.
For example, let’s say that oil becomes completely free at the gas station and so consumers can fill up their cars at no cost. They then have more money left over to spend on other things and it is tempting to think that as they spend this money the rest of the economy benefits. However, we know (or should know) that money itself does not create more real output (look at Venezuela). In order for the money that people have saved on gas prices to be able to purchase more goods and services, producers must be able to produce more of them. In the absence of more domestic production, any increase in spending would have to come from increased imports.
Potential Bailout Adds To The Negative Impact
Finally, on top of the two natural depreciatory forces on the dollar explained above, we also believe that the policy response from the U.S. Fed and government will be dollar bearish. President Trump said on Tuesday he has asked his cabinet to devise a plan to inject cash into the ailing U.S. oil-drilling industry to help it survive the collapse in prices.
This comes after U.S. Energy Secretary Dan Brouillette said last week that he was working with Treasury Secretary Steve Mnuchin to double the size-limit on loans available to mid-tier U.S. energy companies under the recently passed CARES Act stimulus package to USD200 million-USD250 million.
The industry was in part built of the back of the cheap credit as low rates drove investors out on the risk curve into high-risk energy bonds enabling increased output. Should the government decide to throw more money after bad it will simply keep prices depressed for longer to the detriment of the dollar.