Oil


Some musings on the price of oil and the effects it will have. Mind, I’ve not done any economics so this is very much a layman’s take on things.

(EDITED) On the domestic site, the rise of oil prices will cause some prices to become more expensive resulting in an economic slowdown as people will have less money to purchase things – the central bank should not raise interest rates to combat this it will risk a greater slowdown but may be tempted to lower interest rates to keep the economy puttering along but at the risk of inflation. The extent and length of the slowdown will depend on, amongst other things, how overleveraged the people are, how dependent the country’s industries are on oil. A modern healthy economy should be able to adjust to small rises in oil without too much turbulence. (EDITED)

On an international level, if the country is a net oil importer, it will find that its currency will drop in value with regard to oil producing countries thus making its goods more competitive to net oil exporting countries. Depending on the mix of its exports and the increase in oil prices, this may result in its currency finding a new stable low or staying at pretty much the same levels. (or more likely oscillating around).

However, the country may find that most of its trading partners are also net oil importers in which case, those currencies in theory should maintain itself against one another. The slowdown in trading partner country economies will of course mean that overall amount of traded goods will decrease.

If the country is a net oil exporter, its currency will increase in value thus making its oil exports even more expensive. This should reach an equilibrium of a sort eventually.

If you’re the US and do not want to have a slow-down due to oil price hikes and more importantly you want to keep spending, you can maintain the strength of your currency in relation to oil producing nations by encouraging them to buy US T-bonds. This means that for you, the price of oil will remain low (or within acceptable limits) for your citizens and your economy. Countries that do not peg their currency to the US dollar will see their currency devalue. This may alleviate up to a point the slowdown of those countries economies if they trade a lot with the US. If not, tough, your country has to wear the cost of high oil prices.

If you’re the Chinese (or anyone maintaining a peg with the US dollar), you find yourself in a position where you have to keep buying US T-bonds but find your currency is devaluing with regard to petrol exporting nations as you’re buying more from them but not selling more to them. So that means you have to spend more of what you’re earning on petrol but still keep selling what you produce to the US for the same price as before. It should not then take too long for your prices to go up. This in effect is a forced revaluation upwards of the yuan.

Theoretically, Chinese goods will then not be as competitive and trade between China and America should reduce in turn meaning that the Chinese need not buy as many T-bonds to maintain its peg. However, with higher oil prices and oil producing nations buying US T-bonds to keep the US in the same currency position, the US will still have enough dollars to finance its deficit. Plus it will have the added political bonus of decreasing trade with the Chinese without having to resort to messy tariffs and quotas.

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