The Consequence of Energy Dependence

Part II of a Series on Energy Dependence  The first installment of this series tours the trouble spots where we get our oil and explores how vulnerable we are to disruption in the oil supply. It can be found here.

That, year after year, the United States imports far more than it exports, has meant a titanic outpouring of dollars into the coffers of other countries. Those holdings are now poised to explode with oil priced beyond $100 barrel.
     The dollar being the world’s premiere reserve currency, countries flush with cash from their exports to the U.S. have, year after year, reliably sent the money back to Washington, investing it in Treasury notes, thus propping up the American government’s chronic deficit spending.
     It’s a tenuous symbiosis. We hold each other hostage. Even in stasis, it is a foolhardy way to float an economy. The bigger question is whether this arrangement is about to change, and decidedly for the worse.

 AMERICA BLEEDING OUT

The huge increase in U.S. debt, which has skyrocketed from $5.7 trillion to $9.2 trillion since 2000, has caused a plunge in the U.S. dollar – a drop of 35% against the Euro during the period. Interest rate cuts to combat the recession are causing further dollar deterioration, as investors worldwide effectively sell their dollars at fire-sale prices to buy assets denominated in more stable currencies. Yes, there is some consolation in that U.S. goods now look cheap to other countries paying with their stronger currencies. Exports in 2007 increased 12.7% over 2006, and the trade deficit dropped 6%. But that deficit was nonetheless a frightening $711.6 billion in 2007, double that in 2001, and soaring prices of imported oil will overwhelm export gains.

For Americans, the weakening dollar means ever higher prices for oil and all imported goods, exacerbating the trade deficit still further. For petrodollar and other countries, watching their dollar holdings in the U.S. shrink in value is causing them to look elsewhere for where to invest, creating new vulnerability for the U.S.

 RUMBLINGS OF DISCONTENT

Some foreign voices have called for a move away from the dollar. Russia wants to establish “a new international financial architecture” to “challenge U.S. supremacy”, in Vladimir Putin's words. He called the current financial structure “archaic, undemocratic and unwieldy” and suggests that countries should “hold reserves in a wider selection of currencies”. He wants to establish “a world class oil exchange” denominated in rubles; a facility is in fact being readied in St. Petersburg's bourse.

At a summit meeting of OPEC last fall, Iran's Mahmoud Ahmadinejad said that U.S. buyers “get our oil and give us a worthless piece of paper”. Hugo Chavez added, “The empire of the dollar has to end”. This was not bluster; they were recorded when a microphone was inadvertently left open.

They were not alone. A chorus of OPEC nations voiced a desire to price oil in Euros rather than dollars. The United Arab Emirates has announced an intention to shift 8% of its foreign exchange reserves from dollars to Euros, and Saudi Arabia conceded that it would have to consider such a move were the dollar to take a “precipitous” decline.

OPEC is, however, being given ever higher stacks of dollar bills to compensate for their reduced value, and the various petro-states have since made reassuring noises to calm the markets. All export countries know that a precipitous retreat from the dollar would plunge the U.S. into a permanent recession, sending the dollar into a tailspin, and that would reverberate in their own economies by curtailing America's ability to import their goods.

 DIVERSIFYING THEIR PORTFOLIOS

Nevertheless, nations with huge dollar reserves are no longer content to earn anemic returns on U.S. government bonds and are taking a different tack. America is on sale at discount prices and they are shifting to direct investments, buying up assets in this country and around the world. Foreign investors paid