from Follow the Money

The biggest surprise of 2005?

August 9, 2005

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At least for me, it is the limited impact of $60 a barrel oil on the US economy.  US growth looks poised to reaccelerate in q3, even in the face of what by now is a substantial increase in oil prices.   That is not what I would have predicted last summer if I knew then where oil would trade today.

My explanation?  I suspect the resilience of the US economy goes beyond the fact that the US (and the world) economy is less energy intensive than it was back in the early 70s, or even that the economy responds differently to a demand shock than to a supply shock.  I suspect it also has to do with the fact that the US economy has become very credit-intensive and, at least for now, it seems that most of the petrostates' oil windfall is being recycled (one way or another) back into the US credit markets.

High oil prices = oil windfall = global savings glut = low long-term rates ... and the low-long term rates help even as high oil prices hurt.

The recycling process seems to be a bit more complicated that it was in the 1970s, when petrodollars were placed in the banking system and the banks lent the dollars out to what are now called emerging economies in need financing.  New fangled intermediaries like hedge funds that fund themselves (indirectly) with petrodollars presumably are part of the complicated process that turns the oil windfall into new investment in US debt.

China enters into the story as well.  The explosion of supply from China helps to keep the price of manufactured goods down (autoparts look to be next) and to limit wage growth in the manufacturing sector (though one can debate by how much).  The expansion of China's productive capacity is truly extraordinary.  According to Nerys Avery of Bloomberg, "China's steel production rose 50 percent, car output doubled, and computer production trebled between 2002 and 2004, according to government data."

I guess that is what happens if you invest 50% of your GDP a year.

An aside.  One explanation for China's appalling energy to GDP ratio is that the US -- and Europe -- have outsourced energy-intensive manufacturing operations to China.   The fall in the US oil to GDP ratio required an increase in China's oil to GDP ratio: many US imports from China have a lot of embedded petroleum.  Another explanation is that China's energy use is measured correctly, but its GDP is not.   I suspect that too is part of the story.   China's GDP is probably quite a bit larger than the official data indicate.

A last note.  The energy to GDP ratios in the IMF graph above used PPP GDP numbers, which explains why China appears to be more energy efficient than the US.  Do the same graph at market exchange rates, and it looks a very different. 

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