When I read today that October’s US trade deficit dropped to a 14-month low, I had my usual reaction to news items about the trade deficit: so what? Why should (exports-imports) be an indicator of anything of substance in a world of relatively free trade with flexible exchange rates? Sure, there are complex interactions with financial markets, with interest rates, and so on. But isn’t the whole point of trade and financial flows that they equilibrate in ways that reflect the decisions of the many market participants? I’ve always been a trade deficit skeptic, like Don Boudreaux (whose recent comment on a Robert Samuelson column fits with these ideas), so I don’t see why one should get one’s knickers in a twist over trade balances. Mutual exchange of value for value and all that. So what if Someone Who Thinks He Is In Charge (or should be in charge) thinks that we import too many finished goods from China? Isn’t merchantilism hopelessly obsolete, so much so that we should find it quaint instead of bothersome?
Anyway … part of what interests me here is the role of oil price declines since August. As noted in this AP story on the trade deficit figures, much of the overall decline is due to the decreased value of oil imports. I worded it that way for a reason:
Imports fell by 2.7 percent to $182.5 billion, reflecting the big drop in oil. The average price of imported crude fell by a record $7.05 per barrel to $55.47. The volume of petroleum imports was also down following several months this summer when the oil bill surged as global prices hit all-time highs.
The trade deficit with Canada fell by 4.8 percent to $5.4 billion while the deficit with Mexico dropped 11.3 percent to $5.2 billion, reflecting a record level of U.S. exports to Mexico.
Thus both the price and the quantity of crude oil imports have fallen. That’s also why the Canada and Mexico figures are interesting, as they are two of the largest sources of our oil imports. This graph of the weekly price of the Jan 2007 light sweet crude contract at NYMEX over the past year depicts the magnitude of the price change:
[cool NYMEX graph lost in reconstruction of this post-ed.]
Another variable that is moving around in this complex relationship is the exchange rate; the dollar is currently quite weak against both the pound and the euro, as witnessed by the fact that the trade deficit with the EU rose by over 34 percent. But this is all part of the fascinating and complex equilibration.
Let’s examine the fact that the price and quantity of oil imports have fallen and apply a simple supply/demand model. In this model, the way you get simultaneous reduction in price and in quantity is if demand falls — if demand shifts in to the left. Certainly part of that is seasonal; the summer vacation season has ended. We also currently have historically high inventories. I don’t want to go into all of the details about uncertainty surrounding the net present value of those inventories and expectations about future use 3, 6, 12, 18 months in the future, largely because it’s not my expertise. But these aggregate trade figures are consistent with behavior that economizes on foreign oil use, and that is interesting. Could demand be falling because of a slowdown in economic growth? Employment is holding steady, focused primarily where the US has a comparative advantage (services), and while some analysts believe GDP growth will slow somewhat in Q4 2006 it’s only a tweak. This set of evidence leads me to conclude that the combination of historically high oil and gas prices (although they have fallen 20 percent since August) and heightened sensitivity to the politics of oil imports are at the margin changing individual behavior in ways that are showing up in aggregate economic data.
Certainly other factors are at work, and only a careful econometric analysis would tease out the impressionistic relationship I am discussing here. But it’s suggestive, and interesting, to consider the possibility that individual decisions to economize on oil are taking place in response to price signals.