To lower oil price, boost the buck?
The weak dollar may push up energy prices by affecting supply, demand, and investor behavior.
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A different effect is at work in China, which he says has been holding its currency artificially low as a way to boost exports. The result, Professor Morici argues, is a greater shift of manufacturing jobs out of the United States and into China. And because US factories use much less energy than those in China, this affects demand for oil.Skip to next paragraph
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Moreover, in his view, China's resulting trade surplus has enabled the country to afford the artificially low fuel prices it sets for consumers – prices that China adjusted upward last week.
Still, it's hard to gauge how much oil demand has been affected by China's currency-managing methods. "Given the rapid economic growth rate, ... I would argue that demand from China would still be relatively robust" regardless of the exchange-rate policies, says Paul Ting, who runs an energy consultancy in Short Hills, N.J.
A financial effect: Low interest rates or rising inflation can cause investors to flee a currency. Those same rates can help drive up commodity prices and cause investors to buy oil contracts as a "hedge" against feared inflation.
One symbol of the problem: Investors holding US dollars now face negative real returns – interest rates below inflation.
The Federal Reserve has reduced short-term US interest rates to counter the threat of recession, but now is walking a fine line as markets increasingly are also worried about inflation.
"The more that people doubt the Federal Reserve's willingness to reverse this policy course they've chosen, the higher oil prices rise," says Tim Duy, an economist at the University of Oregon in Eugene.
In ordinary times, the Fed would focus on helping the economy out of its slump. This month, Fed Chairman Ben Bernanke said the Fed is now also "attentive" to downward pressure on the dollar.
Economists say that much of the global inflation pressure comes from emerging nations. They have kept money supply relatively loose, partly because their dollar-pegged exchange rates effectively link their monetary policy to that of the Fed.
Managed currency rates and fuel-price controls have put particular pressure on oil prices, Merrill Lynch analysts argue in a recent report. "As neither [emerging market] exchange rates nor domestic commodity prices could adjust through market mechanisms, world commodity price ... had to trend sharply higher in an effort to slow down demand," they write.
So it may be a range of exchange rates, not just the dollar, that's affecting oil prices.
How could the dollar be strengthened?
It might happen naturally, if markets decide that the greenback has dropped below its fair value.
Or sometimes, the world’s big governments can use words and currency trades in a concerted way to to affect the dollar.
Another way – controversial given the weakness of the US economy – might be for the Fed to raise short-term interest rates, which would give investors a better return on dollars.