October 16, 2014
Morning Edition committed one of the seven deadly sins of economic reporting when it told listeners that Europe is hurt and we are helped because oil is priced in dollars and the dollar is rising. (The biggest sin is reporting large budget numbers without any context — which will result in an unpleasant afterlife for most budget reporters.) It actually doesn’t matter that oil is priced in dollars, as some simple arithmetic quickly shows.
Let’s imagine that oil is priced in wheat. Assume the price of a barrel of oil is 20 bushels of wheat. That would translate into roughly $130 a barrel. Now suppose the dollar rises in value against the euro by 25 percent, so that instead of a euro being worth $1.35, it is only worth $1.08. If the price of oil is unchanged in wheat and the price of wheat in unchanged in dollar terms, people in the United States will now be able to buy oil for 25 percent fewer dollars than before, or roughly $104 a barrel. This means we have to give up fewer dollars to get a barrel of oil.
However is Europe hurt in this story? Under the assumptions of a constant dollar price of wheat and a constant wheat price of oil, people living in the euro zone would be paying the same number of euros for a barrel of oil as before. (It would be priced at just over 96 euros a barrel in both cases.)
Now suppose we changed everything and said that instead of being priced in wheat oil really is priced in dollars and the dollar price fell from $130 a barrel to $104 a barrel and the dollar rose by 25 percent against the euro. How is this switch from wheat pricing to dollar pricing any different from the standpoint of people living in the euro zone?
If you answered not at all, you get a free tank of gas. (Bring your copy of BTP to your favorite gas station.)
There is a very minor point that the transactions generally (but not always) take place in dollars. This means that for one millisecond it is necessary for euro zone residents and others to get dollars to buy their oil. This trivially increases the demand for dollars. (You only need the dollar for the millisecond when the transaction occurs.) Also, there is no law that requires oil to be sold for dollars. If a Russian oil company feels like contracting for oil with euro zone customers where the payment takes place in euros, there is nothing to stop them and such transactions do sometimes take place.
Long and short, a higher valued dollar means cheaper oil for people living in the United States. It doesn’t matter that oil is priced in dollars.
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