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Oil-Driven Trade Flows

Earlier this week it was reported that for the first time since 2004, China ran a quarterly trade deficit. That’s not because China stopped exporting manufactured goods, nor is it because China is suddenly buying tons of American imports. Instead, it’s because of oil. As oil gets more expensive, the dollar value of oil imports surges, pushing China into deficit.

America, of course, uses far more oil per capita than China and just like in China when the price goes up the short term impact is much higher spending and relatively little in the way of reduced demand:

Since households are constrained in the amount of money they can spend, this means that in the short-term spending on goods and services that aren’t oil needs to fall in response. This could be fine if oil-exporting nations were taking all their profits in terms of American manufactured goods. And, of course, some of this happens. Persian Gulf states are huge customers for American military equipment and airplanes. But spending all that money on current consumption would be a pretty irresponsible thing for oil exporters to do, and largely they don’t do it. The result is a big drag on American output. Even worse, hawks on the Federal Reserve and (even more so) the European Central Bank interpret the higher cost of oil as “inflation” and push to respond with tighter money, further cutting output.

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