Two Interesting Facts of the Day

As of 2008Q1, wholly 100% of the increase in the trade deficit since 2001Q4 is accounted for (in a mechanical sense) by the increase in the value of oil imports.
And the dollar share of reserves appears to continue its decline.

To the first fact:


Figure 1: Change in the value of petroleum imports since 2001Q4 (blue) and change in trade deficit on a NIPA basis since 2001Q4 (red), in billions of dollars, SAAR. “Lo” and “Hi” denote alternate 2008Q1 levels of petroleum imports under the counterfactual of a $1 gasoline tax, assuming gasoline price elasticity between 0.3 to 1.0 (see text). NBER defined recession dates shaded gray. Source: BEA, GDP release of 26 June 2008, NBER and author’s calculations.

One is tempted to ask how different matters would have been if we had enacted a gasoline tax had been put into place. Three years ago, I wrote in a Council on Foreign Relations special report [pdf]:

On the supply side, production is unlikely to rise strongly given the depletion of onshore reserves. In addition, production takes years to put into operation. On efficiency grounds, a gasoline tax would be preferable to higher fuel economy standards (see Congressional Budget Office, The Economic Costs of Fuel Economy: Standards versus a Gasoline Tax (Washington, DC: Congressional Budget Office, December 2003). In addition, a tax acts immediately, while standards would take longer to have an impact on consumption. A back of the envelope calculation can be useful in defining the potential impact of a gasoline tax. In 2004, the United States imported about $180 billion worth of petroleum and petroleum related products, equal to about one third of the trade deficit. Ignoring interaction effects, a $1 per gallon tax on gasoline would reduce annual petroleum imports by $10 to $25 billion dollars, or about 1.6-4 percent of the trade deficit. The calculation relies upon estimates of the gasoline demand elasticity of 0.3-1.0. Specifically, each barrel of oil yields approximately 19.5 gallons, and U.S. consumption was 19.4 billion gallons. Using CBO’s preferred elasticity, a twenty-cent tax would save 40.5 million barrels of oil, reducing (at 2004 prices) $2.03 billion worth of oil consumption. There is also an increment to tax receipts, but it is very small — less than $20 billion per annum initially.

Updating these figures, using the petroleum import deflator obtaining in 2008Q1, the implied reduction in oil imports — had those taxes been put in place — was between $24.4 to $61 billion, on an annual basis. The range of low and high import reductions are shown as boxes in Figure 1. Note that the calculation ignores the effect of lower U.S. demand on world oil prices, so the impact on the oil import bill is downward biased.

Of course, that is of little comfort, now that we are where we are. Oh, well. But there are still disasters we can avoid. From the conclusion to the same report:

The focus of this essay has been on the economic consequences of inaction. The longer we wait, the greater the likelihood of a global financial and economic disruption. Even absent a discrete crisis, hewing to the current course raises the chances of stagnant economic growth, if not recession, in the future. But there may well be other ramifications.

A cautionary note regarding America’s current path is provided by Britain’s loss of military and political primacy in the 20th century; that development followed a shift from creditor to debtor status. Similarly, a prolonged decline in the dollar’s value and increasing indebtedness will erode America’s dominance in political and security spheres. These trends threaten the dollar’s role as the global currency that facilitates international trade and finance, something the United States has gained immeasurably from over the years. A weaker dollar also reduces American leverage in international financial institutions such as the World Bank and IMF. Finally, a diminished U.S. currency means that each dollar’s worth of military and development assistance has less impact at precisely the time when the nation faces the greatest challenges. Those threats we ignore at our own peril.

That quote brings me to the second fact, that measured dollar reserves continue to decline. Now, since measured and actual dollar reserves almost surely differ, this second fact is not as informative as it could be. My estimate of dollar reserves, as a share of total, also appears to be declining.


Figure 2: US dollar as a share of total foreign exchange reserves (blue), estimated US dollar share, assuming 60% of unallocated reserves are in USD (red), and estimated euro share, assuming 40% of unallocated reserves are in EUR. Source: IMF, COFER, accessed July 9, 2008, and author’s calculations.

The conclusion I draw from this is that we should eschew the snake oil of extending the Bush tax cuts (and associated Laffer curve fantasies) which would likely exacerbate the dollar’s decline, and take responsibility for the future.

29 thoughts on “Two Interesting Facts of the Day

  1. bartman

    Why do you think that the government should try to change private fuel consunmption habits? Do you think that the little people are too dumb to know what’s good for them, and thus need “guidance” from the experts in how to live their lives?

  2. Menzie Chinn

    bartman: Please do not put words in my mouth. As discussed in my posts on several occasions, there is the idea of externalities, which means the marginal private costs deviate from social costs. This is not some exotic idea, as you can find it in introductory economics textbooks; you might find consulting such texts of some use. In addition, if the social rate of discount is different from the private rate, then once again, the socially optimal outcome may not obtain. It’s not a matter of being dumb or not.

  3. bill j

    And that leaves aside the question of the impact of the distribution of effective demand in determining choice as expressed through a market.
    As the Economist explained;
    “Since 2000 after you adjust for inflation, the wages of the typical American worker the one at the very middle of the income distribution have risen less than 1% since 2000. In the previous five years, they rose over 6%. Meanwhile, the share of aggregate income going to the highest earning 1% of Americans has doubled from 8% in 1980 to over 16% in 2004.
    The Economist, 15 July, 2006.
    In other words rich people – a tiny fraction of the US and world population, own a massive proportion of effective demand, and consequently have an altogether disproportionate influence over what is consumed and produced.
    Putting tax on petrol and using that money to say, fund free public transport, would increase utility across society, even if it would hit the consumption of the wealthy.

  4. don

    A really excellent post. And excellent advice. I’m just afraid the response will be the same as to your earlier (also excellent) advice on the gas tax.
    As to the difference between private and social costs, I wonder how often the social costs are calculated to include an estimate of the effects on the price of oil, as well as the effects on pollution and on congestion.
    Given the massive additions to dollar reserves, the decline in the ratio surprises me. I can’t wait to see what happens when the U.S. malaise spreads more globally and it becomes clear that the euro area is not an opimal currency area.

  5. GWG

    Are there any estimates on how much of the decline in the dollar is due to budget deficits versus interest rate policy or the trade balance?
    While I am largely in agreement with your conclusions (but only due to the fact that it appears we cannot reduce spending) it would seem that early next year would not be a particularly good time to increase taxes. Likewise, increasing the gasoline tax would have been a great idea years ago, but will never happen unless oil prices drop considerably or at least stabilize and the economy has time to more fully adjust.

  6. bartman

    Menzie: I was not putting words in your mouth – you had written of taxing gasoline, and the effects of this tax on consumption. Maybe I was being a little pointed or provocative, but that’s the nature of internet forums.
    I understand externalities (I have an econ doctorate, and have taught 101 for a few years), but I often see them being used as a convenient catch-all justification for any and all kinds of regulation and market intervention by wanna-be central planners and anti-market types. As you know, almost anything can be construed as an externality. For example, if I buy a lot of pizza I move the demand curve out, which increases the price for everybody – the simple act of me buying pizza is an externality. You see how it goes? No rational economist would classify that as an externality, but I have seen socialists do it many a time – they think that my consumption of pizza needs to be planned and controlled so as not to create any “distortions” that might affect another individual.
    Instead of “putting worlds into your mouth”, I’ll ask: do you see the formation of a trade defecit as an externality? (That’s what this post seems to be about.) Or do you think that the traditionally defined externalities associated with gasoline use (pollution, noise, congestion) are not adequately internalized by the current tax structure? (The post does not seem to be about that.)
    Bill J.: distribution of consumption (i.e., demand) is much, much flatter than distribution of income or net worth.
    RebelEconomist: if you need tax revenue, then tax the broadest possible base of economic activities, so as to avoid localized distortion. If I had my way, I’d replace taxes on income, corporate earnings and dividends with a broad-based sales tax. But I’d also reduce the scope of government (and the need to tax) by orders of magnitude, so we know my ideas aren’t going to fly.
    If you’re taxing something because you want to internalize an externality, then the tax revenues should be focused as tightly as possible on the people suffering the externality, not go into “general revenue”.

  7. Charles

    Bartman, wrt “…if I buy a lot of pizza I move the demand curve out…,” please allow me to express my considerable pleasure at not having had you as an economics instructor.

  8. mike

    I’ve never really understood why “the dollar’s role as the global currency that facilitates international trade and finance” or its role as a reserve currency is beneficial to the US. I suppose that more people using more (US) dollars means that more people can do commerce with us; is that what they’re talking about, or is there more to it?

  9. franks

    “This is not some exotic idea, as you can find it in introductory economics textbooks”
    HAHAHAHA this blog is great
    this blog is turning into a battleground.
    This post was almost as good as Mankiw’s piece on highest paying majors out of college. HAHA another brilliant observation. what a dork

  10. GK

    Again, we see that virtually all of the trade deficit is just two things, Oil and Chinese Imports. Yet, both of these appear to be near saturation in terms of dollar imports. US oil consumption is actually dropping, as shown in other charts on this website.
    Trade deficit as a percentage of GDP continues to improve, particularly if we take the oil component out.

  11. David

    There has been a lot of talk lately suggesting the Gulf States should dump their dollar pegs, as noted here. While this makes sense to me as a long run outcome, I am concerned how one would actually make the transition from a dollar peg to a basket currency/oil peg in the short run without causing more strain–maybe even a run–on the dollar. If your dollar reserve graph looks ominous now, imagine what it might look like if a transition away from dollars in the Gulf States caused the other major dollar reserve holders to panic.

  12. bartman

    You’ll need to elaborate for poor little dim me, Charles. Are you questioning the validity of the statement that I made?
    If I move to a town and start ordering a lot of pizza, what happens to the local pizza market demand curve? Does it move in? Out? Up? Down? Left? Right? Not at all?
    I imagine, from looking at your blog, that you think that you don’t much like my politics, hence the attempt at an insult. However, your riposte is the effort of an unarmed man in the battle of wits. You can do better, can’t you?

  13. bartman

    The Gulf states allowing their currencies to float, in a restricted manner, against the dollar, will not have an appreciable effect on the dollar in the near- or mid-term. Nobody there is talking about dumping the dollar share of their currency reserves, or changing the currency in which oil is denominated.
    The UAE Dirham trades at a fixed rate of 3.67 Dh/$. If this gradually changed to, say, 3.00 Dh/$ over the next year, what effect would that have on the dollar? I say, basically none.

  14. The Market Traders

    The Dollar’s Decline: Taking Responsibility for the Future

    Menzie Chinn submits: As of 2008Q1, wholly 100% of the increase in the trade deficit since 2001Q4 is accounted for (in a mechanical sense) by the increase in the value of oil imports. And the dollar share of reserves appears to continue its decline. To th

  15. Michael McKinlay

    Coincidence ?
    That our imports are falling as our GDP is falling ? That is the real GDP adjusted for real inflation.
    It is known as demand destruction and as soon as the Asian economies roll over our exports will dive as well.

  16. bsetser

    Menzie — with unallocated reserves growing faster than allocated reserves, your assumption of a 60/40 split for unallocated drives the overall result — as 60/40 is lower than the dollar’s current global share. BAsically you have assumed (I suspect) that the $ share of reporting emerging economies can be applied to non-reporting emerging economies (a not unreasonable assumption, tho not one I would make), and thus as EMs share of the global total rises, the dollar’s overall share will converge toward 60%. Japan basically exerts less impact on the data.
    two points here —
    a) I suspect (but of course do not know) that the non-reporting emerging economies have a higher $ share than the reporting emerging economies, b/c a lot of the countries that do not report data to the IMF seem to peg to the dollar/ manage against the dollar. Think China and the Gulf.
    b) if you look at actual dollars purchased by central banks, that total is still rising fast — cause reserve growth is strong.
    however, there is one data point that is more consistent with your 60% assumption than my assumption (more like 70%) — identified central bank purchases of $ assets are running well below what i would expect. that implies either more “hidden purchases” — i.e. more use of external managers/ purchases through london — or more diversification/ a lower $ share of the flows.

  17. Menzie Chinn

    bartman: To quote the question you posed:

    Do you think that the little people are too dumb to know what’s good for them, and thus need “guidance” from the experts in how to live their lives?

    You will excuse me if I had thought that you were trying to impute these views to me. Regarding your statement:

    Maybe I was being a little pointed or provocative, but that’s the nature of internet forums.

    I would hope that on this weblog we could elevate the tone of the discourse.

    Regarding your understanding of externalities, you clearly have the advantage of me. I do not know your credentials, but you surely have sufficient information from my previous postings and the online bio to know that I am not a socialist, and that I have sufficient training to know what an externality is. Hence, your statement:

    No rational economist would classify that as an externality, but I have seen socialists do it many a time – they think that my consumption of pizza needs to be planned and controlled so as not to create any “distortions” that might affect another individual.

    does not seem relevant to me in this case.

    To your point, then, regarding what my views are regarding the nature of externalities associated with oil consumption, they have been laid out in a variety of for a, including the hyperlinked Council of Foreign Relations report, as well as in this weblog. But for the sake of comprehensiveness, then, let me recount them again:

    • Pollution.
    • Global warming, aka global climate change.
    • National security, in the form of needing to expend resources to safeguard access to oil reserves abroad.

    So, I believe that there is a distortion in the oil component of the trade balance.

    I concur that reasonable people can disagree on the magnitude of the externality, defined as economists define them. I think that is a good place to center a debate on what form of public policy is necessary. I look forward to resuming the debate on that front in a constructive and informed manner.

  18. Morrison Bonpasse

    The success of the euro has shown the world that monetary union is a solid foundation for monetary stability and the optimal monetary union will be a Global Monetary Union. A key difference between the U.S. dollar and the euro is that the European Central Bank manages a common currency for the benefit of 15 nations, soon to be 16, and the Federal Reserve is concerned about the currency for only one nation. As Professor Chinn wrote with Jeffrey Frankel of Harvard in 2005, the euro will likely, as soon as 2022, surpass the U.S. Dollar. Rather than continue this risky, “Who’s on First?” international monetary game, the world should “take responsibility for the future” and research and plan for a Single Global Currency. The euro is likely to be the core of such a Single Global Currency.
    The Single Global Currency Association promotes the implementation of a Single Global Currency, within a Global Monetary Union and managed by a Global Central bank, by the year 2024. With the successful use of the euro and other common currencies, more and more people and organizations and nations are seeing the advantages of monetary unions. Our website is at
    The Association recently published the 2008 Edition of my book, The Single Global Currency – Common Cents for the World. A copy of the 2007 edition is available at the Munchen personal archive at and on the Association’s website.
    The goal of 2024 is only 16 years away. If one looks at the world before the 2002 distribution of the euro to the people of the EMU, you would have seen in 1986 a Europe with a Soviet Union, an East Germany and a Berlin Wall. At that time, most Europeans would have scoffed at the idea of a European monetary union.
    The benefits of a Single Global Currency include:
    – Zero transaction costs to exchange currencies. Presently, $3.2 trillion is traded every trading day and all this trading and its associated costs, approximately $400 billion annually, can be eliminated.
    – The end of currency fluctuations and currency speculation.
    – The end of “Balance of Payments”, “Current Account” and “global imbalances” problems for currency areas. There will, of course, still be trade and wealth inequalities, and more visibly; but they will not be compounded by the problem of foreign exchange transactions and reserve requirements. There would be no need for countries to maintain international reserves of other currencies.
    – Zero manipulation by countries of their currencies, and thus no more need to cajole and jawbone any particular country or currency area about the value of its currency.
    – Zero risk of national and regional currency crises such as occurred in the 1990’s in Mexico, Argentina, Malaysia, South Korea and Russia.
    – Minimal inflation, assuming that the future global central bank sets and achieves a low inflation rate, just as the European Central Bank has done. It’s not clear that a zero inflation rate can be secured, as that would bring an economy perilously close to deflation and a deflation spiral, but certainly a low rate of inflation would be better for the world than the current rates.
    – Worldwide asset values will increase by about $36 trillion due to the elimination of currency risk. Such an increase in asset values will cause annual worldwide GDP to increase by about $9 trillion.
    – With no currency risk, worldwide interest rates would be lower.
    – With zero risk of currency failure and zero manipulation and minimal inflation, the Single Global Currency would satisfy the moral obligation that a stable currency should be considered as a fundamental human right, as is the right to own property. A Single Global Currency would be far more stable than the currencies presently used by billions of human beings
    While all these benefits are expected upon the implementation of a Single Global Currency, considerable benefits will also come during the implementation processes which will see the reduction of national currencies as predicted and welcomed recently by Benn Steil in Foreign Affairs.
    Of course, not all economists agree with the goal of a single global currency. For those who would label the single global currency utopian, we call their attention to the euro, which began as a plan only about 30 years ago. Who would have thought in the 1970’s that Europe would not only adopt a common currency, but also that its member countries would discard their old currencies?
    The single global currency might be an enlarged transformation of one of the current major currencies (dollar, euro, yen), perhaps with a new name such as “dey”, “eartha”, “geo”,”globo” or “worldo” or it might be a new currency with such a name. How we get to that point is, of course, a major challenge, but there are several possible routes. One is to continue the trend of creating and expanding regional monetary unions, and then combine those monetary unions into one. Another is for smaller countries to continue to “ize” their nations’ legal tender, as in “dollarize” and “euroize”, as has been done in El Salvador and Monaco. Compatible with all these and other routes is the need to convene an international monetary conference of nations, monetary unions and related organizations, and begin planning for the implementation of a single global currency.
    Organizations such as the IMF and the Bank for International Settlements, and individual economists should begin to carefully research and write about the benefits claimed above for the Single Global Currency, and about the costs, too. When the vast benefits become better known, the people of the world will demand a Single Global Currency and ask why we have been burdened so long with the existing multicurrency system, which Nobel Laureate Robert Mundell, (“father [among several] of the euro”) describes as “absurd.”

  19. lilnev

    mike: As I understand it, (I’m sure someone will correct me if I’m way off base) the main advantage of the dollar’s status as reserve currency is that we get cheap borrowing costs. All those foreign holdings are dollar-denominated, but they’re not cash — they’re treasuries, i.e. debt. As the world economy has grown, those countries have expanded their reserve holdings by buying more treasuries, keeping the price high and rates low. Thus, for years the gov’t has been able to spend more than it collects in taxes, with foreign central banks providing cheap financing.

  20. Chih Kwan Chen

    US trade deficit of goods, excluding food and industrial materials, was around $25 billion a month at the final quarter of 2001. At the first quarter of 2005 it reached near $40 billion a month, stayed more or less at that level until the fourth quarter of 2007, and now looks like it is falling again.

  21. Expat

    @bartman: Not only are the little people too stupid to run their own lives, but apparently so are the medium and big people. That said, most people don’t know what’s good for them. If Americans could vote for it, they would mandate 1$ gasoline and no mileage requirements for cars.
    People are stupid. Just look at GWB!

  22. Chih Kwan Chen

    Dollar’s fall is the unavoidable consequence of the runaway US trade deficit. If not for the massive dollar buying operations in the hands of Asian governments like Japan, China, Taiwan and so on, dollar would have been much lower today. The reason that the US trade deficit has been growing steadily since the era of Reagan administration is due to the popularity of running trade deficits. First of all trade deficits replace personal savings as the seed money for the financial market. Increasing trade deficits have allowed US consumers to whip down personal saving to near zero and increase their consumption substantially. Even just consider the period from 2001, median real personal consumption per person has increased substantially even though median real personal income has stayed almost flat. People are generally happy until the recent burst of the debt bubble. Then Wall Street has leaped enormous profit from the trade deficit. Just consider the following; the dollars handed out to foreigners due to the trade deficit must flow back to the US financial market, and most of the money flows through Wall Street. This allows Wall Street to create bubbles and gain astronomical profits from the bubbles. It is not just this Bush bubble of mortgage and other debts. There was the Clinton bubble of stocks and Reagan bubble of junk bonds; all are the results of run away trade deficits. There is little wonder when anyone talks about reining in the trade deficit, Wall Street and its representatives on major financial media will all up to the arm and utter the word protectionist. Maybe this country does deserve to tumble down from the throne of the super power simply due to its own shortsightedness and stupidity. As for the gasoline tax, it is still highly debatable whether it alone would have saved this country from its self destruction.

  23. RebelEconomist

    Lilnev, Mike,
    Yes, having a reserve currency is supposed to be an advantage for the issuing country because the extra demand for its debt lowers its cost of funding. In fact, the phrase used by Giscard d’Estaing was “exorbitant privilege”.
    It is, however, vital that the country appreciates that it is the cost of funding that is the privilege and not the funds themselves. I would argue that the US has failed to do this. If you are interested in reading more, see my blog post:

  24. Chih Kan Chen

    For a currency to serve as the global trade settlement currency, there must be plenty of the currency circulating outside its own border. In the good old days when US was running a trade surplus, US needed to supply the rest of the world enough dollar to settle trades via the persistent foreign aids. Nowadays, the run away trade deficit is playing the trick. If one wants to use Japanese Yen as the major trade settlement currency, it simply cannot be done since MOF of Japan insists that Japan should have $100 billion plus a year of trade surplus. Any Yen released to the rest of the world is quickly reabsorbed back into Japan. When some oil producing countries that are not friendly to US, like Russia, wants to convert their petro-dollar into Euro, many European institutions gladly accepted those petro-dollar and invested them into our subprime mortgage backed securities and other poisonous ones. Now they are deeply hurt, this avenue of releasing Euro to the rest of the world is closed. If Euro wants to increase its share as the world trade settlement currency, Euro region needs to run a much larger trade deficit, probably as large as the current US trade deficit. Does Europe has the tenacity to follow this track of US into the certain self-destruction as we are doing?

  25. Menzie Chinn

    bsetser: On this point I think I will defer to you. Next time around I’ll post estimates (or more properly, guesstimates) with 70% and 60% dollar share assumptions.

  26. simon

    An interesting analysis that is purely conceptual.
    First we have no disaster in economic terms. There is no such economic concept.
    Second the opportunity costs is your analysis is largely missing.
    Third a potential set of other policy interventions from the “wise ones” is also missing.
    Alternative history is interesting but bestt left to the History channel. It is not Economics.
    The idea that a stable currency is a human right is beyond absurd. There is no way that such a state is possible.

  27. GNP

    GWG wrote:

    …. it would seem that early next year would not be a particularly good time to increase taxes. Likewise, increasing the gasoline tax would have been a great idea years ago, but will never happen unless oil prices drop considerably or at least stabilize and the economy has time to more fully adjust.


    It is never too late to implement better fiscal policy.

    Implementing high taxes on fuel in one swoop would probably be sufficient to drive the US economy into recession no matter how cheap or expensive oil is.

    The trick is to announce a _credible_ schedule of fuel tax increases, perhaps starting immediately with a small symbolic increase and then gradually implementing the taxes over a 2 to 5 year time horizon, for example.

    If the political consensus behind such a reform is sufficiently strong, one should observe headline oil prices declining if not plunging almost immediately. It would be the first time in my lifetime that Americans would have credibly signalled a social commitment to conservation through reductions in consumption.

    This is one of the few times, that a tax increase would unambigously make Americans better off. Beyond household budgets and trade deficits, galloping obesity and CPOD (Chronic Pulmonary Obstructive Disorder) are ballooning into massive social and economic problems.

    Menzie Chen: Sweet article. Congratulations. Should enhance your reputation for making good calls.

  28. GNP

    Bartmann: I would agree with you. The ‘little people’ do need full social cost prices to help them make better decisions.

    But before you embark upon a neomarxist-inspired populist anti-elitist rant, please consider the following:

    The ‘little people’ in La belle province du Quebec generally support ‘carbon taxes’. So do many of the little people in British Columbia, Norway, Sweden, Iceland, The Netherlands, …… Shall I go on?

    I guess some ‘little people’ are collectively smarter than other ‘little people’.

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