The U.S. Trade Deficit, The Dollar, and the Price of Oil

The U.S. Trade Deficit, The Dollar,
and The Price of Oil
September 29, 2008
James K. Jackson
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division

The U.S. Trade Deficit, The Dollar, and The Price of Oil
Summary
Rapid changes in the price of oil and the impact of such price changes on
economies around the globe has attracted considerable attention. In mid-2008 as the
price of oil rose to unprecedented heights and then dropped sharply, the international
exchange value of the dollar fell and then rose relative to a broad basket of
currencies. For some, these two events seem to indicate a cause and effect
relationship between changes in the price of oil and changes in the value of the
dollar. Despite common perceptions that there is a direct cause and effect
relationship between changes in the international exchange value of the dollar and
the price of oil, an analysis of recent data indicate that the rise in the price of oil is
being driven by an increase in demand that is exceeding the increase in supply.
This report analyzes the relationship between the dollar and the price of oil and
how the two might interact. While the data do not support a strong cause and effect
relationship between the value of the dollar and the price of oil, there likely are
various channels through which changes in the price of oil and in the value of the
dollar may be indirectly correlated. The data also indicate that an increase in the
demand for crude oil that exceeded the increase in the supply of oil and a laggardly
pace in oil production capacity likely are among the main factors behind the sharp
run up in the price of oil in the first seven months of 2008. The rise in oil prices also
is affecting the U.S. trade deficit. This report provides an assessment of the impact
a range of prices of imported oil could have on the U.S. trade deficit.
This report will be updated as events warrant.

Contents
Overview ........................................................1
The Dollar and the Price of Oil.......................................3
Real and Nominal Oil Prices.....................................4
Major Currencies..............................................5
The Price of Oil...................................................7
Oil Exchanges................................................8
Oil Demand and Supply........................................10
The International Exchange Value of the Dollar.........................13
Capital Flows................................................14
U.S. Financial Balance.........................................14
Foreign Exchange Market......................................16
The U.S. Trade Deficit.........................................18
Conclusions .....................................................19
List of Figures
Figure 1. Real and Nominal Crude Oil Price Indexes, 1970-2007............4
Figure 2. Crude Oil Real Price Index and Broad Real Dollar Index,
1999 - 2008..................................................6
Figure 3. Crude Oil Real Price Index and Real Dollar/Euro Index,
1999-2008 ...................................................7
Figure 4. Crude Oil Real Price Index and Real Yen/Dollar Index,
1999-2008 ...................................................8
Figure 5. Crude Oil Real Price index and Real Dollar/Pound Index,
1999-2008 ...................................................8
Figure 6. Change in Oil Demand by Major Area, 2003 to 2007.............12
Figure 7. Change in Oil Supply by Major Area, 2003 to 2007..............13
List of Tables
Table 1. World Oil Demand and Supply, 2003-2007.....................11
Table 2. Flow of Funds of the U.S. Economy, 1996-2007.................15
Table 3. Foreign Exchange Market Turnover...........................17
Table 4. Estimates of the Addition to the U.S. Trade Deficit Associated With
Various Prices for Crude Oil and Changes in Oil Import Volumes.......19

The U.S. Trade Deficit, The Dollar, and The
Price of Oil
Overview
To most observers, it seems apparent that the rise in the price of oil¹ from 2006
through mid-2008 and the decline in the exchange value of the dollar are
interconnected events, or that there is some cause and effect relationship between the
two.² Since oil is priced in dollars, this line of reasoning goes, as the exchange value
of the dollar declines, the purchasing power of oil producers also falls, which, in turn,
prods oil producers to reduce their supplies to the market in order to push up the
market price of oil and restore their purchasing power. This line of thinking is not
unreasonable, considering various incidents, most notably 1973 and 1979, in which
the price of oil rose sharply in response to actions taken by members of the
Organization of Petroleum Exporting Countries (OPEC)³ group of oil producers to
increase the market price of oil. Indeed, OPEC's stated objective is to co-ordinate
and unify petroleum policies among OPEC Countries, in order to secure “fair and
stable prices for petroleum producers; an efficient, economic and regular supply of
petroleum to consuming nations; and a fair return on capital to those investing in the
industry.” After reaching nearly $147 per barrel in August 2008, the price per barrel
of oil dropped to nearly $100 per barrel by mid September 2008. In response to the
drop in oil prices, OPEC announced on September 1, 2008 that it would reduce its
oil production by 500,000 barrels per day.⁴
The data indicate, however, that the rise and in oil prices experienced since 2006
and recent fall in oil prices have not been driven primarily by a reduction in world
supplies, but reflects a number of factors, including the slow-paced growth in oil
production and an increase in demand, most notably among the developing countries,
that has outpaced the increase in supply. In addition, the decline in the international
exchange value of the dollar likely reflects a number of factors, including a change
in the demand for and supply of capital within the U.S. economy, the relative rate of
return on interest-sensitive assets, and expectations about the performance of the U.S.
economy. At the same, some observers have argued that oil market speculators have

¹ CRS Report RL33521, Gasoline Prices: Causes of Increases and Congressional
Response, by Carl E. Behrens.
² Merriman, Jane, “Weak Dollar Central to Oil Price Boom,” Reuters, September 26, 2007.
³ OPEC is comprised of Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya,
Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela.
⁴ Reed, Stanley, “How Real is OPEC’s Production Cut?” BusinessWeek, September 11,

2008.

played an important role in pushing up oil prices so quickly in 2008.⁵ A report issued
on September 11, 2008 by the Commodity Futures Trading Commission (CFTC),
however, concluded that market speculators probably were not responsible for the
rise in oil prices.⁶
While data on exchange rates and on oil prices do not support the case for a
strong cause and effect relationship between the value of the dollar and the price of
oil, there are a number of channels through which changes in the price of oil and
changes in the value of the dollar may be indirectly correlated. In fact, an increase
in the price of oil to offset the loss of purchasing power that is associated with a
depreciation in the value of the dollar can spark a chain of events that could blunt or
even nullify the rise in oil prices.
The pervasive nature of such commodities as oil, which serve as essential
components in economic growth, means that changes in the prices of those
commodities affect the prices of a broad range of goods, services, and economic
activities.⁷ Indeed, according to the Census Bureau, increases in the price of
imported oil were a major factor in rising consumer prices in the United States in the
first six months of 2008. Moreover, rising consumer and commodity prices
undermine the exchange value of the dollar relative to other currencies and reduce
the real incomes of consumers, which can lead to a lower rate of economic growth.
Slower economic growth, in turn, lowers the demand for oil, thereby putting
downward pressure on the price of oil.⁸ Expectations about future economic growth
and, therefore the demand for crude oil, also can affect a broad range of investment
decisions that might affect expectations about the value of the dollar. The interaction
between the price of oil and the value of the dollar is complicated further by the way
changes in the price of oil can affect the economic performance of other nations and,
therefore, have an impact on their respective currencies.⁹
According to Global Insight¹⁰, a number of actors worked to put upward
pressure on oil prices in 2007 and during the first half of 2008. These factors include
both supply and demand issues as well as geopolitical troubles in various countries,
particularly Nigeria and Iran, that created uncertainties in the market concerning the

⁵ Masters, Michael W., Testimony before the Committee on Homeland Security and
Governmental affairs, United States Senate, May 20, 2008.
⁶ Mufson, Steven, “Speculators Did Not Raise Oil Prices, Regulator Says,” The Washington
Post, September 12, 2008, p. D1; Staff Report on Commodity Swap Dealers & Index Traders
With Commission Recommendations, Commodity Futures Trading Commission, September

2008.

⁷ CRS Report RL31608, The Effects of Oil Shocks on the Economy: A Review of the
Empirical Evidence, by Marc Labonte.
⁸ Clifford, Catherine, Oil at 5-month Low on Shrinking Demand. CNNMoney.com.,
September 5, 2008; Barr, Colin, Why Cheaper Oil Signals Trouble. CNNMoney.com.
September 4, 2008.
⁹ Dougherty, Carter, “Fears of European Slowdown Weaken the Euro.” The New York
Times, August 9, 2008.
¹⁰ Market Analysis: Forecast Highlights, Global Insight, July 1, 2008.

stability of oil supplies. A low rate of growth in oil supplies relative to a higher rate
of growth in the demand for oil is cited as the most important market factor behind
the rise in oil prices. Saudi Arabia agreed to increase its production of oil by 300,000
barrels per day in May 2008 and by an additional 200,000 barrels per day in July
2008. Also, price movements in the oil market may have been exaggerated
somewhat by trading in the oil futures market, and other producers, especially non-
OPEC producers, have not increased their supply as had been projected. On the
demand side, continued strong growth in the demand for oil in Asia and the Middle
East pushed the total demand for oil to rise at a pace that has been faster than the rise
in supplies. Demand in the Middle East is rising at double-digit rates as a result of
a boom in construction and oil consumption. In Asia, demand for oil has grown
rapidly in China, where until recently the government was subsidizing the price of
oil to consumers and the government was stockpiling oil to use as substitute for coal
in the Beijing area during the Olympics to reduce the level of air pollution.
The Dollar and the Price of Oil
For many observers, there seems to be a direct cause and effect relationship
between the depreciation in the international exchange value of the dollar and the rise
in the price of oil. These observers argue that because oil is priced in dollars, a
depreciation in the international exchange value for the dollar against other major
currencies erodes the purchasing power of oil producers. The International Monetary
Fund (IMF) has identified three channels through which a change in the value of the
dollar can affect a broad range of commodity prices, including the price of oil. A
change in the value of the dollar can affect commodity prices through: 1) purchasing
power and cost channels; 2) asset channels in which changes in the value of the dollar
affect the return on dollar-denominated financial assets; and 3) a combination of
effects, including changes in monetary policy.¹¹ As a result of these three effects, the
IMF also estimates that among various commodities, the linkage between changes
in the value of the dollar and changes in commodity prices is especially strong for oil
and gold, because they are more suitable as a “store of value,” or as a hedge against
inflation.¹² One explanation for this relationship is that oil market participants and
speculators may have adopted a rough rule of thumb over time concerning changes
in the value of the dollar and subsequent changes in the price of oil and vice versa.
As a consequence the statistical relationship between the two has been strengthened,
because market participants have acted on this informal rule.
The past actions of OPEC oil producers may also have tended to strengthen the
apparent linkage between changes in the value of the dollar and changes in the price
of oil as the producers have acted in concert to adjust their output in order to alter the
world price of oil. OPEC accounts for just over 40% of the world output of crude oil,
and the coordinated actions of its members can affect world oil prices. In addition,
one of OPEC’s stated goals is to secure a “fair and stable price” for the oil the

¹¹ World Economic Outlook, the International Monetary Fund, April 2008. P. 46-50.
¹² The IMF estimates that a 1 percent real depreciation in the value of the dollar would
result in an increase of greater than 1 percent in the price of oil over two years. Ibid., p. 50.

member countries produce, it is not unreasonable to assume that OPEC members
would respond to a loss in the purchasing power of the dollar by reducing their
overall level of production, or holding down the rate of increase in production in
order to raise the market price of oil.¹³
Real and Nominal Oil Prices
Figure 1 shows indexes of the nominal and real (adjusted for inflation) indexes
of the price of crude oil from 1970 to 2007. The figure shows the 1973 and 1979
price increases and the slide in the real price of oil between 1980 and 1999. The
indexes show the stark rise in real oil prices in the 1970s as OPEC oil producers
pushed up crude oil prices. Over the next decade, however, real prices slowly moved
downward to more moderate levels, due in part to an increase in crude oil production
by non-OPEC producers. Naturally, nominal prices increased in the 1970s as a result
of the rise in oil prices, but nominal prices rose at a slower pace than real prices as
national governments focused economic policies on constraining inflation. Both real
and nominal oil prices began rising in 1999 as a result of an agreement signed in

1998 between OPEC members and such non-OPEC producers as Mexico, Norway,

Oman, and the Russian Federation to reduce their supplies of oil. While OPEC’s
Figure 1. Real and Nominal Crude Oil Price Indexes, 1970-2007

Price Index 2000 = 100
^300.0
^250.0
Real Oil Prices
^200.0
^150.0
^100.0
Nominal Oil
^50.0 Prices
^0.0
¹⁹⁷⁰¹⁹⁷⁵¹⁹⁸⁰¹⁹⁸⁵¹⁹⁹⁰¹⁹⁹⁵²⁰⁰⁰²⁰⁰⁵
Year
^So^{urce: CRS, E}ⁿ^erg^y^Inf^o^rm^a^t^io^{n Adm}ⁱ^nistra^tioⁿ
¹³ According to standard economic theory, a reduction in the market supply of a good
relative to a given level of demand will result in a higher market price for the good since the
market demand would be chasing a smaller number of goods (supply), which would tend to
bid up the market price of the good.

production of crude oil declined by about 4% in 1999 from that produced in 1998,
production in 2000 increased by 6% to reach an average of 29.5 million barrels per
day. From 2000 to 2002, OPEC’s production of crude oil fell by about 9.5% to 26.8
million barrels per day. After 2002, OPEC’s crude oil production has increased
every year, reaching an average of 35.4 million barrels per day in 2007.
Data for the second quarter of 2008 likely will show an increase in the real price
of crude oil above the peak reached in 1980. On an annual basis, the average price
of oil, as measured by the spot price of Brent crude,¹⁴ rose from $54.42 per barrel in
2005 to $72.47 per barrel in 2007, or an increase of 33% in nominal terms. In real
terms, the price of oil rose at a slightly more modest 25% rate on an annual average
basis from 2005 to 2007. During the same period, the dollar depreciated less than
7% in real terms as measured against a broad basket of currencies.¹⁵ From January
2008 to May 2008, the real price of oil increased by another 30%, while the real
broad dollar index depreciated by 1.2%. Against other major currencies, the dollar
depreciated about 4% against the Euro in real, or price adjusted terms on average
from 2005 to 2007 and about 3% in the January to May period in 2008. Relative to
the Yen, the dollar appreciated about 1% between 2005 and 2007 in real terms, but
depreciated about 6% against the Yen in the first four months of 2008. Against the
British Pound, the dollar depreciated about 4% in real terms between 2005 and 2007,
but gained about 3% in value in real terms in the first four months of 2008.
Major Currencies
Figures 2 through 5 display indexes of the dollar relative to other currencies in
real terms and an index of the price of oil, also expressed in real terms, from the first
quarter of 1999 through the first quarter of 2008. Figure 2 shows the real broad
dollar index, or an index of the dollar per a unit of a grouping of 26 currencies in real
terms compared with an index of the real price of crude oil. A decline in the dollar
index signifies a depreciation in the value of the dollar relative to the broad group of
other currencies. The data cast doubt on the argument that the price of oil responded
to offset the depreciation of the dollar. Compared with the currencies of the 26
largest U.S. trading partners, the dollar depreciated slightly in real terms, compared
with a large increase in the real price of oil.
The devaluation of the dollar against the Euro since early 2006 also led some
observers to speculate that oil producers would attempt to raise the price of oil to
compensate for the devalued purchasing power of the dollar relative to the Euro and
that a devalued dollar would be a disincentive for producers to explore and drill for
new wells because of the loss of purchasing power. In addition, the devalued dollar
makes oil cheaper for the euro-area countries and, therefore, oil consumption in the
euro area should increase with an appreciation of the euro. The decline in the

¹⁴ Brent crude is the largest classification of crude oil. It is used to price two-thirds of
internationally traded crude oil supplies.
¹⁵ The broad dollar index is an index of the currencies of 26 largest U.S. trading partners
weighted by the importance of the country as a trading partner. For additional information,
see Loretan, Mico, Indexes of the Foreign Exchange Value of the Dollar, Federal Reserve
Bulletin, Winter 2005. P. 1-8.

Figure 2. Crude Oil Real Price Index and Broad Real Dollar Index,

1999 - 2008

Real Price Index 2000 = 100
⁴⁰⁰
³⁵⁰
Crude Oil Real Price Index
³⁰⁰
²⁵⁰
²⁰⁰
¹⁵⁰
¹⁰⁰
Broad Real Dollar Index
⁵⁰
⁰
^I/⁹⁹^I/⁰⁰^I/⁰¹^I/⁰²^I/⁰³^I/⁰⁴^I/⁰⁵^I/⁰⁶^I/⁰⁷^I/⁰⁸
Quarter/Year
^S^o^u^rce:^F^e^d^eral^{Reserve, En}^ergy^In^f^o^rmatⁱ^oⁿ^Ad^miⁿⁱ^st^ratⁱ^on
exchange value of the dollar relative also prompted some observers to argue that oil
should be priced in a currency other than the dollar.
Data through 2007, however, do not support the contention that euro-area
countries would increase their consumption of oil any faster than the United States
due to the drop in the price of oil that resulted from an appreciation of the euro
relative to the dollar. Also, after some initial adjustment, pricing oil in euros, or
some other currency, rather than in dollars would appear to have no real effect on the
demand and supply of oil in the market. Indeed, pricing oil in dollars facilitates the
smooth functioning of the oil market, because the dollar is the most widely used
currency in the world for pricing, or invoicing trade, which facilitates the cross-
border comparison of goods and services.¹⁶ Figure 3 shows an index of crude oil
prices in real terms and dollars per Euro in real terms, so that a rise in the dollar/Euro
index signifies an appreciation in the Euro relative to the dollar, or a depreciation in
the value of the dollar. The data supports the argument that any loss in oil producers’
purchasing power arising from a depreciation in the value of the dollar relative to the
Euro was offset by a larger increase in the price of oil, which may well provide an
incentive to oil producers to expand their drilling and exploration activities.
¹⁶ Goldberg, Linda S., and Cedric Tille, The International Role of the Dollar and Trade
Balance Adjustment, NBER Working Paper 12495, August 2006; and Goldberg, Linda S,
and Cedric Tille, Macroeconomic Interdependence and the International Role of the Dollar,
NBER Working Paper 13820, February 2008.

Figure 3. Crude Oil Real Price Index and Real Dollar/Euro Index,

1999-2008

Real Price Index 2000 = 100
⁴⁰⁰
³⁵⁰
Crude Oil Real Price Index
³⁰⁰
²⁵⁰
²⁰⁰
¹⁵⁰
¹⁰⁰
Real Euro Index
⁵⁰
⁰
^I/99^I/00^I/01^I/02^I/03^I/04^I/05^I/06^I/07^I/08
Quarter/Year
^S^o^u^{rce: F}^e^d^{eral R}^e^serv^{e, E}ⁿ^{ergy In}^f^o^rm^atioⁿ^A^d^mⁱⁿⁱ^stratioⁿ
Similar trends are seen in movements in the value of the dollar relative to the
Yen and the British Pound. Figure 4 shows the index of the Yen per dollar exchange
rate, expressed in real terms and the index of the real price of crude oil. In this
figure, a decline in the index indicates an appreciation in the value of the Yen relative
to the dollar, since fewer Yen are required to buy a dollar. Figure 5 shows the index
for dollars per Pounds expressed in real terms and the index for real crude oil prices.
In this case, a rise in the dollar/Pound index indicates an appreciation in the value of
the Pound, since more dollars would be required to purchase a Pound. In both cases,
the relative movement in the real prices of foreign currency against the dollar has
been small relative to the increase in the real price of crude oil since 2004.
The Price of Oil
As indicated previously, the OPEC cartel of oil producers has acted in concert
on occasion to alter the supply of oil in the market in order to affect the price of oil
and, therefore, the export earnings of its members. In practice, OPEC oil producers,
or other oil producers for that matter, do not attempt to set the price of oil directly,
but attempt to alter the supply of oil in the market relative to a given level of
expected demand and then rely on the market to search out the corresponding price.
The price of oil, then, reflects the actual level of demand and supply in the market,
which is reflected in the spot, or current, market, and the price of oil is affected by
expectations about demand and supply conditions and about production capacity,
reflected in the futures market. In addition, during times of economic instability,
investors may well trade such commodities as oil that they calculate will generate a

return on their investment that exceeds such traditional financial investments as
stocks, bonds, or government securities.
Figure 4. Crude Oil Real Price Index and Real Yen/Dollar Index,
1999-2008
Real Price Index 2000 = 100
⁴⁰⁰
³⁵⁰
Crude Oil Real Price Index
³⁰⁰
²⁵⁰
²⁰⁰
¹⁵⁰
¹⁰⁰
Real Yen Index
⁵⁰
⁰
^I/⁹⁹^I/⁰⁰^I/⁰¹^I/⁰²^I/⁰³^I/⁰⁴^I/⁰⁵^I/⁰⁶^I/⁰⁷^I/⁰⁸
Quarter/Year
^S^o^u^rce:^F^e^d^eral^Reserv^e,^En^{ergy In}^f^o^rm^atⁱ^oⁿ^Ad^mⁱⁿⁱ^st^ratⁱ^on
Figure 5. Crude Oil Real Price index and Real Dollar/Pound Index,

1999-2008

Real Price Index 2000 = 100
⁴⁰⁰
³⁵⁰
Crude Oil Real Price Index
³⁰⁰
²⁵⁰
²⁰⁰
¹⁵⁰
¹⁰⁰
Real Pound Index
⁵⁰
⁰
^I/99^I/00^I/01^I/02^I/03^I/04^I/05^I/06^I/07^I/08
Quarter/Year
^{Source: F}^e^{deral Reserve, Energy}^Inf^o^{rmation Administration}

Oil Exchanges
Similar to other commodities, oil is traded on specialized commodities
exchanges. Most of this trading is conducted by licensed brokers, who act on behalf
of clients to buy and sell oil on the spot market and in the futures and options
markets.¹⁷ The major futures exchanges for oil are the Intercontinental Exchange,
located in London, which acquired the International Petroleum Exchange in 2001,
and the New York Mercantile Exchange (NYMEX). The New York Exchange states
that it is the world’s largest physical commodity futures exchange. The NYMEX
operates on the bid-ask system in which buy and sell transactions are executed
between floor brokers. In this process, buyers compete with each other by bidding
up prices and sellers compete by bidding prices down. Such markets are identified
as price discovery markets, because the price of the futures contract is determined
through open bids. Futures contracts are firm commitments to make or accept
delivery of a specified quantity and quality of a commodity during a specified month
in the future at a price agreed upon at the time the contract is made. In the
commodities exchanges, futures contracts are traded in standardized units in a highly
visible, extremely competitive continuous open auction. The NYMEX reports that
less than 1% of all oil futures contracts take physical delivery, the remainder are
settled by cash payments.
Although relatively little physical quantities of oil change hands in futures
markets, the markets serve as important sources of information about market
conditions and provide mechanisms for determining the price of oil in the global
energy market. As a result, oil prices that are determined in the futures market are
useful in at least three ways.¹⁸ First, since the futures markets are conducted in full
public view, a broad assortment of traders, including producers, commercial users,
speculators, and financial institutions, make financial and production decisions based
on the prices that are determined in the those market. Second, the prices that are
generated in the futures markets are publicly available and are used as reference
points for physical trades in oil. Third, because the markets are conducted on a bid-
ask system with floor brokers, the prices react quickly to new information about the
supply and demand factors that are expected to influence the price of oil.
Futures and options contacts are used by both buyers and sellers to reduce the
risks inherent in trading commodities.¹⁹ Factors that might cause an abrupt change
in supply, demand, and price such as international politics, war, changing economic
patterns, and structural changes within the energy industry have created uncertainty
about market conditions. Such uncertainty, in turn, leads to volatility in the market
and creates risk for the market participants. The futures price, then, represents the
current market opinion of what the commodity will be worth at some time in the
future. Since the future price of a commodity can not be known with any certainty,
buyers and sellers attempt to lock in prices and profit margins in advance through the

¹⁷ For additional information, see CRS Report RL34555 Speculation and Energy Prices:
Legislative Responses, by Mark Jickling.
¹⁸ CRS Report RS22918, Primer on Energy Derivatives and Their Regulation, by Mark
Jickling.
¹⁹ A Guide to Energy Hedging. New York Mercantile Exchange.

use of futures and options contracts in order to hedge, or to reduce, their risks. The
purpose of the hedge is to avoid the risk of an abrupt change in market conditions and
prices that could result in major losses for buyers and sellers.
Since the spot price and the futures market price do not have a perfect
relationship, there will always be the potential for some profit or loss. Hedging, then,
reduces exposure to risk for a buyer or a seller by shifting part of the risk associated
with the market price of a commodity to investors who are willing to accept the risk
in exchange for a profit opportunity. As indicated above, most traders do not take
physical delivery of the commodities they are trading, but hope to profit by correctly
anticipating future price trends, which some observers argue has been a factor in
driving high and volatile prices. Concerns over the impact of such trading on the oil
market spurred a number of legislative proposals during the 110^th Congress.²⁰
Unlike a futures contract, an options contract conveys a right, but not an
obligation, to engage in a transaction. There are two types of options, calls and puts.
A call conveys the right, but not the obligation, to the one holding the option to
purchase the underlying futures contract at a specified price up to a certain time. A
put gives the owner of the option the right, but not the obligation, to sell the
underlying futures contract at a specified price up to a certain time. A call is
purchased when investors anticipate a rise in prices and a put is bought when
investors expect neutral or falling prices. When options are used in combination with
futures contracts, investors can develop strategies that cover virtually any risk profile,
time horizon, or cost consideration.
Oil Demand and Supply
The data in Table 1 show the world demand and supply of petroleum in
millions of barrels a day on average by major area from 2003 through 2007, including
the four quarters of 2007. As indicated in Figure 6, between 2003 and 2007, the
demand, or consumption, for oil among all consumers increased by 7.3%, rising
from an average of 79.61 million barrels per day in 2003 to an average of 85.38
million barrels per day in 2007. The developed economies, represented by the
members of the Organization for Economic Cooperation and Development
(OECD),²¹ accounted for about 60% of world demand for oil. These developed
economies increased their demand for oil by 0.7% between 2003 and 2007, with U.S.
demand rising by 3.3%. During the same period, demand for oil among European
OECD countries fell by 1%. In addition, from 2006 to 2007, when the euro was
appreciating against the dollar, demand for oil among the European OECD countries
fell by more than 2%, while demand for oil in the United states grew by nearly 2%.
Although demand for oil in China started from a low base, such demand over the
2003-2007 period increased by 35.9%, leading a 17.5% increase in the demand for
oil among developing countries.

²⁰ Ibid.
²¹ For additional information about the OECD, see CRS Report RS21129, The Organization
for Economic Cooperation and Development, by James K. Jackson.

Table 1. World Oil Demand and Supply, 2003-2007
(Million Barrels Per Day)
2003 2004 2005 2006 2007 2007
Annual AverageQuarter

1st. 2nd. 3rd. 4th.

Petroleum (Oil) Demand
OECD
United States20.0320.7320.8020.6920.7020.7720.6520.7020.68
Europe OECD15.4415.4815.6115.6315.2815.2014.9215.3915.61
Total OECD48.6049.3649.6649.3448.9549.4848.0448.5949.70
Non-OECD
China 5.58 6.44 6.72 7.20 7.58 7.33 7.52 7.59 7.87
Former U.S.S.R.3.914.044.074.214.284.254.324.224.32
Other Non-21.5222.4923.2023.8824.5824.3024.6024.6724.74
OECD
Total Non-31.0132.9733.9935.2936.4335.8836.4436.4836.93
OECD
Total World79.6182.3383.6584.6285.3885.3584.4885.0786.62
Demand
Petroleum (Oil) Supply
OECD
United States8.808.708.328.338.488.438.538.408.56
Other OECD14.4614.1113.5613.2612.9313.3212.9712.6612.80
Total OECD23.2522.8121.8821.5921.4221.7421.5021.0721.36
Non-OECD
OPEC 31.88 34.45 36.09 35.83 35.4134.97 35.06 35.43 36.17
Former U.S.S.R.11.3511.7712.1612.6112.6112.6012.5512.66
Other Non-OECD14.5214.8915.0215.1114.8015.1515.2715.23
Total Non-OECD60.3162.7563.0163.1362.3862.8163.2564.06
Total World79.6283.1284.6384.6084.5584.1284.3184.3285.42
Supply
Di f f eren ce 0.003 0.794 0.982 -0.024 -0.837 -1.23 -0.172 -0.746 -1.200
(demand less
supply)
^So^urce^:^Int^e^rn^a^tⁱ^onal^Pet^r^ol^eum^M^ont^hl^y^{, May}^,^{2008. En}^erg^y^In^f^o^rm^atⁱ^oⁿ^A^d^mⁱⁿⁱ^s^t^ratⁱ^oⁿ^.
^T^a^bl^{e 2.1.}
Figure 7 shows that world oil supplies increased by 6.2% over the period from
2003 to 2007, or by less than the increase in the world demand for oil. During this
period, oil supplies provided by U.S. producers and oil producers in other developed
countries fell by 3.6% and 7.9%, respectively. During the same period, OPEC
producers increased their supply of oil by 11.4% and oil suppliers from other
developing countries increased their supplies by 12%. The shortfall between the
change in demand and the change in supply was met by oil that had been held in
stocks elsewhere. The rising demand likely was an important factor in pushing up

the price of oil in the market and likely affected the pricing expectations of oil
brokers and traders in the futures market.
Figure 6. Change in Oil Demand by Major Area, 2003 to 2007

Percent change
40.0
35.938.0
36.0
34.0
32.0
30.0
28.0
26.0
24.0
22.0
17.518.020.0
16.0
14.0
12.0
7.38.010.0
3.34.06.0
0.72.0
0.0
U. S . A. OECD Ch in a Non -OECD T otal
Source: Energy Information Administration

Figure 7. Change in Oil Supply by Major Area, 2003 to 2007

Percent change
14.0
12.0
11.112.0
10.0
8.0
6.2
6.0
4.0
2.0
0.0
-2.0
-3.6-4.0
-6.0
-8.0
-7.9
-10.0
U.S.A. OECD OPEC Non-OECD Total
Source: Energy Information Administration
The International Exchange Value of the Dollar
Although attention has focused on the international exchange value of the dollar
for many years, the depreciation of the dollar since 2006 has drawn particular
attention. As previously stated, some observers have argued that the rise in the price
of oil has occurred in part to offset the decline in the purchasing power of oil
producers as a result of the depreciation of the dollar against other major currencies.
According to standard economic theory, the international exchange value of the
dollar is determined by a complex interplay of demand for and supply of goods and
capital within the U.S. economy and the demand for and supply of dollars in
international currency markets. While dollar-related transactions generally are
independent of those transactions that determine the market price of oil, there may
be channels through which movements in the price of oil and changes in the value
of the dollar may have spillover effects. This is especially true for the price of oil,
which has a far-ranging impact on the performance of the U.S. economy and on
global flows of dollars. Over time, such a connection may have become more
stylized in the minds of some observers who may link changes in the price of oil to
changes in the value of the dollar and vice versa. Such global capital flows, in turn,
are facilitated by liberalized international capital markets and floating exchange rates,

which greatly expand the amount of capital flows between countries. These flows
also have sparked growth in the development and the use of financial instruments
that are designed to ease the international trade of currencies and to provide
investors, corporations, and financial services providers with a hedge against
unpredictable changes in the value of currencies.
Capital Flows
Capital inflows also help bridge the gap in the United States between the
amount of credit demanded and the domestic supply of funds. A shortfall in the
domestic supply of credit relative to domestic demands for those funds tends to raise
domestic interest rates and draws in capital from abroad. Those inflows, in turn, help
to keep U.S. interest rates below the level they likely would have reached without the
inflows. The necessity to attract capital inflows, however, has complicated the
conduct of economic policy. As the Federal Reserve has lowered interest rates on
credit in order to stimulate economic activity and stem a slowdown in the economy,
the lower interest rates have blunted capital inflows as foreign investors have sought
assets in other markets where relative interest rates are higher.
Capital inflows, however, do allow the United States to spend beyond its means,
including financing its trade deficit, because foreigners have been willing to lend to
the United States in the form of exchanging goods, represented by U.S. imports, for
such U.S. assets as stocks, bonds, and U.S. Treasury securities. Such inflows put
upward pressure on the dollar, because demand for U.S. assets, such as financial
securities, translates into demand for the dollar, since U.S. securities are denominated
in dollars. As demand for the dollar rises or falls according to overall demand for
dollar-denominated assets, the value of the dollar changes. These exchange rate
changes, in turn, have secondary effects on the prices of U.S. and foreign goods,
which tend to alter the U.S. trade balance. In addition, an increase in the U.S. rate
of inflation tends to undermine the value of the dollar relative to other currencies,
which tends to shift demand from the dollar to other currencies. At times, foreign
governments have intervened in international capital markets to acquire the dollar
directly or to acquire Treasury securities in order to strengthen the value of the dollar
against particular currencies.
U.S. Financial Balance
The most common way of measuring capital inflows is through the U.S. balance
of payments accounts. According to standard economic theory, macroeconomic
developments in the U.S. economy are the major driving forces behind the
magnitudes of capital flows, because the macroeconomic factors determine the
overall demand for and supply of credit in the economy. Naturally, these
macroeconomic conditions can be affected by changes in the price of oil, or by
changes in macroeconomic policies. To the extent that changes in the price of oil
alter the basic savings-investment relationship in the economy, such price changes
could have long-lasting impact on the economy and on the trade balance.
One way of viewing the interaction between capital inflows and the domestic
demand and supply of funds is through the domestic flow of funds accounts. These
accounts measure financial flows across sectors of the economy, tracking funds as

they move from those sectors that supply the capital through intermediaries to sectors
that use the capital to acquire physical and financial assets.²² Table 2 shows the
major accounts in the net flow of funds in the U.S. economy from 1996 to the first
quarter of 2008, with the quarterly data for 2007 and 2008 representing quarterly
values at annual rates. The net flows show the overall financial position by sector,
whether that sector is a net supplier or a net user of financial capital in the economy.
Since the demand for funds in the economy as a whole must equal the supply of
funds, a deficit in one sector must be offset by a surplus in another sector.
Table 2. Flow of Funds of the U.S. Economy, 1996-2007
(in billions of dollars)
Government
State and
Y e ar H ousehol ds B usi nesses RO WTot a l Local F ederal
1996 175.2 19.8 -196.8 -1.2 -195.6 137.9
1997 47.4 -18.3 -116.6 -47.5 -69.1 219.6
1998 128.0 -45.7 64.8 48.8 16.0 75.0
1999 -132.7 -62.6 115.3 9.9 105.4 231.7
2000 -371.0 -82.9 252.5 54.5 198.0 476.3
2001 -494.4 -82.9 233.4 35.4 198.0 485.4
2002 -343.4 8.7 -382.6 -95.6 -287.0 501.7
2003 -101.8 30.3 -546.3 -70.4 -475.9 535.4
2004 -230.6 136.8 -468.6 -32.9 -435.7 554.4
2005 -741.0 -26.1 -413.1 -16.1 -397.9 773.3
2006 -656.9 -170.5 -338.8 -50.3 -283.0 829.3
2007 -188.0 -45.4 -353.3 -90.7 -284.0 677.4
I 20076.4-57.9-486.5-95.7-387.8728.1
II 2007-1,199.610.8-130.2-64.3-65.9621.4
III 2007618.5-86.9-435.9-84.8-351.1441.9
IV 2007-177.8-47.6-449.5-118.2-331.3918.2
I 2008219.2-90.9-636.8-162.7-474.1592.1
^No^te^{: n}^e^g^a^tiv^{e v}^a^lu^{es in}^dⁱ^{cate a n}^e^{t in}^f^l^o^w^o^f^f^uⁿ^d^s,^o^r^th^{at th}^{e d}^e^m^aⁿ^d^f^o^r^f^uⁿ^d^{s in}^th^{at secto}^r
^w^e^{re g}^r^{eater th}^an^th^{e s}^u^pply^of^f^uⁿ^d^s^prov^{ided by}^th^{at s}^ector.
^Source:^{Board of}^G^o^v^e^rⁿ^o^r^s^o^f^t^h^e^F^e^deral^R^e^s^e^rv^{e S}^y^s^t^em^,^Fl^ow^of^Funds^Account^s^of^t^h^e
^Uⁿⁱ^t^e^{d St}^at^es^{, Fl}^ow^s^{and O}^u^t^s^t^andi^ngs^Fi^r^s^t^Q^uar^t^e^r²⁰⁰⁸^{, Ju}ⁿ^e^{5, 2008.}
Generally, the household sector, or individuals, provides funds to the economy,
because individuals save part of their income, while the business sector uses those
funds to invest in plant and equipment that, in turn, serve as the building blocks for

²² Teplin, Albert M., The U.S. Flows of Funds Accounts and Their Uses, Federal Reserve
Bulletin, July 2001, pp. 431-441.

the production of additional goods and services. The government sector (the
combination of federal, state, and local governments) can be either a net supplier of
funds or a net user, depending on whether the sector is running a surplus or a deficit,
respectively. The interplay within the economy between saving and investment, or
the supply and uses of funds, tends to affect domestic interest rates, which move to
equate the demand and supply of funds. Shifts in the interest rate also tend to attract
capital from abroad, denoted by the rest of the world (ROW).
Starting in 1999, the household sector began dissaving, as individuals spent
more than they earned. Part of this dissaving was offset by the government sector,
which experienced a surplus from 1998 to 2001. As a result of the large household
dissaving, however, the economy as a whole experienced a gap between domestic
saving and investment that was filled with large capital inflows. Those inflows were
particularly large in nominal terms from 2000 to 2006, as household dissaving
continued and as government sector surpluses turned to historically large deficits in
nominal terms. Such inflows kept interest rates below the level they would have
reached without the inflows, but they put added pressure on the international
exchange value of the dollar during that period.
In 2007, capital inflows fell by about $150 billion from the amount recorded in
2006. This drop in capital inflows reflected a sharp drop in household dissaving, a
decrease in business sector dissaving and an increase in the deficits experienced by
State and Local governments as a result of the slowing rate of growth in the U.S.
economy. The decrease in capital inflows combined with the slowing rate of
economic growth and concerns about the stability of the financial services sector
likely placed downward pressure on the exchange value of the dollar, or a
devaluation of the dollar. In the first quarter of 2008, the flow of funds data show a
large drop in capital inflows on an annual basis from the rest of the world, from $918
billion in the fourth quarter of 2007 to $592 billion through the first quarter of 2008,
which would put downward pressure on the value of the dollar. In addition,
households turned from a dissaving of $178 billion in the fourth quarter of 2007 to
a net saving of $219 billion in the first quarter of 2008, reflecting the impact of rising
prices on reducing the real disposable income of households and concerns among
households over the state of the economy.
Foreign Exchange Market
International factors also affect the value of the dollar. The dollar is heavily
traded in financial markets around the globe and, at times, plays the role of a global
currency. Disruptions in this role have important implications for the United States
and for the smooth functioning of the international financial system. This prominent
role means that the exchange value of the dollar often acts as a mechanism for
transmitting economic and political news and events across national borders,
including expectations about the performance of the economy and concerns about the
impact of such supply factors as the rise in the price of oil. While such a role helps
facilitate a broad range of international economic and financial activities, it also
means that the dollar’s exchange value can vary greatly on a daily or weekly basis as
it is buffeted by international events.

A triennial survey of the world’s leading central banks conducted by the Bank
for International Settlements in April 2007 indicates that the daily trading of foreign²³
currencies through traditional foreign exchange markets totals more than $3.2
trillion, up sharply from the $1.9 trillion reported in the previous survey conducted
in 2004, as indicated in Table 3. In addition to the traditional foreign exchange
market, the over-the-counter (OTC)²⁴ foreign exchange derivatives market reported
that daily turnover of interest rate and non-traditional foreign exchange derivatives
contracts reached $2.1 trillion in April 2007. The combined amount of $5.3 trillion
for daily foreign exchange trading in the traditional and OTC markets is more than
three times the annual amount of U.S. exports of goods and services. The data also
indicate that 86.3% of the global foreign exchange turnover is in U.S. dollars, slightly²⁵
lower than the 88.7% share reported in a similar survey conducted in 2004.
Table 3. Foreign Exchange Market Turnover
Daily averages in April 2007, in billions of U.S. dollars
1992 1995 1998 2001 2004 2007
Foreign Exchange Market Turnover
Instrument
Spot transactions$3944945683866211,005
Outright forwards5897128130208362
Foreign exchange swaps3245467346569441,714
Reporting gaps43536128107129
Total "traditional" turnover8201,1901,4901,2001,8803,210
Over the Counter Derivatives Market Turnover
Foreign exchange instruments9787140291
Interest rate instruments2654891,0252,090
Reporting gaps131955113
Total OTC turnover3755751,2202,090
Total market turnover8201,1901,8651,7753,1005,300
United States
Foreign exchange turnover244351254461664
OTC derivatives turnover90135355607
Total 2444413898161,271
Source: Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity
in 2007. Bank for International Settlement, September 2007.

²³ Traditional foreign exchange markets are organized exchanges which trade primarily in
foreign exchange futures and options contracts where the terms and condition of the
contracts are standardized.
²⁴ The over-the-counter foreign exchange derivatives market is an informal market
consisting of dealers who custom-tailor agreements to meet the specific needs regarding
maturity, payments intervals or other terms that allow the contracts to meet specific
requirements for risk.
²⁵ Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in
2007. Bank for International Settlement, September 2007. pp. 1-2. A copy of the report
is available at [http://www.bis.org/publ/rpfx07.pdf]

The U.S. Trade Deficit
Rising oil prices add to the Nation’s trade deficit and boost the rate of change
in wholesale and consumer prices, as long as the oil price increases are not offset by
actions by the Federal Reserve to tighten the money supply.²⁶ According to data
published by the Census Bureau of the Department of Commerce,²⁷ the prices of
petroleum products over the past year have risen sharply, at times rising considerably
faster than the change in demand for those products. As a result, the price increases
of imported energy-related petroleum products worsened the U.S. trade deficit in
2006 and 2007, and will again in 2008. This rising cost added an estimated $50
billion to the nation’s trade deficit in 2006 and another $28 billion in 2007.²⁸
This rise in oil prices also increases the cost of a broad range of goods,
services, and economic activities and lowers the real discretionary incomes of
consumers, which reduces the rate of economic growth. In turn, a lower rate of
economic growth reduces demand for oil and the price of oil falls to equate supply
and demand, assuming that the supply of oil remains constant. The trade deficit also
represents a transfer of wealth from the United States to the oil producers. This
transfer of wealth reduces the real discretionary incomes of U.S. consumers. To the
extent that the additional accumulation of wealth abroad is returned to the United
States as payments for additional U.S. exports or to acquire such assets as securities
or U.S. businesses, some of the negative effects could be mitigated. The data in
Table 4 provide estimates of the impact different prices for imported crude oil could
have on the annual U.S. trade deficit. The table also provides estimates for the
increase in the trade deficit if the amount, or the volume, of imported oil declines by

3% and 6% on an annual basis, as a result of lower demand for oil.

According to the Census Bureau, the United States imported 4.81 billion
barrels of energy-related petroleum products in 2007. Energy-related petroleum
products is a term used by the Census Bureau that includes crude oil, petroleum
preparations, and liquefied propane and butane gas. Crude oil comprises the largest
share by far within this broad category of energy-related imports. At an average price
of $64.28 per barrel, imported petroleum products cost $318.82 billion dollars in
2007. After subtracting U.S. exports of petroleum products, the U.S. trade deficit in
petroleum products was $293 billion, or 36% of the total trade deficit in 2007 of
$819 billion. At an average price of $100 per barrel and assuming that the amount,
or the volume, of petroleum products the United States imports does not change, the
addition to the U.S. trade deficit that results from a rise in the price of petroleum
products would be $162 billion. At an average price of $130 per barrel, the cost of
imported petroleum would add $306 billion to the annual trade deficit. Naturally,
should import volumes decrease as a result of greater energy conservation, the

²⁶ Consumer Price Index: June 2008, The Bureau of Labor Statistics. P. 1.
²⁷ Census Bureau, Department of Commerce. Report FT900, U.S. International Trade in
Goods and Services, July 11, 2008. Table 17. The report and supporting tables are
available at [http://www.census.gov/foreign-trade/Press-
Release/current_press_release/ftdpress.pdf].
²⁸ For additional information, see CRS Report RS22204, U.S. Trade Deficit and the Impact
of Rising Oil Prices, by James K. Jackson.

addition to the annual trade deficit would be less. If import volumes fell by 3% at a
time when the average price of imported petroleum products was $100 per barrel, the
addition to the annual trade deficit would be $147.54 billion. This amount would be
reduced further to $133 billion should import volumes fall by 6%.
Table 4. Estimates of the Addition to the U.S. Trade Deficit
Associated With Various Prices for Crude Oil and Changes in
Oil Import Volumes
20072008
(Actual values)Estimated values
QuantityValue
(billions(billionsPrice per barrel
ofof
b a rrel s) dollars)
Price per barrel$64.28$100.00$110.00$120.00$130.00
Crude oil imports3.69$237.21$369.06$405.96$442.87$479.77
Total energy-related4.81$318.82$480.78$528.86$576.94$625.02
Petroleum Products
imports
Change in trade deficit (in $billions)$161.96$210.04$258.11$306.19
With 3 percent reduction in import volumes
Crude oil imports$357.99$393.78$429.58$465.38
Total energy-related Petroleum Products$466.36$512.99$559.63$606.26
imports
Change in trade deficit (in $billions)$147.54$194.17$240.81$287.44
With 6 percent reduction in import volumes
Crude oil imports$346.91$381.60$416.30$450.99
Total energy-related Petroleum Products$451.93$497.13$542.32$587.51
imports
Change in trade deficit (in $billions)$133.11$178.31$223.50$268.69
^So^urce^:^U^.^{S. Int}^e^r^natⁱ^onal^T^r^{ade i}ⁿ^G^oods^{and Ser}^vⁱ^ces^M^a^{y 2008}^{, C}^eⁿ^s^u^s^B^u^reau^{. Es}^tim^ates
^dev^e^l^{oped by}^C^R^S^.
Conclusions
Despite common perceptions that there is a direct cause and effect
relationship between changes in the international exchange value of the dollar and
the price of oil, an analysis of recent data indicate that the rise in the price of oil is
being driven by an increase in demand that is exceeding the increase in supply.
Attempts by oil producers to raise the market price of oil in order to offset the loss
of purchasing power of a depreciating dollar likely would find those efforts
blunted partially or in whole by the repercussions of the rise in oil prices.

Increases in oil prices tend to push up prices among a broad range of goods,
services, and economic activities due to the ubiquitous presence of oil as a source
of energy. In addition, higher relative inflation tends to undermine the exchange
value of the dollar relative to other currencies, devaluing the dollar relative to
other currencies and reducing the purchasing power of the dollar. Domestically,
rising prices reduce real incomes and lower the overall level of consumption. In
turn, lower consumption reduces economic growth, which would tend to reduce
the demand for oil and lead ultimately to a lower market price for oil.
The relationship between the dollar and the price of oil is complicated by
the impact the price of oil can have on the rate of inflation and the rate of
economic growth in the United States, the rate of economic growth and the rate of
inflation in other countries, and effects on foreign currencies. For instance, rising
oil prices not only raise the price of energy in the United States, but in countries
around the globe. Rising prices, in turn, tend to undermine the purchasing power
of national currencies. Depending on the level of domestic dependency on foreign
oil, the impact of changes in oil prices can vary. Concerns over rising prices in
Europe and the prospect of slowing economic growth in the Euro zone countries
have tended to push down the exchange value of the Euro relative to the dollar.²⁹
Upward pressure on the market price of crude oil also can come from
market participants and investors who are bidding up the price of oil in an effort
to invest in commodities that they calculate will generate a rate of return that
exceeds that of traditional financial investments. With demand for crude oil rising
faster than supplies, it is difficult for the market to determine what the future price
of crude oil might be, which provides a climate that is susceptible to speculation,
although there is no clear evidence that such speculation has been a major factor
in the rise in crude oil prices since 2006.
Over the long run, a sustained increase in the price of energy imports could
permanently alter the composition of the nation’s merchandise trade deficit.
Some of the impact of higher oil prices, however, could be offset if some of the
dollars are returned to the U.S. economy through increased purchases of U.S.
goods and services or through purchases of such other assets as securities or U.S.
businesses. Some of the return in dollars likely will come through sovereign
wealth funds (SWFs), or funds controlled and managed by foreign governments,
as foreign exchange reserves boost the dollar holdings of such funds. Such
investments likely will add to concerns about the national security implications of
foreign acquisitions of U.S. firms, especially by foreign governments, and to
concerns about the growing share of outstanding U.S. Treasury securities that are
owned by foreigners. Over the long-run it is possible for the economy to adjust to
the higher prices of energy imports by improving its energy efficiency, finding
alternative sources of energy, or searching out additional supplies of energy.
Increased pressure is already being applied to Congress to assist in this process.
The sharp rise in prices of energy imports experienced since early 2007 is
increasing the U.S. rate of inflation, likely will have a slightly negative impact on
the rate of economic growth in 2008, and will pose a number of policy issues for

²⁹ Dougherty, Fears of European Slowdown Weaken the Euro.

Congress. A slowdown in the rate of economic growth in the United States will
lessen the demand for energy imports and could help restrain the prices of energy
imports. An important factor, however, will be the impact Atlantic hurricanes
have on the production of crude oil in the Gulf of Mexico. Most immediately,
higher prices for energy imports will worsen the nation’s merchandise trade
deficit, add to inflationary pressures, and have a disproportionate impact on the
energy-intensive sectors of the economy and on households on fixed incomes.
For Congress, the increase in the nation’s merchandise trade deficit could
add to existing inflationary pressures and complicate efforts to stimulate the
economy should the rate of economic growth slow down. In particular, Congress,
through its direct role in making economic policy and its oversight role over the
Federal Reserve, could face the dilemma of rising inflation, which generally is
treated by raising interest rates to tighten credit, and a slowing rate of economic
growth, which is usually addressed by lowering interest rates to stimulate
investment. A sharp rise in the trade deficit could also add to pressures for
Congress to examine the causes of the deficit and to address the underlying factors
that are generating that deficit. In addition, the rise in prices of energy imports
could add to concerns about the nation’s reliance on foreign supplies for energy
imports and capital inflows and add impetus to examining the nation’s energy
strategy.