Oil’s Role in Fueling the Shift From a Manufacturing To A Financial Economy

We spend a lot of time — not necessarily incorrectly — talking about various effects to our economy caused by the emergence of China, in particular the trade deficit.

We don’t spend enough time talking about the distortions to our economy caused by higher oil prices. Sure, we talk about how money is transferred to many of the wrong countries, how it funds terrorism, and the threats to our economic security.

We need to talk a little more about the castration of American demand caused by higher oil prices.  That is, the simple wallet economics that tells us that four dollars of gas spent at the pump precludes spending on other goods.

The scale of this spend displacement is enormous.  The scale is laid out well in this Economist analysis.  Cumulative surpluses of oil exporters since 2000 are over $4 trillion, which is twice as much as that of China in that period.  So, we should be spending proportionate energy on this problem.

There are two main ways this has distorted to our economy.  First, each dollar we spend on oil imports from OPEC countries, only 34 cents come back in American exports.  Oil exporters do not demand our goods in the way we need their energy.  Because 2/3s of our oil dollars sent abroad do not return, domestic demand is likely significantly reduced as compared to a world in which we spent less money for oil, and spent more of those dollars on other goods.

Second, unlike China, the oil exporters are less likely to take those dollars and recycle them into our Treasury bonds.  Instead, the oil exporters have funneled more of the money into alternative investments whether directly through their own sovereign wealth funds or through hedge funds and private equity funds.  In addition to our own pension funds and endowments, this is where the funding has come for the financial engineering side of our economy.

So, one can connect the dots from our inability to deal with our oil addiction and the massive flows of money out of the country which don’t return through the purchase of enough goods to support a more robust manufacturing economy but which do return in investment funds — investing in for example, LBOs, equities, real estate — that have thrived in the aggregate over the last two decades.  Whatever one thinks the latter change is efficient or inefficient, everyone should be able to agree it is a much different economy than a manufacturing economy, and appreciate oil’s role in supporting this shift.