Thursday, December 24, 2015

Oil, the US$, and corporate profits


 - by New Deal democrat

Previously this week I have written that the effect of US$ strength has been the biggest economic story of 2015, and that for the last 15 years, the US$ has closely tracked the price of gas.  Because of the increasing importance of international trade to the US economy, the US$ deserves some weighting as a short leading indicator.  Let me conclude with two notes.

First, this is the first time that a big decline in the price of gas has coincided with a surge in the value of the US$.  Let's compare with the two prior occasions.

In 1986, the price of oil precipitously fell by nearly 50% (red), but that was accompanied by a weakening US$ (blue):  



These two tailwinds helped propel the economy to a second round of growth in the late 1980s.

In 2006, there was a smaller (and less lasting!) decline in gas, that again coincided with a weakening US$:



Now here is the last 6 years:


That the price of gas has fallen so much is a real boon to consumers.  In fact both USC Prof. James Hamilton and oil analyst Steve Kopits have shown that whenever crude oil expenditures exceed  4% or more of US GDP, as recession has followed:




That a slow move to 4% would be self-correcting was the origin of my theory about the "Oil choke collar."  But the US produces more oil than it used to, so industrial production in the Oil Patch has suffered.  Still, the collapse in gas prices would still be a significant net positive if the US$ hadn't eaten into exports so much.

Here's a look at the US$ (blue) and exports (iinverted, red): 


While it almost has to be that a hit to exports will take a toll on US domestic corporate profits, the  relationship isn't very strong, as shown in the graphs below:



So there is no reason to think that US corporate profits will automatically continue to suffer so long as the US$ remains strong.  And in another month, the YoY comparisons of the US$ may look much more tame: