Oil and the dollar: which is the cart, which the horse?

Posted by: Aaron Pressman on August 18, 2008

It’s the dog days of August and naturally an investor’s mind starts to wander to those big, unanswerable questions like what’s up with the U.S. dollar. In fact, the dollar is up and quite a bit over the past few weeks.

After peaking back in 2002, the dollar has been sliding for most of the past six years. There was a brief respite in 2005 but it’s been generally down, down, down. The Federal Reserve’s trade-weighted broad dollar index was around 130 in February, 2002. It got down below 95 in mid-July. But since hitting that 12-year low, the trend has suddenly and sharply reversed. As of Friday, the index was up to 98.7.

The sharp reversal has all manner of talking heads talking about whether the long bear market is finally over.

I’m wondering today about the question of the dollar and oil. The dollar bottom roughly coincides with the peak in oil. Coincidence? Perhaps. But there’s been an increasing correlation over the past few years between the amount of dollars flowing to OPEC and weakness in the dollar. One theory is that OPEC’s bankers have gotten increasingly bummed out about the falling value of their dollar holdings and thus have been moving to invest in things denominated in other currencies.

To test the theory with some actual data, I compared the monthly change in the dollar index to the change in the monthly dollar value of OPEC’s oil exports. If the theory is true, more dollars flowing out to OPEC should result in increased dollar selling, pushing down the value of the dollar. And that’s increasingly what happened over the past few years. In 2005, there’s a modest negative correlation of -0.39 but it rises to -0.44 in 2006 and even higher to -0.79 in 2007. If you just look at the dollar versus the euro, the correlation is even stronger, rising to 0.81 in 2007 (dollar/euro is measured in the opposite direction as the dollar index, so a positive correlation supports the OPEC dollar dumping theory for euros).

There’s only oil export data available through May, 2008, so I don’t have much for this year. The correlation has almost disappeared completely in those first few months, coming in at 0.08.

Still, there’s the strong suggestion — combined with the recent anecdotal experience — that increasing dollars going to OPEC have been a big part of the dollar’s fall and the recent drop in dollars flowing to OPEC could be helping the greenback get its groove back. What do you think? Any data you’ve seen to explain the dollar’s move?

Reader Comments

Henry

August 18, 2008 9:02 PM

I just love the articles on BW. They always avoid the two subjects that are literally destroying the future financial security and personal liberties of all Americans. They subjects are: profligate, aggressive, unnecessary and endless wars; and the relentless decline in the value of the US dollar. Both of those evils are brought to you courtesy of our very own and beloved Federal Government, of course. Oh well, tally ho, it is off to poverty and enslavement we go!

alfonso Lavanna

August 19, 2008 6:36 AM

Look at the Economist Forum : "The FED can learn ....."
It's interesting.

Dalbir

August 19, 2008 11:58 PM

Concerted attempt by the Wahhabi Ummah to break the back of the infidel US economy with higher oil prices ?

We have seen what they did in 70s so hardly surprsing given their hate, and how they spend money to spread hate via their radical mosques.

Petras Vilson

August 21, 2008 12:46 PM

Henry writes: "profligate, aggressive, unnecessary and endless wars"

Huh ? Last I checked we are NOT in Iran or Pakistan yet...nor North Korea, Zimbadwe, Darfur, or Georgia despite strong humanitarian and even compelling national security arguments (in some cases) that we should be.

I'm not advocating we invade all these countries... as there is no broad international support for such interventions unlike Iraq and Afghanistan. Yes there was broad international support notwithstanding State Senator Obama's "most difficult decision" to oppose the Iraq war.

The two countries we've choosen with broad allied support (except France and Germany and the tyrannies of course) to invade.. are now making remarkable progress towards democracy and civility despite all the self-flaggelation by the left.

Amandeep

September 3, 2008 3:59 AM

Another good emperical eveidence that dollar leads oil price rather than other way round. See the link below


http://www.dailyfx.com/story/other/free_third_party_research/US_Dollar___Oil_Correlation_1219674072277.html?engine=rss&keyword=article

myinvestorsplace01

October 30, 2008 10:42 PM

The dollar is in very tough shape, and frankly it will probably fail by 2010. Our dollars are fiat based currency meaning its value is based on nothing other than "full faith and credit" rather then gold or silver things with intrinsic value.


http://www.myinvestorsplace.com/

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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