Expensive Oil Turns The Tables On China

Jul 11 2008 | 10:33am ET

By John R. Talyor -- The price of oil is changing many aspects of the global economy.

Looking at the situation from the point of view of a young man raising his family in Concordia, Kan., about 75 miles from his job in Abilene, things are reaching the critical stage with gas at $4 a gallon.

His seven-year-old Ford F-150 pickup gets about 14 miles per gallon, if he’s lucky, costing him $35 a day to drive to work. Even if he earns an above-average U.S. wage of $35,000 per year, he is spending 26% of his pre-tax and pre-Social Security wage at the pump.

Deducting this, about one-third of his take home pay goes to Exxon or BP. Obviously this does not work. With no mass transit and no local jobs, his only choice is to move nearer to the job and abandon his home. The sharp rise in the cost of energy will bankrupt some businesses and force people to leave the countryside as millions of individuals will find themselves in untenable situations, like our friend in Kansas.

It might be difficult for Americans to adjust, but in countries like China, where it takes three times as much energy to produce a unit of GDP as it does in the U.S., persistently high oil and coal prices could prove catastrophic for the economy and its workers. A Chinese laborer might not own a car. However, the cost of energy will not only put the dream of owning one out of reach but will also force his employer to cut his wages even while it raises prices to cover its energy costs.

Chinese companies exporting to the U.S. and Europe are not only hit by increases in operating costs, but also in the cost of transporting their products to far away markets. Shipping costs have increased by a factor of two or three, and for low cost items this can be the difference between making or losing the sale.

With oil at $140 a barrel, Walmart’s purchases from China will drop and those from local suppliers will rise. The “buy local” campaign in the U.S. and Europe is getting a tremendous boost from expensive oil, and the big losers are the export countries of Asia—and the lower-tech the export, the bigger the impact. Weight per value is the key determinant.

Our friend in Kansas might have to give up his light manufacturing job in Abilene, but given the high price of corn he can work on a farm. On the other hand, we heard that they are producing clothes hangers in the U.S. again, as they are too expensive to ship—so perhaps jobs will increase, wages will rise and he will be wealthy enough to buy a high-mileage car.

High-priced oil helps the U.S. in many ways. As the world’s biggest debtor, the U.S. wins from global inflation. And, if the cost of transportation stays high, the world’s biggest importer will also win because its factories can replace those imports that cost too much to ship here.

There is one other way the U.S. gains in a time of global inflation, and that is in agriculture. U.S. wheat, corn, soybeans and beef are all available for export. Don’t be surprised if the U.S. trade balance improves dramatically in the next year or so—the non-oil part might even go into surplus—and the dollar will climb when it does.

The losers in this new picture will be the low-tech manufacturer located far from their final markets. China looks very vulnerable.

John R. Taylor is the founder of FX Concepts.

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