The US can write blank cheques/checks because virtually all the oil transactions in the world are done in dollars, shoring up the US economy and enabling an ever-growing national debt. So suggests Rob Newman in his well-researched History Of Oil TV programme. Iraq switched to dealing in Euros between the Gulf Wars, for political rather than economic reasons, and it may be no surprise to find that other countries dabbling with Euro oil trading (e.g. Iran, Venezuela) are not on Prez Bush’s Christmas card list.
What would the effect on the US economy be if the dollar lost its position as the #1 oil trading currency, whether replaced by the Euro, bartering, or even a special oil-trading currency such as the proposed Iranian Oil Bourse (IOB)? Would the US economy be plunged back into a 1930s-style recession, and without the timely intervention of World War 2 to bring on the boom years, or would the world go on turning more-or-less as before?
I’d guess the world would keep on turning. Instead of buying dollar-denominated assets directly, oil exporting countries would first buy dollars, then convert them to assets. It’s not as if they want to shock to US economy: we’re their biggest customer, after all.
It’s not my intention to tease, and I don’t want to see a nosedive in the US economy as it’ll drag down the rest of the world with it. That’s never good.
The fact remains that the loosening of the US dollars grip on global oil trading could have implications for the global economy, not just the US, and the only serious currency competitor for the $ is the Euro. Unless Iran sets up the IOB before they are persauded to desist. It adds yet another muddying factor into the politics of the Middle East, and must be a concern for US politicians and economists.
Rob Newman is indeed a comedian (author and general polymath, the talented bastard), though his credentials are impeccable and his research is thorough. He even put forward the intriguing theory that Iraqi oil had a major part to play in the start of World War 1, the Germans having set up an oil supply route from Iraq to Germany. This would have given the German economy a huge advantage over the rest of the industrialised world, just as oil begins to replace coal as the fuel of choice for ships, road vehicles, new-fangled military engines etc. Franz Ferdinand getting shot was a lucky happenstance, and smokescreen for a situation that led to war. Maybe.
Tell me what you think these implications are. Because I think, for the reason I mentioned above, that this will have zero impact on either demand for or supply of dollars. It would just create a minor detour in the cycle of the dollar through the world economy.
After having read the thread linked to by hawthorne, I’ll elaborate on that little bit. Were the dollar to lose it position as reserve currency to the world, sure, * that * would have pretty major implications for the economies of the US, and by extension, the world. But changing the currency of oil contracts wouldn’t cause this.
Dollars and Euros are both fully convertible, widely-traded, completely liquid currencies. If oil-exporting countries wanted to have Euros after they sell their oil, they could go buy some damn Euros. Easy as shooting fish in a barrel. By and large, they don’t. What does this tell us? That they want dollars. So if we wake up tomorrow, and magically all oil contracts are Euro-denominated, what would we expect? Oil sellers to go to the currency markets with a pocketful of Euros and leave with some USD. This won’t happen. There’s no reason for it to. But if it did, it wouldn’t matter anyway.
I tend to think that the opposite is true. The US dollar enjoys it’s position as the reserve currency to the world because of the strength of the US economy, not the other way around.
Of course. But there is a virtuous cycle at work. The strength of the US economy relative to everyone else is what led to the dollar being the world’s reserve currency in the first place. But its use as such has strengthened the US economy as well. The seigniorage the US federal government gets from it is effectively a free, no-interest loan, but one that could be called at any moment.
I suppose the natural question is: how much has Europe suffered economically during the past several decades because of the predominant use of dollars for oil contracts?
Once a figure can be put to this question, I’m sure it will shed a lot of light on how much the US might suffer in a transition to the Euro.
Well, I disagree. Oil is traded in dollars leading countries to hold a reserve of dollars. If that arrangement should come to an end more dollars will be available on the market, leading to a slight decline of the value of the dollar. Meaning American goods will be cheaper, but imported products will become more expensive.
At least this is my understanding of the situation.
Well, having the reserve currency gives you the benefit of being able to borrow money in your own currency and therefore repaying foreign buyers of your debt in your own currency. Thus, no Argentina-type situation, where the local currency devalues against the dollar, but slugs of your debt are dollar-denominated, so that devaluation leads to severe consequences beyond just price inflation on imported goods.
The temptation of having the reserve currency is precisely what we are seeing right now: both the government and private citizens borrow more than would otherwise be possible, and run up a current account deficit that would cause a currency crisis anywhere else, partially exacerbated by the distortion upwards in the value of the currency as a result of its being used as a reserve and therefore being more in demand than it would be otherwise.
Finally, the reserve held in foreign central banks acts as an overhang when the reserve status ends, the reverse of the upward distortion during the time when the currency in question had reserve status. For the British pound, the members of the Commonwealth countries, who had large holdings of sterling in their reserves, came to an agreement in 1968 not to sell their holdings of sterling too quickly, and for gold, the Washington Agreement of 1999, renewed in 2004 or 2005, does the same thing for gold, regulating the amount of gold that can be sold each year by the signatories to that agreement. In both cases, the motive was to slow down a slide in the value of these respective former currencies (despite the recent rise in gold, it was in a sustained bear market back in 1999).
One day, such an agreement will be found necessary for the dollar holdings of the world’s central banks, once its reserve status ends.
However, trading oil in euros instead of dollars isn’t going to be the catalyst for ending that reserve status. As long as the dollar is the de facto world currency, an official decision to price oil in euros by, say, Iran, will just result in forcing people to do a quick conversion to dollars to figure out the price in terms they are familiar and comfortable with. The other OPEC nations aren’t going to follow, and more significantly, the rest of the commodity markets, from copper to gold to diamonds to lumber, aren’t going to follow either, so the impact will be minimal. It’ll be a nuisance, nothing else.
It took World War One to dethrone gold, and World War Two to put the final kibosh on the pound as the world’s reserve currency. By comparison, pricing oil in euros isn’t quite in the same league as world-changing events go.
Ridiculous. The Germans and the British were working together at that point on joint prospecting in Iraq through the Turkish Petroleum Company. Moreover, the British already controlled the Iranian oil fields and had an agreement with the Sheikh of Kuwait for exclusive control over their oil fields.
There would have been no advantage to the Germans over the British, although France was still left out in the cold with regards to oil concessions from colonies.
Do Not Taunt and others have it right. It doesn’t matter what the contract specifies: dollars, euros, pesos, bullion, wampum, baseball cards, just so long as the market is liquid, which it is, at least for greenbacks and euros. You could take your euros and buy dollars, take your dollars and buy euros, or take your pesos and buy baseball cards. As long as there is liquidity, transperency, and convertability, makes no difference.