OPEC kisses the dollar goodbye.

So says the Independent. The government of Saudi Arabia denies it, but that hardly matters. Policy wonks have known for years that this had to happen eventually. Whether it happens now or next month or next year is less important than the fact that it is happening sometime.

The story goes like this. All international oil trades are denominated in U.S. dollars. This is very good for people buying oil in the United States. It means that even when the value of the dollar plunges, we can continue to slurp up foreign oil at the same price in dollars. OPEC has lived with this for decades because the dollar was the basis for the world economy. But with the plunge in the dollar’s value over the last couple years, they’re losing a lot of money. Basic logic says that they have a strong motivation to cut the dollar out of the system. Now they’re doing exactly that.

If the Independent article is to be believed, the change will be phased in over nine years. At the end, Americans will spend a lot more on oil, while foreigners will have less interest in propping up the dollar. But while the direct consequences are easy to list, there’s also a lurking awareness of what this says about the world economy. America just isn’t as economically strong as it once was, while other nations are growing stronger. You can’t run up enormous deficits forever and not expect it to have consequences.

It’s not just oil. The U.S. status as the reserve currency of the world has allowed it to borrow money at lower interest rates than gets from lending it. This difference is huge, and is one of the factors that has allowed the U.S. to maintain a current account deficit without being hammered financially. If the U.S. loses that status, it’s going to be very expensive.

Other countries are trying to move away from the dollar because they are frankly frightened by the amount of borrowing the U.S. is undertaking, and by the amount of money the fed has printed. They are worried that the United States will wind up inflating its debt away at the expense of its debt holders. And they’re right to be worried about that.

Yet another unintended consequence of the fiscal insanity of the U.S. government.

It’s not just the fiscal deficit that’s the problem: it’s also the trade deficit. (That is, the problem isn’t just that the federal government spends more than in takes in from taxes, etc.: it’s also that the American people as a whole buy more from foreign countries than they sell to foreign countries.)

Some investors seem to think it likely:

Stocks and Gold Gain as Investors Shun the Dollar

What will happen to the US economy if the dollar lose this position? The Euro-zone is the world’s largest economy. Would it benefit us if the euro became the dominant reserve currency and the currency of the oil trade?

This doesn’t make sense. When the dollar plunges, the price of oil goes up and vice versa. For example, today.

Only if the oilprice does not change. In reality, when you check the exchange rates and the oil price curves, you see that there is a very strong correlation. When the dollar falls, the oil price goes up.

That’s why we Europeans weren’t so much hit by the high oil prices. Here, the difference between 2000 and 2008 (the all time high) is around +40% of the price, not as much a difference as in the US. The plunging dollar smoothed the oil price spike for us.

Edit:
LonghornDave was faster …

Funny how this story has been creeping up over the last two years, some pointing to China, some pointing to ‘a UN-backed bundle of currencies’, some pointing to the Euro. The Euro was very popular as a proposed replacement two-three years ago.

Clearly, it’s already happened and we’re all doomed.

Dammit, I bought Lee Kum Kee soy sauce made in China tonight instead of Kinkoman, made in the good old USA however you spell it.

It’s all my fault…

Not according to this: http://uk.biz.yahoo.com/06102009/325/oil-states-say-talks-replacing-dlr.html

OK, so I get why being a reserve currency is good (though don’t you also get the downside when countries want to start spending their savings?). But what’s so great about being a trade currency? China’s been pushing for the Yuan to be more widely used as a trade currency, but I’m not sure what they’re getting out of it except prestige. Same here.

You’d lose the upside, but I’d think the absolute worst that could happen is that you break even for a while, then go back to reaping the rewards.

I’d assume it’s the same thing as for the reserve currency: in order to trade in US dollars, they first need to have some US dollars in their petty cash drawer, and they do that by buying some US dollars from the United States.

Ohnoes, the US will have to compete on an even playing field!

Soon as we see inflation, or signs of inflation, or signs that there may soon be signs of distant inflation, your post will have merit. Right now the exact opposite is happening, and the government seems powerless to stop it.

This is an interesting article on the matter, bringing up A: what I said about the rumors having been around for two years, B: the odd aspects to part of the article, and C: how the right wing has jumped on the matter.

Anyone able to critique the analysis here?

A huge part of the percieved value of currency comes from trust. Prestige adds to trust.

It’s pretty good. It lacks historical perspective ( this isn’t the first time something like this was discussed, even the fanatical anti-Communist Saudis discussed it with with Russians after the Arabs nationalised their oil in the mid-1970s, but it never came to anything. It’s been mooted a few times since by various people but never taken seriously till maybe now.)

The problem for the US is that other playas are now looking at a US financial system that is now explicitly backstopped by the US government, a country where crony capitalism/corporate socialism is taking away America’s biggest asset, its free and transparent capital markets. And they’re thinking, quite rightly, that your money isn’t safe in that financial system. So they’d be silly not to have a Plan B handy. And like that article says if it spurred American manufacturing that’d be a good thing because the US trade deficit will eventually blow up in a way that makes the ongoing financial crisis look minor.

Well, that, and also that you are, generally speaking, not quite so dependent on it. Though I imagine that varies a lot depending on where you live, just as it does here.

It’s a good summary of the issues, especially the pros and cons of having the world currency. Too often, this sort of discussion tends to decline into empty ideological hackery that focuses on the bad while ignoring the good.

I agree with all this, but I want to expand a little more on it.

First, there were rumblings about US debt and the long-term stability of the US dollar even before the crisis. Our current deficits, let’s not forget, are mostly inherited structural deficits which people have been eyeing for a while. Obama’s latest counter-cyclical contributions are a rather small percentage of the whole. And second, we’ve got a lot on our plate right now as it is. It’s possible that this cronyism won’t be smacked down by adequate regulation, but then again, Barney Frank seems to believe that the big financial institutions have lost most of their lobbying mojo (an excellent interview, BTW, highly recommended). It’s just a matter of legislative priorities. Health care first, then sweeping up the financials. I’m not certain we’ll manage to rein in the bad apples, but I think a better, more transparent, more trustworthy and trusted system is definitely possible.

A move to an international reserve currency (based on special drawing rights, maybe) might be inevitable at this point, but it could easily be the result of a more balanced international economy rather than a rush away from US dollars.

I’d love to see effective regulation too but I don’t see any realistic possibility that that they’ll do it.

And if it knocks the Chinese off their leeching grab on the dollar, it might be so much the better. That’s how they manage to keep everything so cheap, with the artificial pegging of the yuan. And believe me, they’re pegging that yuan hard.

If they ever set it free, I’d expect some pretty severe inflation. The longer they wait, the worse it gets. And that’d… probably do bad things to their economy, right?