The Kuwait Thread (merged)

by **ColossalContrarian** » Sun 20 May 2007, 23:50:20

So how does dropping the dollar peg effect how they will trade oil?

Will it still be in USD or will it be out of the currency basket they talked about (Euro, Franc, Yaun maybe)?

Wasn't this the pretext to the War in Iraq, trading oil in Euros?

by **Micki** » Mon 21 May 2007, 02:36:56

In the short term they will probably continue to sell oil in US$.
The foreign reserves will then however regularly be re-balanced.
Effectively this is the same thing as selling in other currencies as US$ will end up being sold for other currency or commodity.

I don't think they would be target for invation even if they completely dropped the US$.
These invasions requite lots of propaganda in order to win support and none such has been done with Kuwait.
The only way to do something short term would be to pull off another 911, point the finger of blame and use this as justification.

by **MrBill** » Mon 21 May 2007, 05:04:09

Gulf oil producers as well as Chinese exporters that run large current account and trade surpluses SHOULD decouple from the US dollar. Otherwise they allow their own currencies to be influenced by the external value of the dollar AND by US interest rate policies. This at the moment means that they are importing inflation, especially as much of their imports come from the eurozone and elsewhere and not from the USA.

This is a very necessary step in re-balancing capital imbalances. A weaker US dollar is necessary to help reduce the US trade deficit, and higher real interest rates are necessary to attract the capital flows to plug the balance of payment deficit that is part of its current account deficit.

Once again it does not matter in which currency crude is priced. It is produced around the world in many domestic currencies. Not in US dollars. What is important is in which currency oil exporters as well as Asian exporters re-invest their export revenues. If they perceive a risk to the US dollar then they will demand more premium in the form of higher dividends and higher interest rates or coupons to buy USD-denominated assets.

Kuwait takes a long awaited step in the right direction. Its about time. The US is certainly not going to invade them. That is just more US dollar hegemony nonsense being recycled on the Internet. Freely traded currencies help balance the global economy. Pegged currencies that are artificially too weak help make it less stable. And there was a limit to how much stress the euro and Sterling could take on their own without some of those exporters also letting their currencies appreciate as well.

by **Micki** » Mon 21 May 2007, 08:57:32

US dollar hedgemony nonsense

Rumors about invading Kuwait perhaps yes.
But you sound like you are poo-pooing the whole hedgemony debate. You think that is all conspiracy theory?

One who in that case seems to disagree with you is Dr Ron Paul who in Feb06 wrote an article called "the end of Dollar hedgemony".
Article

Here he even suggests that one of the reasons to atttack Iraq may well have been the fact that they stopped selling oil for US$.

In November 2000 Saddam Hussein demanded Euros for his oil. His arrogance was a threat to the dollar; his lack of any military might was never a threat. At the first cabinet meeting with the new administration in 2001, as reported by Treasury Secretary Paul O'Neill, the major topic was how we would get rid of Saddam Hussein-- though there was no evidence whatsoever he posed a threat to us. This deep concern for Saddam Hussein surprised and shocked O'Neill.

It now is common knowledge that the immediate reaction of the administration after 9/11 revolved around how they could connect Saddam Hussein to the attacks, to justify an invasion and overthrow of his government. Even with no evidence of any connection to 9/11, or evidence of weapons of mass destruction, public and congressional support was generated through distortions and flat out misrepresentation of the facts to justify overthrowing Saddam Hussein.

There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in Euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war.

by **Petrodollar** » Mon 21 May 2007, 10:42:14

It is important to note that Kuwait has not announced that they are re-denominating their oil pricing and transactions to a basket of currencies (which is what Iran has done). Rather, this de-pegging of their domestic currency is essentially the same thing that China did in July 2005 when it divorced itself from the dollar.

Let's not get this confused with the petrodollar-recycling phenomenon, which is separate issue that I will discuss in a moment. Anyhow, I am not surprised by this announcement, and Kuwait has exhibited a history of acting somewhat independent of US economic interests. But first....

MrBill stated

Once again it does not matter in which currency crude is priced. It is produced around the world in many domestic currencies. Not in US dollars

Produced? Huh? I don't understand why you would use the word "produced" in this context. The issue at hand is what currency is oil priced and oil transacted. You know darn well that NYEMX and the London IPE only offer monopoly dollar pricing for global oil trade via the WTI and Brent oil markers. (I've leave Iran out of this discussion for the moment).

My question? Why do you continue trying to obfuscate the important issue(s) - or sometimes post blatantly inaccurate information which you must know to be wrong? (e.g. last week you stated that the RTS does only dollar-settlements — when it clearly offers both dollar and ruble settlements — and preferably transactions in the ruble according to Putin and the central bank of Russa).

Despite your ongoing obfuscation, most of the experts knowledgeable of the subject re petrodollar recycling publicly disagree with you (as do the majority of posters on this board who responded to your earlier poll). This group of experts that I speak of include the U.S. Treasury, the IMF, the CIA, OPEC executives, the EU, the ECB, Vladimir Putin, and global economists such as Paul Donovan and global commodities traders such as Bill O'Grady of A.G. Edwards. (I've posted all of these sources in prior posts circa 2005-07, so please don't ask me to post them again... ;-)

Anyhow, I strongly encourage you to read Dr. Sprio's book, a 15-year research project will educate you of the real politic of the petrodollar recycling system, and the extraordinary measures both Republican and Democratic administrations undertook to maintain the dollar's monopoly pricing and transaction role for global oil trade (going back to 1973-1974). Here's Spiro's astute analysis:

So long as OPEC oil was priced in U.S. dollars, and so long as OPEC invested the dollars in US government instruments, the US government enjoyed a double loan. The first part of the loan was for oil. The government could print dollars to pay for oil, and the American economy did not have to produce goods and services in exchange for the oil until OPEC used the dollars for goods and services. Obviously, the strategy could not work if dollars were not a means of exchange for oil.

The second part of the loan was from all other economies that had to pay dollars for oil but could not print [US] currency. Those economies had to trade their goods and services for dollars in order to pay OPEC. Again, so long as OPEC held the dollars rather than spending them, the U.S. received a loan. It was therefore important to keep OPEC oil priced in dollars at the same time that the government officials continued to recruit Arab funds.

The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets, Cornell University Press, (1999)
http://www.amazon.com/Hidden-Hand-Ameri ... 080142884X

Sprio's research (which you inappropriately dismissed as "out of date" when I recommended it to you back in 2005) is extremely well documented with dozens of official US documents (declassified U.S. Treasury and CIA memos) and backed with various first person interviews that Spiro conducted with many of the participants (in the US, Dubai, Saudi Arabia, etc).

Your refusal to read any of this history seems to be a plea for ongoing ignorance, and I'm only giving you such a hard time as I find your incuriosity and disdain for important research rather inexcusable for a prospective PhD student. This is especially true if you're interested in understanding how and why the post-1971 "Bretton Woods II" era was set up and how the petrodollar recycling system impacts the US economy.

You once remarked that the price of oil is simply a factor of "supply and demand." That's not true according to Daniel Yergin's prize winning book, The Prize, which carefully documents that that history of oil pricing has not been "free market" economics (Standard Oil from 1870 to 1911, Texas Railroad Commission from the 1935 to 1970, and OPEC from the 1970s onward)

....and likewise, the pricing and depositing of oil proceeds for the past 3 decades was not exactly "free market" economics either. It is unfortunate that these decisions have not, and are not, done in a transparent manner, which I suspect is your main objection to reviewing documented history, but you should not let your personal cognitive dissonance and bias color you views to the point where you become an unyielding economic fundamentalist, unwilling to review any facts that may contradict what you want to believe about global oil produciton and trade - be it CERA's faith-based reports about no "visible peak in sight" regarding global oil production - or the principle mechanism of dollar hegemony - petrodollar recycling. Here's some words of wisdom....

Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence.

— John Adams, 2nd US President, 1770

****

Regarding Kuwait's recent announcement, and for those who are open-minded and interested in the arcane history of petrodollar recycling, it was actually Kuwait who sponsored in 1978 an idea within OPEC to transition oil transactions to a basket of 3 currencies (US dollar, Japanese yen and German mark). At the time the dollar was undergoing a rapid devaluation against the German Mark and other major currencies - just as the today dollar is losing significant value relative to the euro...

The response in 1978? Well, the U.S. immediately called upon it "special relationship" with Saudi Arabian autocracy to squash Kuwait's proposal. (In 1973, an earlier proposal to price and sell oil in 12 currencies was also squashed by the U.S.-Saudi nexus, but I digress).

According to Dr. David Spiro, after Kuwait's announced in 1978 concerning its intentions within OPEC proposing a basket of currencies for oil pricing and transactions, U.S. Treasury Secretary Blumenthal flew personally to Saudi Arabia to met with the Saudi Finance minister to dissuade him of an OPEC proposal to transact oil sales in a basket of three currencies — in return the US awarded the Saudi monarchy with a remarkable 350 percent increase in voting power within the International Monetary Fund. Here's an excerpt form that meeting based on a FOIA request:

Confidence in the dollar remains fragile. Recent and more frequent news reports regarding OPEC's growing disenchantment with use of [the] dollar for oil pricing further disturb the market. If OPEC changed the unit of accounting for oil pricing it could precipitate a major market reaction which would be in the interest neither of the Saudis, other OPEC members, nor the US.

— Internal U.S. Treasury memo from Assistant Treasury Secretary C. Fred Bergsten to Treasury Secretary W. Michael Blumenthal, entitled, "Briefing for Your Meeting with Ambassador to Saudi Arabia, John C. West", 10 March 1978

Footnote: David Spiro, p. 123.

Well, from a macro perspective, I suspect more Gulf counties will follow Kuwait be de-peg from the dollar, more Asia countries will also follow China's lead by de-pegging, and the G8 nations (plus China and India) will continue to decrease their dollar reserves and increase their reserves with euros and more stable currencies (i.e. yen, sterling, etc). The movement to other petrocurrencies is the key dynamic here, and that is why Iran, Russia and Venezuela are getting so much attention from the neoimperialists.

Despite the dissmissive rhetoric and occasional threats against the recalcitrant nations that are threaten the petrodollar’s monopoly role, I see no reason for these global trends to abate, and my projected timeframe for the solidification of a basket of currencies for international oil trade is the 2008-2012 period, preceded by a gradual, orderly shift away from the dollar standard, toward a mixed dollar-euro standard, and possibly toward a basket of three or four world reserve currencies/petrocurrencies thereafter(i.e. rubles and RNB/yuan?)

This however is a nightmare from the Washington-Federal Reserve perspective, because encroachment of petroeuros in the global oil trade will certainly diminish a key facilitator of US deficit spending. As outlined in Petrodollar Warfare, a careful analysis of the available evidence makes it clear that Washington is attempting to undermine the recalcitrant nations that threaten the petrodollar’s monopoly role...

FWIW: Here's the prophetic end of Spiro's book, which in my analysis (and subsequent book), helps explain the tragic quagmire in Iraq, and the ongoing geopolitical tensions b/t the US and Iran, Russia, Venezuela and increasingly, China, among others...

In this book, I argue that cooperation after hegemony seems unlikely in the extreme. Petrodollar recycling was unusual in that it was a severe shock to international economic stability. Yet insofar as the oil shocks were a symptom of US hegemonic decline, similar shocks can be expected in the future. International institutions do not have the capability to handle such threats to stability, and US unilateralism will prevent the strengthening of multilateral cooperative regimes.

Although the relative decline of US hegemony has led to an increase in observable power outcomes, the result ultimately will be worldwide economic instability. When it is in a period of relative decline, it is in the short-term interest of the United States to pursue unilateral exploitation of its dominant position. This interest is increasingly at variance with the international goals of confidence, stability, and cooperation.

— David E. Spiro, The Hidden Hand of American Hegemony

Website · by **roccman** » Mon 21 May 2007, 11:02:22

Petrodollar,

Excellent read!!

Thanks for the book references as well.

Just one question...what factors do you see mitigating a slow and orderly transition from the US Dollar to a basket - like the euro, yuan, etc?

Or another way ...why not a mad dash to the door?

Once again - thanks for the read!!

by **MrBill** » Mon 21 May 2007, 11:42:39

Petrodollar wrote:

Produced? Huh? I don't understand why you would use the word "produced" in this context. The issue at hand is what currency is oil priced and oil transacted. You know darn well that NYEMX and the London IPE only offer monopoly dollar pricing for global oil trade via the WTI and Brent oil markers. (I've leave Iran out of this discussion for the moment).

My question? Why do you continue trying to obfuscate the important issue(s) - or sometimes post blatantly inaccurate information which you must know to be wrong? (e.g. last week you stated that the RTS does only dollar-settlements — when it clearly offers both dollar and ruble settlements — and preferably transaction in the ruble according to Putin and the central bank of Russa).

Despite your ongoing obfuscation, most of the exports knowledgeable of the subject re petrodollar recycling publicly disagree with you (as do the majority of posters on this board who responded to your earlier poll). This group of experts that I speak of include the U.S. Treasury, the IMF, the CIA, OPEC executives, the EU, the ECB, Vladimir Putin, and global economists such as Paul Donovan and global commodities traders such as Bill O'Grady of A.G. Edwards. (I've posted all of these sources in prior posts circa 2005-07, so please don't ask me to post them again...

Sorry, but you're the one that consistantly write things that simply are not true. You read a headline meant to be a sound bite for consumption by a domestic audience and you think it must be government policy already. Even when you go so far as to quote headlines and text that are several years old and still have not come to be.

I do not believe I wrote the RTS was only settled in dollars? Especially as I know crude traded on the RTS can be settled in rubles and dollars. The point being that the RTS crude contract is not a physically settled crude contract. And whether you settle in dollars or ruble the price is the same. The only difference is in what currency you settle based on the exchange rate of the MICEX/CBR. But as you are not a trader or a banker or work in Russia you cannot be expected to know how the RTS or MICEX trades? Of course, my company does trade on the RTS and MICEX.

I can understand you wanting to be right about something. You certainly have gotten a lot of things wrong. The IOB and oil in euros. March 20, 2006 certainly came and went. India and China wanting to buy oil in euros. Norway wanting to price North Sea Brent in euros. N. Korea wanting a security guarantee to abandon their nuclear ambitions. The list goes on.

Oil is produced around the world in many local currencies. Hence it is consumed locally in those currencies as well. Canadian oil consumed in Canada is not priced in US dollars. Just as most crude oil is traded directly between buyers and sellers through cash brokers and is not traded on the ICE, NYMEX or any futures exchange for that matter.

Buyers may simply find it convenient to price international deals in US dollars because many deals that are priced as a spread over a futures month use ICE Brent or NYMEX WTI as their reference price. But many would also use Dubai or another cash marker as their reference price too. Many deals are priced based on Platt's reported prices and not on ICE or NYMEX prices at all. But once again you do not trade futures or physical crude, so why should I expect you to understand the difference between a basis market and a futures market? Of course, I have traded both.

And my point, which is very clear, is that it does not matter in which currency oil is sold. What matters is in which currency the proceeds from oil sales are re-invested. That in turn depends on the depth and liquidity of capital markets and the oil producers desire to repatriate those export receipts versus invest them abroad in US dollars, euros, Sterling or any other freely traded currency. That is a point you do not want to understand, so I cannot help you. But again you are not a banker or asset manager, so really who cares what you think?

by **Gerben** » Mon 21 May 2007, 15:00:21

First of all I like to thank both Petrodollar and MrBill for their clear explanations.

I think you both made strong points, but I have a feeling that you are both missing each others point. Although I’ll not call myself an expert, I think both isues are linked and have to add up.

As Petrodollar points out the fact that pricing and transactions in oil take place in dollars is a key factor contributing to the strength of the US dollar.

MrBill correctly points out that many currencies are used for oil transactions and also that it is important in what currency the money is re-invested.

Although MrBill’s critics are correct, Petrodollar also has a point. The problem is that his explanation is a bit oversimplified. The fact that pricing and transactions in oil take place in dollars plays a key role in determining in what currency the oil income is re-invested. Furthermore the petrodollar status also plays a key role in determining in what currency central banks of oil importing countries keep their reserves.

Dollars are used for transactions (for one country: buying oil, for another country: selling oil). It only makes sense to keep the money in the currency it is most likely to be used in. Since many transactions are settled in dollars, keeping your reserves in dollars makes sense. Any transaction creates additional costs and risks. This means that it makes sense to keep reserves in the transaction you are most likely to do your transactions in. The currency to use is the dollar (unless you sell your oil in your own country, or like Norway largely to countries using Euro’s while you also import many of your goods in Euro’s, or like Iran when you have a US boycot). If you do most of your international trade in dollars, you want to keep dollars in reserve.
The petrodollar status thus says: because many international transactions are transacted in dollars, countries are encouraged to keep reserves in dollars.

@MrBill. It is strange to me how you seem to feel the necessity to attack the messenger while trying to make your point.

by **MrBill** » Tue 22 May 2007, 03:44:09

Gerben wrote:

@MrBill. It is strange to me how you seem to feel the necessity to attack the messenger while trying to make your point.

Well, we have a long history going back to his publicly disparaging remarks to me when he insisted I had no idea what I was talking about when I pointed out that the IOB could not even be technically implemented by March 20, 2006, much less the obstacles an Iranian oil bourse would face to replace the incumbants' advantage of the ICE, NYMEX, CME, etc.

He has infered I am a liar, have an ulterior agenda and do not know what I am talking about in financial and capital market matters. I certainly do not have to accept that graceously. He is an expert in cut & paste, so if I did make a mistake I am sure he would re-post it here for my benefit instead of just 'refering' to my supposed error or not?

But now I have to address your points, which I do not agree with.

Dollars are used for transactions (for one country: buying oil, for another country: selling oil). It only makes sense to keep the money in the currency it is most likely to be used in. Since many transactions are settled in dollars, keeping your reserves in dollars makes sense.

First of all, it would only make sense for central banks to hold US dollars for the purchase of crude IF they were also the central purchasing agents for commercial oil transactions.

I know of no central bank in the world that plays this dual role. Not even the PBOC that holds massive amounts of US dollars in their foreign reserves despite China buying foreign oil priced in US dollars.

In reality, central banks sterlize inflows of US dollars by putting them aside in their foreign exchange reserves. They do this by buying USD on the open market and selling their own domestic currency (CCY). This sterlizes export receipts where the exporter sells USD earned by sales to buy CCY to pay for their domestic costs and disperse any profits.

They do this because the local capital markets may not be large enough to accomodate large inflows of capital, or because those sales of USD to buy CCY may make the CCY too expensive and thus hurt exports and job growth related to exports.

Secondly, what is good for the country's export competitiveness is not necessarily in the importer's best interest. They want a stronger CCY, so that the USD needed to buy crude imports costs less. This is important because their domestic costs are in CCY, so if they have to sell more CCY to buy the same amount of USD then it pushes up their costs. The central bank is certainly not compensating them (commercial players) for these extra costs.

And thirdly, forget importers for a second, it would make absolutely no sense for an oil producer to hold USD from oil sales in USD in order to import crude. Especially countries like Russia that sell most of their oil in US dollars and then turn around and import goods mainly from the eurozone. As you said, "Any transaction creates additional costs and risks." They (Russia) actually open up a currency mismatch between their assets & liabilities when they export in USD and import in EUR. Many OPEC producers face a similiar dilemma, which is one reason why it makes sense for Kuwait and others to severe their USD peg.

The bottom line is that countries need a certain amount of reserves for their import cover needs. Those reserves can be kept in US dollars, euros, Sterling, Swiss francs, yen or any other freely covertible currency. They do not want to keep their reserves, technically needed to defend their local currency against an attack by speculators, in an illiquid, hard to convert currency.

But in whatever currency they decide to keep their foreign exchange reserves that capital has to be invested somewhere. Preferably where they can earn a positive return and in deep, liquid markets where the flows can move freely in and out without causing market turmoil. Up to now, the US dollar zone has been the best alternative. That is changing due to perceived currency risks from the US' massive current account and trade deficits as well as unfunded future liabilities.

However, from an Asian central bank or oil producers persepective the alternative is to either park those reserves elsewhere or repatriate them. There is nothing stopping these countries from bringing that capital home and putting it to work domestically. Of course, it will cause their own CCY to appreciate viz a vie the USD, and if their capital markets are not deep and liquid enough it can cause asset bubbles and domestic inflation.

There are risks to investing the export receipts in foreign capital markets and there are also risks to repatriating the money. Especially in some countries where rule of the law and enforcement of the law are two different things. Also, investment may be either politically directed or interfered with.

As an example, Mr. Putin this week publicly said that perhaps some of Russia's oil stabilization fund should be used to buy the public shares of Russian companies. I am not convinced this is wise as technically those are private or quasi-private companies with private shareholders and it would likely be inflationary as well as distorting. Mr. Putin also said that he would like to bring inflation down further. So you see the two statements are somewhat at odds with one another.

As Petrodollar points out the fact that pricing and transactions in oil take place in dollars is a key factor contributing to the strength of the US dollar.

And this is my whole point. Wrong and wrong again!

Commercial importer sells CCY to buy USD
Commercial importers sells USD to buy OIL
(i.e. no central bank involved here)

There is NO extra demand for USD, so it cannot contribute to the strength of the US dollar, unless

Exporter sells OIL to buy USD

AND

Exporter sells USD to buy USD-denominated assets, creating extra demand for USD assets.

There is an absolute, clearly defined line between being paid in USD and deciding to invest in USD assets.

The same decision as to
sell USD to buy EUR, or
sell USD to buy real-estate, or
sell USD to buy shares, or
sell USD to buy bonds, or
sell USD to buy machines (capital goods), or
sell USD to buy toys (consumption).

This is the USD as a transaction currency versus the USD as an investment currency. If you CHOOSE to invest in USD-assets you are consciously accepting USD interest rate, currency and credit risks. If you do not like them you can insist on a higher spread or yield or re-invest those export receipts in another CCY.

One last point about the ICE, NYMEX, Dubai and other organized exchanges that offer physically settled contracts, and those like the RTS that has a crude contract based on crude delivered to Amsterdam, Rotterdam, Antwerp (ARA), are 'cash settled' or 'contracts for differences', but are 'not physically settled'.

There is naturally a difference. But the point being that these 'markers' are reference points for other commercial contracts for import and export between buyers and sellers in the physical market. The vast majority of direct sales do not pass through any organized exchange. They are so-called 'basis trades'. They trade and are settled based on a spread over and above the relevant futures contract, but they are not part of the exchanges volume or even cleared or supervised by the exchange's clearing house.

For example

Saudi Aramco, the world's biggest state oil company, offered to sell its naphtha at higher premiums to benchmark prices in the second half of this year.
Saudi Aramco raised the premium for its A-310 naphtha to $20 a metric ton from $3 a ton in the first half of this year, said traders involved in negotiations in Tokyo with the Dhahran, Saudi Arabia-based company. Aramco raised the premium by almost threefold for its A-180 naphtha, the most expensive grade, to $25 a ton from $8.50 a ton.
-------------------------------------------------------------------------------------- con't ----
The cargoes are sold on a free-on-board basis, which means
the buyer will pay for any shipping costs to the destination, and
there is no charge to the buyer for delivery to the vessel at the
loading port.
Saudi Aramco's benchmark price is calculated from the
average assessments of the product in Japan by oil-pricing
services Platts and Argus Media.

Source:
May 22 (Bloomberg)

So you see that Saudi Aramco is not even using ICE, NYMEX or any other futures markets to price their crude. It is based on Platts' or Argus Media's published assessment of commercial contracts as reported to these private agencies. No futures exchange involved. No trade over the exchange. No settlement through the exchange.

This is typical for most cash sales and purchases. The exchanges are used for hedging purposes and price discovery. Not the trade of physical crude. Except for that tiny minority of contracts that mature on an exchange that offers physical settlement.

So you see the truth is not somewhere between our points of view. Just because something seems plausible does not make it the truth. I prefer the correct answer.

by **halcyon** » Tue 22 May 2007, 06:04:54

MrBill & Petrodollar

thank you for a very long and detailed post.

Unfortunately, I'm not sure I follow all of your logic.

Let me try and give a simplified train of thought of how I've heard these things go:

1. NOCs produce/sell/export most of the exported oil that goes towards OECD countries. NOCs mean that the money they handle often goes mostly to central banks.

2. Most Middl-East NOCs are selling(/forced to sell) their oil in USD only.

3. When anybody wants to buy oil from Middle-East (US, EU countries, Japan, etc), they need more USD currency or tradable USD nominated assets.

4. The need for oil trade currency (USD) creates a pricing pressure for USD. USD doesn't want a strong dollar, at least not overly so. To combat this and to leverage it's position, US gov (in collusion with fed) can print more money.

5. Printing more USD could lead to domestic inflation (CPI). However, when it is exported (when the NOC buys it), so is part of the inflation.

6. NOC countries may try to combat inflation of USD money by printing their own currency, but if their own currency is not liquid and huge volume traded, most of the inflation will hit them in their own knee. This option is thus only available to countries who have a bigger currency (more trading volume) and mechanism to keep some of that extra printed currency out of domestic markets. These are mostly non-NOC currency markets (UK, EU, Japan, China, etc.)

--------------- UP-to-HERE is Petrodollar's argument, AFAIK ----------

6. When the oil transaction is settled. The USD is now in the selling NOC country (and out of US for now).

-------- Somewhere here MrBill's argument starts (?) -----------

7. NOC exporters have mostly re-invested this in their own countries, by ordering a lot of construction and other type of industrial work from American companies. Properly overpriced, this leads to lessening of the inflatory effect, when the USD for these construction works flows back to US (that is, NOC countries pay much of the inflation as too high prices in construction work). This went on for decades through 'special relations' between US and KSA for example.

8. But the USD cash/asset flow keeps coming in. Construction is maxed out. Where do NOC countries put the dollars? Part of they hold as currency/USD assets. This keeps the (asset/investment) inflation in the NOC country, out of US. No big deal, they have too much money anyway. They are not yet overly concerned. This was all good in the time of steady dollar, when everybody believed in dollar and wanted a cash position in it (and it offered decent profit). Some even pegged their currency to dollar to improve forecasting and to leverage the position of USD.

9. However, too much USD assets in central banks and commercial players' bank accounts of NOC countries cause a problem. The USD asset risk for them is now too big. Or maybe they just become more hungry and want to shop elsewhere. What do they do? They unwittingly invest them in other USD markets (stocks, real estate, etc). This creates an inflationary effect in those regional asset markets.

-------- Somewhere here MrBill's argument stops (???) ----------

10. When all major US market asset classes are inflated enough and the risk is still too concentrated to USD nominated assets AND US is still printing more money, making it more risky position to be in, NOCs start pumping it to other markets.

11. NOCs invest heavily in EU, UK, BRIC, Balkan and other markets. In all asset classes, in order of lucrativeness and profit expectations. This causes an inflation in those asset markets, even if not so much in CPI of those regional areas.

12. Now the dollar is spread around everywhere in all countries, including a lot of it returning to US. The inflationary pressure for USD and various asset markets is growing a bit unnerving to some. Some are saying that the central banking system is heading for a systemic collapse or that the current 'print-more-money' approach (espoused by not only US, but all major currency operators) is just a fancy ponzi-scheme.

13. Countries (or operators in general) want still to reduce their USD risk. This now includes a lot of central banks that sold their own bonds and received USD as payments and which they now hold in large amounts (China, Russia, EU, UK, etc.). Many want to start reduce their USD asset risk position.

14. Everybody is now in the same dilemma: they have too much USD asset holding risk. They want to reduce, but who is buying? If they dump their USD holdings, the prices will plummet (very few buyers), so they do not want to rock the boat as their own USD related holdings will depreciate rapidly.

15. So they start putting limits (China, Russia) for US assets holdings. They start offloading USD slowly and increasing other currency related holdings, to try and balance the risk. They want to do this as secretively as possible, but everybody knows it's going on. With many moves they have to be completely open (markets see).

16. US is still printing more money, although trying to cool the overheating domestic markets, in which investment asset classes have pretty much all overheated. They are ALL over-valued (on average).

17. As one example, in US excess liquidity and very low interest rates (aka printed money) have created a huge loan risk in the domestic market (esp. real estate, but other assets as well). If US too rapidly raises interest rates, it runs the risk of crashing these loan risk leveraged markets, cooling investments and risking a recession or even a major depression. So it still has to print money, even though it's trying to do less of it. Between a rock and a hard place, comes to mind.

18. Everywhere in the world everybody is starting to think how can they reduce the SYSTEM of having to take in USD assets, in addition to reducing their current USD holding POSITION. So, oil exporters move towards more balanced currency baskets (China, Russia, Venezuela, etc.). This reduces the systemic risk in the long run, although it does no miracles to current position.

19. Other countries who have been trying to peg their currency (officially or otherwise) to USD are eyeing the risk and will want to detach their currency from the USD valuation risk. This is especially important for countries who export oil (hence Kuwait does their move). Again, another systemic attempt, but does not solve the current situation.

20. The situation is untenable. Money is still flowing to market and many other currencies are also growing rapidly. All asset classes pretty much in all major markets are over-valued. Everything is a bubble. Going to a cash position is tricky (which currency?). Investing to asset classes seems risky as well (due to over-valuation). Risk and pressure on CPI is increasing due to excess liquidity. Everybody is waiting nervously. What is the solution? Print more of other currencies? Balance the system? What if investors become jittery? What if yen-carry-trade starts flowing back? What if US real estate market crashes? What if oil price still keeps rising rapidly, even if global economy is cooling off? Too many options, too many questions, not enough clear cut answers. Tension builds up...

Phew.

1st, my apologies if I have mispresented your position/arguments. That is un-intentional and I welcome corrections. Most of what I write is my own (or borrowed from elsewhere).

I'm merely trying to point out that in the haphazard causal network of events, MrBill/Petrodollar arguments do not target the same sequence of events, but different parts. That is, there is a theoretical possibility that they are partially compatible.

Now, please be gentle.

I'm neither a geo-strategist nor a banker.

The above summarizes in chunks what I've understood or tried to learn from elsewhere. With warts and all.

Some of it may be wrong. Much of it may be wrong, but I doubt all of it is wrong.

I have left out a lot, so it is truly an over-simplification.

Still, I'd like to hear, if you have time/interest to still participate:

- Can you see the two arguments (MrBil and Petrodollar) to be at least partially compatible (not the whole arguments, but some parts)?

- What options do you see for major operators to get out of this situation with decreased risk of a major crash (if you see such a thing at all)?

- Do you think that US asset position can keep on strengthening and if so, how/why?

- If a big one happens (crash of real estate + yen-carry-trade + a lot of the derivatives/hedges/ETFs), then do we run a risk of a major global recession? Even depression? Regional great depressions?

- What's the positive upside in all this?

Sorry if that's too much questions. Nobody here is obliged to answer. I'm just trying to wrap my head around some of this stuff myself.

by **MrBill** » Tue 22 May 2007, 07:02:37

halcyon, I need time to respond to your post. Will print it out and re-read it. Thanks.

In the meantime, here is an update on Kuwait's new 'trade & investment weighted basket' to replace its US dollar peg.

13:24 22May07 RTRS-UPDATE 1-Kuwait currency basket linked to imports,investment
Kuwait's dinar will track the currencies in the which country's imports and investments are priced, the central bank governor said on Tuesday, after the oil exporter abandoned its peg to the weak U.S. dollar.
The dollar would still account for a major share of the new currency basket, Sheikh Salem Abdul-Aziz al-Sabah told reporters, declining to name any other currencies or what weights they had.
Markets had been waiting for word of the composition of the
basket after Kuwait scapped the peg on Sunday, saying the U.S.
currency's decline was stoking inflation by driving up import costs.
A trade-weighted basket would still have been dominated by the dollar in which Kuwait prices its oil exports.
If the currency basket mirrored the sources of Kuwait's top
merchandise imports, it would roughly consist of 46 percent
dollars, 29 percent euros, 15 percent yen and 10 percent
sterling, Monica Fan of RBC Capital market said in a note.
The basket was "import and financial related", Sheikh Salem told reporters.
Asked to explain "financial related", Sheikh Salem said: "We
set our financial relations, in terms of investment. For example, where we are investing and in which currencies."
Like other Gulf Arab states, Kuwait has been investing more of its windfall revenues from a near tripling of oil prices in the five years to July in Asia.
In 2005, the state-owned Kuwait Investment Authority doubled the cash allocated to Asian assets to 20 percent from 10 percent of the its portfolio.
Kuwait's decision to abandon the dollar peg threw regional plans for monetary union into disarray and triggered speculation that other countries would follow suit.
The United Arab Emirates central bank governor ruled out any
changes to its foreign exchange policy on Tuesday.
"We are committed to a decision by Gulf leaders to keep
currencies pegged to the dollar at a fixed rate," Sultan Nasser
al-Suweidi told reporters in Kuwait.
After Kuwait, the UAE was the most likely candidate to
loosen a dollar peg, which the six oil producers had agreed
would stay in place until monetary union in 2010, according to
analysts polled by Reuters in March.
The central banks of Saudi Arabia, Bahrain, Oman and Qatar
had already ruled out a policy shift.

The main reason behind the change.
"Markets had been waiting for word of the composition of the
basket after Kuwait scapped the peg on Sunday, saying the U.S. currency's decline was stoking inflation by driving up import costs. A trade-weighted basket would still have been dominated by the dollar in which Kuwait prices its oil exports."

The reason why I wait to see what is implemented versus what is announced.
"Kuwait's decision to abandon the dollar peg threw regional plans for monetary union into disarray and triggered speculation that other countries would follow suit. "

Again let's see what if officially announced versus what transpires?
"The central banks of Saudi Arabia, Bahrain, Oman and Qatar
had already ruled out a policy shift."

by **MrBill** » Tue 22 May 2007, 10:30:49

In answer to halycon's questions.

MrBill & Petrodollar

thank you for a very long and detailed post.

Unfortunately, I'm not sure I follow all of your logic.

Let me try and give a simplified train of thought of how I've heard these things go:

1. NOCs produce/sell/export most of the exported oil that goes towards OECD countries. NOCs mean that the money they handle often goes mostly to central banks.

MrBill:

Or state invest agencies. Central banks tend to buy more US government agency bonds, while investment agencies can and do buy other US securities. Investments made through London investment banks in US securities may not show up as central bank purchases, but as flows via the UK or an offshore center. (See Brad Setser's RGE blog for breakdowns).

2. Most Middl-East NOCs are selling(/forced to sell) their oil in USD only.

MrBill:

3. When anybody wants to buy oil from Middle-East (US, EU countries, Japan, etc), they need more USD currency or tradable USD nominated assets.

MrBill:

4. The need for oil trade currency (USD) creates a pricing pressure for USD. USD doesn't want a strong dollar, at least not overly so. To combat this and to leverage it's position, US gov (in collusion with fed) can print more money.

MrBill:

5. Printing more USD could lead to domestic inflation (CPI). However, when it is exported (when the NOC buys it), so is part of the inflation.

MrBill:

6. NOC countries may try to combat inflation of USD money by printing their own currency, but if their own currency is not liquid and huge volume traded, most of the inflation will hit them in their own knee. This option is thus only available to countries who have a bigger currency (more trading volume) and mechanism to keep some of that extra printed currency out of domestic markets. These are mostly non-NOC currency markets (UK, EU, Japan, China, etc.)

MrBill:

--------------- UP-to-HERE is Petrodollar's argument, AFAIK ----------

6. When the oil transaction is settled. The USD is now in the selling NOC country (and out of US for now).

MrBill:

-------- Somewhere here MrBill's argument starts (?) -----------

7. NOC exporters have mostly re-invested this in their own countries, by ordering a lot of construction and other type of industrial work from American companies. Properly overpriced, this leads to lessening of the inflatory effect, when the USD for these construction works flows back to US (that is, NOC countries pay much of the inflation as too high prices in construction work). This went on for decades through 'special relations' between US and KSA for example.

MrBill:

8. But the USD cash/asset flow keeps coming in. Construction is maxed out. Where do NOC countries put the dollars? Part of they hold as currency/USD assets. This keeps the (asset/investment) inflation in the NOC country, out of US. No big deal, they have too much money anyway. They are not yet overly concerned. This was all good in the time of steady dollar, when everybody believed in dollar and wanted a cash position in it (and it offered decent profit). Some even pegged their currency to dollar to improve forecasting and to leverage the position of USD.

MrBill:

9. However, too much USD assets in central banks and commercial players' bank accounts of NOC countries cause a problem. The USD asset risk for them is now too big. Or maybe they just become more hungry and want to shop elsewhere. What do they do? They unwittingly invest them in other USD markets (stocks, real estate, etc). This creates an inflationary effect in those regional asset markets.

MrBill:

-------- Somewhere here MrBill's argument stops (???) ----------

10. When all major US market asset classes are inflated enough and the risk is still too concentrated to USD nominated assets AND US is still printing more money, making it more risky position to be in, NOCs start pumping it to other markets.

MrBill:

Emerging markets, for example. Kuwait increased its asset allocation to Asia from 10 to 20%.

11. NOCs invest heavily in EU, UK, BRIC, Balkan and other markets. In all asset classes, in order of lucrativeness and profit expectations. This causes an inflation in those asset markets, even if not so much in CPI of those regional areas.

MrBill:

They also try to buy valuable assets like ports and oil companies if they are allowed to. If not, then real-estate in London is always a good bet (sic).

12. Now the dollar is spread around everywhere in all countries, including a lot of it returning to US. The inflationary pressure for USD and various asset markets is growing a bit unnerving to some. Some are saying that the central banking system is heading for a systemic collapse or that the current 'print-more-money' approach (espoused by not only US, but all major currency operators) is just a fancy ponzi-scheme.

MrBill:

13. Countries (or operators in general) want still to reduce their USD risk. This now includes a lot of central banks that sold their own bonds and received USD as payments and which they now hold in large amounts (China, Russia, EU, UK, etc.). Many want to start reduce their USD asset risk position.

MrBill:

14. Everybody is now in the same dilemma: they have too much USD asset holding risk. They want to reduce, but who is buying? If they dump their USD holdings, the prices will plummet (very few buyers), so they do not want to rock the boat as their own USD related holdings will depreciate rapidly.

MrBill:

15. So they start putting limits (China, Russia) for US assets holdings. They start offloading USD slowly and increasing other currency related holdings, to try and balance the risk. They want to do this as secretively as possible, but everybody knows it's going on. With many moves they have to be completely open (markets see).

MrBill:

16. US is still printing more money, although trying to cool the overheating domestic markets, in which investment asset classes have pretty much all overheated. They are ALL over-valued (on average).

MrBill:

Yes, and yet, no one wants higher rates rein in the economy and bring down inflation. Because they are all over leveraged. And depending on low interest rates, which ironically were partially caused by Asian central banks buying USD bonds and driving down rates in the first place. The original stimulus stemming from budget deficits and low interest rates to bail out dot.com investors and shell-shocked consumers post-9/11.

17. As one example, in US excess liquidity and very low interest rates (aka printed money) have created a huge loan risk in the domestic market (esp. real estate, but other assets as well). If US too rapidly raises interest rates, it runs the risk of crashing these loan risk leveraged markets, cooling investments and risking a recession or even a major depression. So it still has to print money, even though it's trying to do less of it. Between a rock and a hard place, comes to mind.

MrBill:

Yes again. It is either recession, depression, inflation and/or currency depreciation or a decade of low, slow, no growth. That is between a rock and a hard place. The definition of a dilemma.

18. Everywhere in the world everybody is starting to think how can they reduce the SYSTEM of having to take in USD assets, in addition to reducing their current USD holding POSITION. So, oil exporters move towards more balanced currency baskets (China, Russia, Venezuela, etc.). This reduces the systemic risk in the long run, although it does no miracles to current position.

MrBill:

19. Other countries who have been trying to peg their currency (officially or otherwise) to USD are eyeing the risk and will want to detach their currency from the USD valuation risk. This is especially important for countries who export oil (hence Kuwait does their move). Again, another systemic attempt, but does not solve the current situation.

MrBill:

Yep, but the decoupling was necessary and desirable in the first place, so really this is a non-issue. So long as these countries do not pick-up bad habits from their Asian friends and start manipulating their own CCY down to remain export competitive. The very reason they would leave the USD-peg in the first place.

20. The situation is untenable. Money is still flowing to market and many other currencies are also growing rapidly. All asset classes pretty much in all major markets are over-valued. Everything is a bubble. Going to a cash position is tricky (which currency?). Investing to asset classes seems risky as well (due to over-valuation). Risk and pressure on CPI is increasing due to excess liquidity. Everybody is waiting nervously. What is the solution? Print more of other currencies? Balance the system? What if investors become jittery? What if yen-carry-trade starts flowing back? What if US real estate market crashes? What if oil price still keeps rising rapidly, even if global economy is cooling off? Too many options, too many questions, not enough clear cut answers. Tension builds up...

MrBill:

Phew.

1st, my apologies if I have mispresented your position/arguments. That is un-intentional and I welcome corrections. Most of what I write is my own (or borrowed from elsewhere).

MrBill:

Not at all. I enjoyed them.

I'm merely trying to point out that in the haphazard causal network of events, MrBill/Petrodollar arguments do not target the same sequence of events, but different parts. That is, there is a theoretical possibility that they are partially compatible.

MrBill:

They could be, but I will never admit it! As I like to say, even a broken clock can be right twice per day, but that does not mean it is accurate.

Now, please be gentle.

I'm neither a geo-strategist nor a banker.

MrBill:

I am a hobby banker, so that is okay.

The above summarizes in chunks what I've understood or tried to learn from elsewhere. With warts and all.

Some of it may be wrong. Much of it may be wrong, but I doubt all of it is wrong.

I have left out a lot, so it is truly an over-simplification.

Still, I'd like to hear, if you have time/interest to still participate:

- Can you see the two arguments (MrBil and Petrodollar) to be at least partially compatible (not the whole arguments, but some parts)?

- What options do you see for major operators to get out of this situation with decreased risk of a major crash (if you see such a thing at all)?

- Do you think that US asset position can keep on strengthening and if so, how/why?

- If a big one happens (crash of real estate + yen-carry-trade + a lot of the derivatives/hedges/ETFs), then do we run a risk of a major global recession? Even depression? Regional great depressions?

- What's the positive upside in all this?

MrBill:

That we are all in this mess together?

Sorry if that's too much questions. Nobody here is obliged to answer. I'm just trying to wrap my head around some of this stuff myself.

by **Doly** » Tue 22 May 2007, 11:11:55

halcyon wrote:- Do you think that US asset position can keep on strengthening and if so, how/why?

- If a big one happens (crash of real estate + yen-carry-trade + a lot of the derivatives/hedges/ETFs), then do we run a risk of a major global recession? Even depression? Regional great depressions?

I don't know. What's even worse, the world's leading economic commentators don't know. I remember reading in the Financial Times about some unexpected turn of things in emerging markets something like this: "In Shakespeare's plays, people wouldn't always know what a portent was about, but at least it was a safe bet that if you saw horses eating each other it could be nothing good. In the current economic environment, we don't even know if significant developments are good or bad."

by **halcyon** » Tue 22 May 2007, 16:31:49

MrBill, thanks for a long and detailed reply.

Some comments and further clarifications.

halcyon wrote:2. Most Middl-East NOCs are selling(/forced to sell) their oil in USD only.

MrBill wrote:
MrBill:
It is a convention. They are not forced to do anything.

I'm not sure. According to sources I've read, KSA once tried to to get off USD only nominated oil exports and US pretty much said that do that and the option is military intervention (this was late 70s/early 80s, can't find my source now).

Syria switched to euro sales and the world did not end NOR did the others follow.

But US did try to stop them and has before since and after this put more pressure on Syria (ref. Al-Jazeera & Dureid Dargham). Syria is on Rumsfeld's original list of countries US is supposed to attack/punish (ref: Asia Times). Funny coincidence.

I would look for more bi-lateral long-term supply contracts in euro in the future. For instance from Russia to the EU to offset Russia’s imports.

Yes. Russia can do what they want without US reprisal. They have a nuclear deterrent.

Funnily enough, since Russia started implementing this, Cheney had his now infamous Lithuanian speech. Again, funny coincidence.

Iran has been talking about the same thing with their IOB. Since at least 2004 US has started their current round of serious demonizing campaigns of Iran and it's leader, who has made US job on this so much easier, btw. Again, funny coincidence.

I could say something about Venezuela and Chavez as well, but with his nationalization program (of wells AND rigs) I think he's asking for it and it is really difficult to try to discern which moves are against the nationalization/related issues and which against oil currency baskets (if any).

MrBill:
I maintain it makes no difference in which currency oil is priced IF you have the identical grade of oil being offered for sale in dual currency AND the only difference is the foreign exchange rate between two convertible currencies (i.e. USD or EUR).

I'm not sure.

Reserve currency position is how I've understood it.

If all things were equal, the amount of reserve currencies in world circulation would be roughly equal to the share of world GDP of each country (without currency conversion shenanigans in the comparison).

Currently (and historically) USD has been way over-represented in their share. There's much more of USD currency reserves around the world than there is share of world combined GDP by US.

This allows US to print more money and to export much of the ensuing inflation elsewhere.

I'm not sure I've understood your counterargument on this, so my apologies if this is a rehash of old stuff for you.

MrBill:
No one is going to sell comparable oil below its market value in rubles or dollars or euros.

Domestic markets excluded of course, because Iran is in fact doing just this (subsidizing domestic consumption by driving price below world price levels).

Otherwise I agree and it's just a minor temporal deviation anyway.

But yes, for the price oil, it doesn't matter what currency it is priced/traded in.

But it matters to the the entity printing that specific currency (i.e. value and volume of that currency).

MrBill:
However, presumably the point that oil producers want to switch away from selling their crude in USD is that the greenback is losing its buying power. So I am not sure how switching to ‘stronger’ euros or yens is going to solve these importer’s foreign currency needs?

Well it does nothing to the price of oil, that we settled.

But it diversifies the currency risk, if you can diversify your currency-nominated asset risks (cash, treasury assets, etc) across various currencies, right?

MrBill:
Oil purchases are ALWAYS a net wealth transfer from the importer to the exporter. It does not matter in which currency the deal is transacted. As a matter of fact it does not matter if we are speaking about oil or any other commodity like base metals or agricultural commodities.

Agreed.

MrBill:
I have refuted this point in my last post. Any USD bought to buy OIL are sold as soon as the buyer takes OIL in exchange for USD.

Completely agree.

However, there is ALWAYS money in the circulation. Bigger the volume of circulation (oil trade), more there is dollar-related holdings distributed among everybody who buys/sells oil.

This increases the total amount of dollars in circulation.

The more deals are priced in oil, the more dollars there are in circulation.

The more there is need for others to buy/hold dollars, the more you can print them.

USD is in (small part) this sense like a very volatile exchange commodity against oil trades

Everybody buys it and there's a lot of it in circulation and it is to the benefit of the printer to make sure this position stays, so that one can keep printing it (exporting inflation and supporting domestic spending by a huge deficit).

What matters is then what does the seller do with the USD they receive when they sell OIL?

I deal with this in 7-11 (how excess liquid assets are diversified by oil exporters to various asset classes/markets).

Two different issues. The transaction CCY versus the investment CCY. Fuller explanation in the above post.

-snip-

Commercial importer sells CCY to buy USD
Commercial importers sells USD to buy OIL
(i.e. no central bank involved here)

There is NO extra demand for USD, so it cannot contribute to the strength of the US dollar, unless

I think there is. As long as others have to:

- constantly buy oil
- constantly buy usd to buy oil (usd only oil exports)
- oil consumption increases

Thus the "any given snapshot in time" amount holding of USD currency holdings of everybody who has to buy oil in USD has grown compared to previous snapshot.

You have to buy/hold more dollars as you consume more oil, IF the oil is traded in USD.

Exporter sells OIL to buy USD

AND

Exporter sells USD to buy USD-denominated assets, creating extra demand for USD assets.

Yes, I agree on this.

To summarize:

1. The bigger the share the oil trade done in USD (by all countries)
2. The bigger the growth of oil consumption (by all countries)
3. The more USD is used to buy back US production/assets

The more demand there is for USD, even outside US.

The FED does not devalue the USD by simply printing money.

Agreed. When I say "printer" or "Print more money" it is a figurative term to describe all currency creation methods available to central
and consequently to private banks.

Money supply matters, but the real rate of interest the FED charges as well as minimum reserve requirements are the tools used to ration demand for those USD.

That issue is separate from in which currency OIL is priced. It is important not to mix too many issues together and lose the overview of each piece of the argument.

Complete in agreement again.

However, the ability to:

1. create more money
2. export a lot of it through systemic dependencies

is an ability to export inflation to other countries and continue a debt-infuced domestic spending spree.

This "ability" can be supported by various factors and strong reserve currency position and amount of currency tied to oil transactions world-wide are some of those factors, afaik.

[list]Printing too much money supply will lead to asset price inflation because those extra USD have to flow somewhere.

Agreed. However, exported inflation is better than domestic one. (to a degree). Even for a post-keynesian banker.

When we speak of exporting inflation it is in two different, but distinct ways. One is exporting that extra liquidity from money supply growth to a foreign capital market because there is no return for it in the domestic market. That leads to asset price inflation in the foreign market such as property prices in emerging markets like Shanghai, Mombai or Moscow.

Exactly what I was trying to refer to. Good example. Thanks.

The second way is through a weaker USD. This is Kuwait’s problem at the moment. They export OIL in USD and then need to import STUFF in EUR. And their Kuwait dinar (KWD) is pegged to the USD that is going down in value.

Yes. For US, weak dollar = good for exports, bad for (oil) imports.

For others, the reverse, unless they are pegged of course.

Another country’s domestic inflation is not a serious concern to the FED. And I say that with a number of caveats. Obviously, hyper-inlfation can be destabilizing and that affects capital markets that are interconnected. Of course, if they cannot afford to buy US made goods (like Boeings) in USD then that lowers the US’ exports.

Agreed again.

MrBill:
[list]Your point is inaccurate. You cannot fight inflation by creating your own inflation. You can devalue your own CCY, so that nominal exchange rates stay the same. But again then your own CCY buys less, so you’re importing inflation from abroad.

Why not. If you have the ability to export the inflation, you can fight imported inflation, by creating more money, which you can then use to purchase goods.

Of course, this will affect the exchange rates (with some time lag) and the extra printed money will probably get invested back in domestic markets as times go by.

But if your CCY is not major traded currency and you are unable to export it, you can't print your way out of the problem.

Hence, NOC countries can't do it.

That is not the goal of UK, EU, Japan, China, etc. The latter two are keeping their own domestic interests weaker than they should be on a trade weighted or purchasing power parity (PPP) basis, so as to keep their exports competitive in the USD zone and competitive with EUR substitutes.

And how are they doing this?

AFAIR, everybody has learned the folly of long term support buys for USD. They don't work in the long term and are really expensive.

The easier option is to print your own currency to devalue it, right?

By creating more ccy of type X, you essentially devalue it in forex markets, right?

The question: how to do this without bigger domestic CPI increase?

Rhetorical question: if you increase the the income divide, doesn't it enable more of the printed money to flow to the richer middle class + the rich class? Doesn't that money get diverted mostly into assets, and not directly into CPI? Also, doesn't cleaning the CPI basket, esp of such goods as major energy and housing items help to keep the inflation figures down? Do I see a historical trend here from the past few years?

Really China and Japan have the most to gain by following the ECB and BOE’s lead and raising interest rates and allowing their CCYs to rise viz a vie the USD. OIL would become cheaper in CNY or JPY, while their consumers would be better off.

Good point. I don't know how they easily adjust the imports/exports balance in times of extremely volatile oil prices. Of course, they don't buy with spot-prices, but spot reflects to long term contracts as well in due time.

Balancing the situation via exchange rates can get tricky, I guess.

MrBill:
[list]The money actually stays for the most part in the USA. Foreign banks may offer bank accounts in USD, say a German bank in London, UK, but they in turn have their NOSTRO accounts in the USA at a US bank.

Makes sense. Asset owned by a NOC country at this point, regardless of where is the taxation country of financial institution used. Makes some sense to invest in US then, if it's already in the US. At least initially (as posted earlier).

However, in answer to the question as you posed it, yes, if they over paid for the work in question then it would be more inflationary of course. But it would not lesson inflation back in America.

Good point. Very good point, in fact. Unless if the overcharging for work allowed the company to re-invest much of the money somewhere else again, thus keeping it away from domestic circulation.

No wonder the big players like Haliburton and Brechter are so favoured by the US depts.

Heavens knows they do not want to give it to their own citizens in the form of education, healthcare, infrastructure and other services. They might come to expect it!

Oh so true. The ignorant are easier to herd and probably a lot cheaper too.

MrBill:
[list]Many are saying it, but the flows continued unabated because there is no alternative except to voluntarily, gasp, slow exports and therefore your growth and re-investment problem.

Ah, of course. Proves that my mental picture is still way too incomplete. Thanks for filling in that bit also.

MrBill:
[list]Bit bass-ackward that one. If a country sold USD denominated eurobonds like Argentina for example they would have received cash in USD and a corresponding USD liability to repay. They would then be worried about their foreign exchange mismatch between their local CCY and the USD. Not about a weaker USD.

Makes sense.

China’s risk along with Japan’s and other Asian central banks is that they hold too many USD bonds. Trillions. More than is needed to protect themselves against a devaluation. More than they are comfortable with.

This is in fact what I was trying to refer to, but confused things. Thanks.

The ONLY way to solve the problem is to slow export lead growth and re-invest more of those export receipts domestically. But China Inc.’s ‘Jobs First’ economic development plan calls for real GDP growth of 7-8% p.a., so slowing growth is not in the cards.

So as long as China will not (has no option) to slow down the growth and exports to US, USD dollar position remains roughly as it is.

And many Asian exporters and OPEC and non-OPEC producers are in a similar bind. They have no place to go with their export receipts courtesy of the US taxpayer (or shall I say unborn generations of Americans). But they have gotten quite used to the high headline growth that comes from this stimulus to the worldwide economy.

Can you elaborate? How do they manage it?

MrBill:
[list]But moving to currency baskets does not solve anything at all. Export surpluses still need to be re-invested. So someone has to run a deficit. All you can do is shift the burden onto to someone else.

... which can buy you some time?

I've noticed that often fixes are more of temporal than systemic in nature.

"Let's deal with the other currency problems when we have them."

Any deficits ran to grow faster than trend will have to be re-paid by lower consumption later to pay for that stimulus. Remove the stimulus and you get lower growth. Again re-paid either by voluntary saving OR by currency depreciation.

Never mind peak oil depletion that predicts more or less that there will never be enough new economic activity to pay for existing debts, so the consequence will be lower living standards. But for everyone. Not just America. OPEC and non-OPEC oil producers as well as those dynamic Asian exporters. The party will be over.

Very enlightening.

MrBill:
[list]That we are all in this mess together?

Although in some ways comforting, it still doesn't make it less scary

Thank you for a very enlightening lesson.

by **Petrodollar** » Tue 22 May 2007, 18:33:04

I'm in a bit of rush, but I'll quickly address this one critical issue about oil pricing in the dollar...

MrBill:
It is a convention. They are not forced to do anything.

halcyon
I'm not sure. According to sources I've read, KSA once tried to get off USD only nominated oil exports and US pretty much said that do that and the option is military intervention (this was late 70s/early 80s, can't find my source now).

...Indeed, there are some unattributable former US officials who have suggested that Kissinger told Saudi Arabia back in the 1970s that if they tried to divest itself of its petrodollar investments the US would consider that to be an "act of war."

One wonders what he told them in 1973-1974 when OPEC floated a proposal for a "basket of currencies" for oil transaction...of course Saudi did what the US told them and used their influence in OPEC to bring to a vote in 1975 that made dollar the official monopoly oil pricing and transaction currency for all of OPEC's oil trade...until a guy named Saddam Hussein decided to go with euros in late 2000...

Anyhow, here's 2 excerpt from my book's manuscript, which I hope might help you appreciate the history and the geopolitics of this issue and how the US created a Faustian deal with the House of Saud to maintain the status quo...but for how long?

Today the US dollar's value is steadily falling relative to other major currencies, and this is once again causing major oil-exporters to question whether they should price and transact global oil sales in the dollar. The US is attempting to thwart this momentum, just like it did in 1974 and again in 1978.

The difference today is that US-backed interventions are not just covert (i.e. Venezuela cirica April 2002, unilateral "smart sanctions" against Iran circa 2006 to present), and we have entered a period where overt military power is also being deployed to maintain US hegomony in the economic and energy relams, such as Iraq (and Iran is the neocons had their way). This transformation of US foreign policy is also likely to do to Peak Oil concerns, but the story of petrodollar recycling and how important it is to US policy makers is a story that really began about 36 years ago....

...back in the late 1960s the Vietnam war was raging, huge US debt was being created under Johnson's "guns and butter" programs, and beginning in 1967 the gold withdraws from the US Treasury from western Europe really began to accelerate. In other words, the post World War II monetary order (Bretton Woods Agreement) was beginning to break down.

Indeed, by the summer of 1971 the drain on the Federal Reserve’s gold stocks had become critical, and even the Bank of England joined the French in demanding US gold bullion for dollars. In August 1971 the British ambassador showed up at the Treasury Department to redeem $3 billion for its fixed exchange value in gold of $35 per ounce (approximately 5.3 million ounces, or 2600 tons of gold).40 On August 11, 1971, the Nixon administration abandoned the dollar–gold link entirely, moving instead to a system of floating currencies. Otherwise Nixon would have risked the collapse of the gold reserves of the US. Rather than risk damaging US credit, he changed the rules, or more accurately, he abandoned the rules.

The break with gold effectively ended the Bretton Woods Agreement and soon opened the door to the second phase of the American Century, the petrodollar-recycling phase. After the break with gold, large international banks, such as Citibank, Chase Manhattan, and Barclays Bank, in effect privatized control over monetary policy. These institutions assumed the role that central banks had held under the Bretton Woods gold system, but of course without any ability to redeem dollars for gold. Market forces determined the dollar’s value, which resulted in substantial devaluation after August 1971. In an effort to stem this inflation, the Nixon administration adopted wage-price freezes in late 1971, but inflation continued to rise throughout the 1970s, resulting in what economists referred to as “stagflation.”

The combined forces of a free-floating dollar, unexpected emergence of a US trade deficit in 1971, along with the massive debt associated with the ongoing Vietnam War contributed to both the volatility and devaluation of the dollar from the early-to-mid 1970s. At this point US Treasury officials worried for the first time about how to finance the US budget and trade deficits with foreign savings. Furthermore, OPEC’s growing disenchantment with the use of dollar for oil pricing was beginning to severely diminish confidence in the dollar as it fell in value relative to other major currencies.

According to research outlined in David Spiro’s The Hidden Hand of American Hegemony it was during this time that OPEC began discussing the viability of pricing oil trades in a basket of twelve currencies. This unpublished proposal called the “Geneva II basket,” involved currencies from the Group of Ten nations, or G-10.41 These members of the Bank for International Settlements (BIS), plus Austria and Switzerland, included the major European countries and their currencies, such as Germany (mark), France (franc), and the UK (pound sterling), as well other industrialized nations, such as Japan (yen), Canada (Canadian dollar), and of course the US dollar.

It should be noted that the powerful G-10/BIS also has one unofficial member, the governor of the Saudi Arabian Monetary Authority (SAMA).

To prevent this monetary transition to a basket of currencies that would have immediately diminished the dollar’s role in world trade, and introduced currency risk into the US economy for imported oil, the Nixon/Kissinger administration began high-level talks with Saudi Arabia. The purpose of these secret negotiations was to receive assurances from Saudi Arabia that it would enforce within OPEC continued pricing of international oil sales in dollars only — despite US assurances to its European and Japanese allies that it would not act unilaterally to enforce the dollar as the monopoly oil transaction currency. 42

In 1974, as global oil prices escalated 400 percent, Kissinger convinced the Saudis to have an American appointed as director of SAMA, and invest most of Saudi’s assets with select New York and London banking interests to establish what became known as petrodollar recycling. That year the Saudi government secretly purchased $2.5 billion in US Treasury bills with its oil surplus funds, and the petrodollar flows were then used to help finance the emerging US trade deficit.43 During both of the oil shocks of the 1970s, billions of petrodollars were carefully directed by the banking elites in London and New York — ultimately into US debt instruments of the Federal Reserve.

In typical understatement Spiro notes that, “clearly something more than the laws of supply and demand ... resulted in 70 percent of all Saudi assets in the United States being held in a New York Fed account.”44 Naturally, this artificial arrangement with Saudi Arabia prevented a market-based adjustment and was the basis for the second phase of the American Century, the petrodollar phase. What follows is the extraordinary history in which petrodollar recycling was vigorously implemented during the 1970s.

....

In 1974 US Secretary of State Kissinger and Assistant Treasury Secretary Jack Bennett (later to become director at Exxon) set in motion the mechanism for handling the surplus OPEC petrodollars. Kissinger had David Mulford, at the time an American in charge of the London-based Eurobond firm of White Weld & Co, appointed director and principle investment advisor of the Saudi Arabian Monetary Agency (SAMA).47

Engdahl notes this peculiarity, “little publicity was given to this rather usual appointment of a national of the county against which Saudi Arabia had only months earlier enjoyed an oil embargo.”48 {In otherwords, can you imagine what would happen today if an Iraqi national were replaced Bernacke as head of the US Federal Reserve...the 1970s US dealings with Saudi Arabia and Iran were very strange...}

Nonetheless, with Mulford as the new director of SAMA, along with some “advisors” in the UK-based Barring Brothers, the US orchestrated a secret financial arrangement that creatively transformed the high oil prices of 1974 to the direct benefit of the Federal Reserve Bank of New York. With joint US/UK control of Saudi assets, the bulk of petrodollars were deposited in leading New York and City of London merchant banks (Chase Manhattan, Citibank, Manufacturers Hanover, Bank of America, Barclays, Lloyds and Midland Bank).49

Please note, Spiro uncovered at least one docment that showed that the US transfered hundreds of millions of Saudi's petrodollars into certain Federal Reseve accounts without bothering to even notify or consult with the Saudis re this "investment...again, it begs the question about who actually controlled these deposits.

Note: The folloing is a crucial point to understand.

In 1975 OPEC ministers followed Saudi Arabia’s lead and agreed to accept no other currency than the US dollar in payment for deliveries in oil, not the British pound, not the highly valued German mark, not Japanese yen or even the Swiss franc. According to Engdahl, the result of this arrangement was that “the world was forced to buy huge amounts of dollars more or less continuously, in order to purchase essential energy supplies. Even more extraordinary, this OPEC dollar pricing agreement remained in force despite the subsequent enormous losses to OPEC as the dollar gyrated up and down through the next decade and more.”50

Indeed, inflationary pressures on the dollar continued into late 1970s despite OPEC’s agreement to transact oil sales exclusively in the dollar. From December 1977 to September 1978, the relative purchasing power parity of OPEC dollar-denominated assets fell by a total of 40 percent.51 {although more gradual, this is also the dollar's drop in value relative to the euro since 2001- hence the interests in petroeuros, especially since the majority of trade imports into the Middle East come the EU} In other words, by exclusively using the dollar for oil trasactions, OPEC had in effect involuntarily reduced the price of oil by 40 percent. The effect of this was a second proposal within OPEC, sponsored by Kuwait, to price oil in a basket of three currencies; the US dollar, the German mark, and the Japanese yen.52

Once again, according to de-classified documents, the US secretly intervened and put a stop to this proposal. In 1978 Treasury Secretary Michael Blumenthal flew to Saudi Arabia and quietly convinced the Saudis to ensure that OPEC members would continue to price oil in dollars only.53 In exchange for preventing OPEC from shifting the price of oil out of dollars, the US provided Saudi Arabia with significantly more voting power within the International Monetary Fund.54

Although this history is largely unknown, and even less understood by the public, it is obvious that during the 1970s both Democratic and Republican administrations undertook extraordinary measures in order to maintain the dollar’s role as the monopoly oil pricing and transaction currency.

Throughout the oil shocks of 1973–1974 and 1979–1980, Saudi Arabia and the other OPEC producers deposited their surplus dollars in US and UK banks, which then took these OPEC petrodollars and re-lent them as eurodollar bonds or other types of loans to countries of developing countries desperate for dollars to finance their oil imports. While beneficial to the US and UK-based financial centers, by 1980 the buildup of these petrodollar debts contributed to the developing world’s debt crisis of the early 1980s. Hundreds of billions of dollars were recycled among OPEC, the London and New York banks, and the developing countries.

For the past 30 years, the US has exploited the dollar’s hegemonic status. The net effect of petrodollar recycling has provided the Federal Reserve with an unparalleled ability to create credit and expand the money supply in a way that was impossible under the previous Bretton Woods Agreement. After the Nixon administration ended the dollar–gold link, a massive shift from gold to dollar reserve assets quickly took place. In 1970 gold represented approximately 50 percent of the International Reserve assets, but after 1971 gold was rapidly replaced by foreign exchange currencies, which now represent about 95 percent of central bank reserve assets. Under this process US dollars became the major reserve currency for most nations, while OPEC’s petrodollar flows helped finance US trade deficits.

Here's a graph from Richard Duncan's The Dollar Crisis that vividly shows what the petro-dollar recycling system allowed the US to do after the collapse of the Bretton Woods Agreement (circa 1971):

another except from my book:

US Dollar: Fiat Currency or Oil-Backed Currency?

What the powerful men grouped around the Bilderberg had evidently decided that May [in 1973] was to launch a colossal assault against industrial growth in the world, in order to tilt the balance of power back to the advantage of Anglo-American financial interests and the dollar. In order to do this, they determined to use their most prized weapon — control of the world’s oil flows. Bilderberg policy was to trigger a global oil embargo in order to force a dramatic increase in world oil prices. Since 1945, world oil had by international custom been priced in dollars …. A sudden sharp increase in the world price of oil, therefore, meant an equally dramatic increase in world demand for US dollars to pay for that necessary oil.

Never in history had such a small circle of interests, centered in London and New York, controlled so much of the entire world’s economic destiny. The Anglo-American financial establishment had resolved to use their oil power in a manner no one could have imagined possible. The very outrageousness of their scheme was to their advantage, they clearly reckoned.
— F. William Engdahl, A Century of War, 2004 71

At this point [Sheikh Yaki Yamani] makes an extraordinary claim: ‘I am 100 percent sure that the Americans were behind the increase in the price of oil [circa 1973-1974]. The oil companies were in real trouble at that time, they had borrowed a lot of money and they needed a high oil price to save them.’

‘He says he was convinced of this by the attitude of the Shah of Iran, who in one crucial day in 1974 moved from the Saudi view’ [of status quo]… ‘to advocating higher prices.’

‘King Faisal sent me to the Shah of Iran, who said: “Why are you (Saudi Arabia] against the increase in the price of oil? That is what they want? Ask Henry Kissinger — he is the one who wants a higher price.”’ [emphasis added]

Yamani contends that proof of his long-held belief has recently emerged in the minutes of a secret meeting on a Swedish island, where UK and US officials determined to orchestrate a 400 per cent increase in the oil price.

— Observer (UK) interview with Sheikh Yaki Yamani (Saudi Arabian Oil Minister from 1962–1986) at the Royal Institute of International Affairs, January 14, 2001 72

As previously discussed, the crucial shift to an oil-backed currency took place in the early 1970s when President Nixon closed the gold window at the federal treasury. This moved the dollar’s redemption value from a fixed amount of gold to a fiat currency that floated against other currencies. The effect of this was that the federal government thereafter had no restraints on printing new dollars and could pursue undisciplined fiscal policies to maintain America’s superpower status. The only limitation was how many dollars the rest of the world would be willing to accept on the full faith and credit of the US government. When the dollar lost its gold-backing in August 1971 and was set adrift, the US economy was thrust into an uncertain period of rapid dollar devaluation and escalating inflationary pressures.

During this time a two-pronged strategy was pursued by US and UK banking elites to exploit the unique role of oil in maintaining dollar hegemony. One component was the requirement that OPEC agree to price and conduct all of its oil transactions in dollars only, and the second was to use these surplus petrodollars from the high oil prices to reverse the dollar’s falling valuation, thereby allowing the Federal Reserve to expand credit and fund US deficits. OPEC’s decision solidified industrialized and developing nations under the sphere of the petrodollar.

In the early 1970s President Nixon became overwhelmingly embroiled in what became known as the Watergate Scandal. Consequently he named Henry Kissinger both Secretary of State and head of the National Security Council. In these highly empowered roles, Kissinger promptly pursued the monetary strategy outlined in the Bilderberg plan. During 1973–1974 US Treasury Secretary William Simon began secret negotiations to persuade Saudi Arabia to conduct global oil sales in dollars only and thereby thwart proposals to shift oil trade to a basket of twelve currencies. Saudi Arabia, as the largest OPEC oil producer, was the natural choice for Simon. Neither Congress nor the CIA was informed of this “Special Arrangement” until Saudi Arabia had already completed its purchases of $2.5 billion in US Treasury bills.”73 By the time Congress was informed of this “add-on arrangement,” it was a fait accompli.

Engdahl contends that Kissinger, acting as Nixon’s intelligence czar, was able to “misrepresent to each party [Israelis, Syrians and Egyptians] the critical elements of the other, ensuring the [October 1973 Yom Kippur] war and the subsequent Arab oil embargo.” Engdahl reasons that once the oil embargo began “the Arab oil-producing nations were to be the scapegoat for the coming rage of the world, while the Anglo–American interests responsible stood quietly in the background.”74

Regardless of this specific assertion, the Bilderberg group’s prophesy of oil prices escalating by 400 percent, along with dramatic increases in dollar liquidity, came true seven months after its May 1973 meeting. By January 1974 the benchmark price of OPEC’s oil stood at $11.65 per barrel (up from $3.01 in early 1973). It is also a matter of historical record that during this time, the US appointed an American banker as director of the Saudi Arabia Monetary Authority, who secretly bought US debt obligations and established a petrodollar-recycling system involving certain New York and London banks.

This brilliant, if somewhat nefarious, act of monetary jujitsu enormously benefited not only the US and UK banking interests, but also the Seven Sisters of the US-UK petroleum conglomerate (Exxon, Texaco, Mobil, Chevron, Gulf, British Petroleum, and Royal Dutch/Shell). These major oil interests had incurred tremendous debts from the capital requirements for their large new oil platforms in the inhospitable areas of the North Sea and Prudhoe Bay, Alaska. However, after the 1974 oil price shocks, their profitability was secure. Engdahl candidly notes that “while Kissinger’s 1973 oil shock had a devastating impact on world industrial growth, it had an enormous benefit for certain established interests — the major New York and London banks, and the Seven Sisters oil multinational of the United States and Britain.”75

The unique new monetary arrangement was formalized in June 1974 by Secretary of State Kissinger, establishing the US-Saudi Arabian Joint Commission on Economic Cooperation. The US Treasury and the New York Federal Reserve would “allow” the Saudi central bank to buy US debt obligations “outside the normal Federal Reserve auction” process with Saudi petrodollars.76
Likewise, London banks would handle eurozone-based international oil transactions, loaning these revenues to oil-importing countries in the form of eurobonds. The debt and interest from these loans would then flow to the dollar-denominated payments to the IMF, thereby completing the recycling of surplus petrodollars to the Federal Reserve.

The net effect of actions taken by US Treasury officials, elite UK banking interests, along with the assistance of Saudi Arabia, was the creation of an oil-backed dollar. In 1975 the rest of OPEC adopted the petrodollar-recycling system in which the dollar went from being “as good as gold” to being “as good as black gold.” For better or worse, this also meant that the printing on US Federal Reserve notes could have been changed from “In God We Trust” to the more accurate descriptor “In OPEC We Trust,” or more specifically, “In Saudi Arabia We Trust.”

Until November 2000, no OPEC country violated the petrodollar oil price arrangement. As long as the dollar was the strongest international currency, there was little reason to consider other options. However, in the autumn of 2000, Saddam Hussein emerged from a meeting of his government and announced that Iraq would soon transition its oil-export transactions to the euro. Saddam referred to the US dollar as the currency of the “enemy state.”77 It is not clear if Saddam initiated the idea of shifting to a petroeuro or if the EU approached him with this idea. Regardless, Iraq opened up a euro-based bank account with the leading French bank, BNP Paribas. Shortly thereafter, Iraqi oil proceeds went into a special UN account for the Oil-for-Food program and were then deposited in BNP Paribas.78

At the time of the transition, Iraq’s UN Oil-for-Food account held $10 billion. A short news story detailing this development appeared on November 1, 2000, on the Radio Liberty website of the US State Department.79 CNN ran a very short article on its website on October 30, 2000, but after this one-day news cycle, reporting on Iraq’s switch to a petroeuro essentially disappeared from all five of the corporate-owned US media outlets — which collectively control 90 percent of the information flow within the United States.80 Today, the same censorship in the US regarding Iran's attempts to move to petroeuros for its oil export transaction currency with China and its other trade partners.

Although the Iraqi move to defy the dollar in favor of the euro did not in itself have much impact, the ramifications regarding further OPEC momentum toward a petroeuro were quite profound. If invoicing oil in euros was to spread, especially against an already weak dollar, it could create a gradual or perhaps even rapid sell off of dollars by foreign central banks and OPEC oil producers. In the months before the latest Iraq War, hints in this direction were heard from Russia, Iran, Indonesia, and even Venezuela. There are indications that the Iraq War was a forceful way to deliver a message to OPEC and other oil producers: do not attempt to shift from the petrodollar to a petroeuro system. Engdahl’s conversation with a forthright London-based banker is enlightening:

Informed banking circles in the City of London and elsewhere in Europe privately confirm the significance of that little-noted Iraq move from petrodollar to petroeuro. ‘The Iraq move was a declaration of war against the dollar,’ one senior London banker told me recently. ‘As soon as it was clear that Britain and the US had taken Iraq, a great sigh of relief was heard in London City banks. They said privately, “now we don’t have to worry about that damn euro threat.”’81

Petrodollar recycling works quite simply because oil is an essential commodity for every nation, and the petrodollar system demands the buildup of huge trade surpluses in order to accumulate dollar surpluses. This is the case for every country except the US, which controls the dollar and prints it at will. Because approximately 65% of international trade today is conducted in dollars, other countries must engage in active trade relations with the US to obtain the means of payment for their "oil bill" that they cannot themselves issue. The entire global trade structure today has formed around this dynamic, from Russia to China, from Brazil to South Korea to Japan. Every nation aims to maximize dollar surpluses from its export trade because almost every nation needs to import oil. This insures the dollar’s international liquidity value.

Even though two-thirds of world trade is conducted in dollars, US exports are only about one-third of the global total. Thus, from a theoretical perspective, it is arguable that the dollar is over represented in the global economy by a factor of two. Currencies like the dollar have one advantage over gold: a central bank can use it to buy the state bonds of the issuer, in this case the US Federal Reserve. Most countries around the world are forced to control their trade deficits or face either currency devaluation or even currency collapse.

Such is not the case in the United States, whose number one export product is now the dollar itself. This unique arrangement is largely due to the dollar’s world reserve currency role, as underpinned by its petrodollar role.

Hope that bit of historical context helped...and here's the bottom line from various global economists...

It is crucial to the dollar’s dominant role as a reserve currency that dollar pricing of oil should continue.
— Stephen Lewis, economist at London-based Monument Securities, February 2005

Matthew Lynn, “Dollay may lose its reserve status,”The Sunday Business Post, February 6, 2005, http://archives.tcm.ie/businesspost/200 ... ry2097.asp

A switch away from the oil-dollar nexus would be [of] major strategic and political significance, said a senior official with an international economic agency who declined to be identified. … [The senior official said] ‘This would be considered by the U.S. as an unfriendly act.’
— “OPEC Boost Euro Deposits Over Dollars,” Washington Times, December 8, 2004

misc. footnotes:

40. Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The Battle for the World Economy, 1997, pp. 60–64. Excerpt from “The Commanding Heights, Nixon, Price Controls, and the Gold Standard,” http://www.pbs.org/wgbh/commandingheigh ... ngold.html.
41. David E. Spiro, The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets, Cornell University Press, 1999, pp. 121–123.
42. Ibid, p. x.
43. Ibid, pp. 110–112.
44. Ibid, p. 125.
45. Engdahl, A Century of War, p. 130.
46. Ibid., pp. 130–138. Engdahl was able to purchase the secret minutes of a May 1973 Bilderberg meeting from a Paris bookseller. His book contains photocopies of the cover page and related text discussed in chapter 1. The cover page is stamped: “SALSJOBADEN CONFERENCE 11-13 May 1973,” “PERSONAL AND STRICTLY CONFIDENTIAL” and “NOT FOR PUBLICATION EITHER IN WHOLE OR IN PART”
47. Ibid, p. 140.
48. Ibid, pp. 152–153.
49. Ibid, p. 141.
50. Ibid, p. 154.
51. David E. Spiro, op. cited, p. 122.
52. Ibid, p. 123.
53. Ibid, pp. 123–124.
54. Ibid, pp. 103–105.
55. Engdahl, A Century of War, p. 140.
56. Duncan, The Dollar Crisis, pp. 8–9.

71. Oliver Morgan and Islam Faisal, “Saudi Dove in the Oil Slick,”Observer, January 14, 2001, http://observer.guardian.co.uk/business ... 88,00.html.
73. Spiro, op. cit., p. 110.
74. Engdahl, op. cit., pp. 137-138.
75. Ibid., p. 136.
76. Spiro, op. cit., p. x.
77. Block, op. cit.
78. Charles Recknagel, “Iraq: Baghdad Moves to Euro,” Radio Free Europe, November 1, 2000, http://www.rferl.org/nca/features/2000/ ... 160846.asp.
79. Ibid.
80. “UN to Let Iraq Sell Oil for Euros, Not Dollars,” CNN News, October 30, 2000, http://archives.cnn.com/2000/WORLD/meas ... euro.reut/.
81. Engdahl, “A New American Century? Iraq and the Hidden Euro-dollar Wars,” currentconcerns.ch, no. 4, 2003, http://www.currentconcerns.ch/archive/2 ... 030409.php

by **halcyon** » Wed 23 May 2007, 03:31:38

Thanks Petrodollar. I have the book (Petrodollar warfare) on order, but haven't received it yet.

I still see that the point you and MrBill are making are mutually compatible. Of course, I may be wrong and misrepresenting your arguments, but I think that the major points are compatible.

Petrodollar: Trading of major commodities (like oil) in dollars creates a constant need for dollars for all commodity buyers.

MrBill: Dollar position can only be leveraged by US, if the money gets reinvested in such a way that weakens the rise of CPI (in US) and maintains a certain level of belief in USD as a major currency. Of course, inflation will occur in (other markets) other asset classes.

Combined, the two arguments make for a powerful reserve currency position argument and to me explain the current quagmire we are in.

However, there are interesting questions for me personally still to understand:

- Why does US seem to like it's currency get devaluated at this stage (if it's already in triple deficit and gains no big export benefit with it's own exports being relatively small)? => Could there a big financial move being planned? Some kind of "financial/currency switch" not completely dissimilar to what the Bretton=>Dollar-commodity move was?

- If on the long term, the Dollar-only commodity pricing system is under attack, how can US keep exporting dollars? Is there an additional option available to them?

- What will happen when the yen carry trade / stoozing ends? Can any other currency take over the role of Yen? If not, will all inflated asset classes just drop in value in a major way? Big losses for lenders? What does this mean for the world economy (as opposed to just asset evaluation)?

I feel like I'm staring at the puzzle pieces, some of which are starting to take shape, but the puzzle itself still remains a complete mystery

Ah well, should have gone into macro-economics instead of computer science.

by **MrBill** » Wed 23 May 2007, 03:59:58

halcyon wrote:

Yes, I agree on this.

To summarize:

1. The bigger the share the oil trade done in USD (by all countries)
2. The bigger the growth of oil consumption (by all countries)
3. The more USD is used to buy back US production/assets

The more demand there is for USD, even outside US.

The question is not why is OIL priced 'mainly' in USD, but why is most international trade priced 'mainly' in USD?

The four largest economies in the world are now the USA, Japan, Germany and China. They are also 3 out of the 4 largest exporters. And 2 out of the 4 largest creditor nations.

The USA aside for a second why do not Japan, Germany and China do more trade in EUR, CNY and JPY?

And for that matter as they are all net importers of OIL and other commodities why would they not insist on paying for those imports in EUR, CNY and JPY? The buyer is supposed to be king, right?

Forget any difficulty with hedging. It takes me literally seconds to click, click on my electronic trading platform and buy WTI or Brent futures or options, while almost simulaneously doing the needed FX transaction as well. Certainly, two traders side by side could do them simultaneously.

The markets are so large and the spreads so tight for institutional and corporate clients that hedging is more a matter of strategic planning in nature and not a execution issue.

So any seller of crude could easily transact in USD or EUR according to the buyer's wishes, while still using the existing exchanges for hedging purposes. A simple Excel spreadsheet linked to Reuters provides live price updates and can track crude prices in EUR as well as USD.

And for that matter it is much easier for existing exchanges to offer new contracts than for a new exchange to start-up from scratch. The array of electronic contracts offered by the CME, CBOT, LME, ICE, NYMEX, etc. is mind boggling. I cannot believe there are enough traders in the world to actually monitor all those different contracts? But apparently there is a demand for all these financial futures and options.

If there was a demand for an oil futures contract in EUR then one of these exchanges - who are in competition with one another for customers and market share - would surely provide it. And they could provide it cheaper and more effectively then any new exchange that sprung up in the desert with no supporting infrastructure.

I cannot provide you a source, but I did read there were 500.000 traders in The City of London alone. In a city of 10 million I can believe it. But maybe that includes back office and middle office support staff as well? In any case it is a large number. Then add up the number of traders in New York, Chicago, Frankfurt, Tokyo, Dubai, etc. and you get an even bigger number of traders and hence opinions.

That is why I always laugh when I read this quote in particular.

Petrodollar wrote:

Quote: Informed banking circles in the City of London and elsewhere in Europe privately confirm the significance of that little-noted Iraq move from petrodollar to petroeuro. ‘The Iraq move was a declaration of war against the dollar,’ one senior London banker told me recently. ‘As soon as it was clear that Britain and the US had taken Iraq, a great sigh of relief was heard in London City banks. They said privately, “now we don’t have to worry about that damn euro threat.”’81

Or this one

Quote:
It is crucial to the dollar’s dominant role as a reserve currency that dollar pricing of oil should continue.
— Stephen Lewis, economist at London-based Monument Securities, February 2005

I have never even heard of Monument Securities? But Reuters and Bloomberg are full of news stories every single day with various economists from banks, brokers and funds, so there are no shortage of opinions. Everyone has one.

Give me three traders and they will give you at least three opinions. Morgan Stanley is bearish commodities, while Goldman Sachs is bullish. Both cannot be right. They are both looking at the same data.

So it is amusing to me that we openly laugh at bankers and economists as being hopelessly out of touch with reality, but as soon as they say something that supports our opinion then we gladly trot their words of wisdom out as proof we are right.

Gimme a break. There are a buyer and seller to every trade. They obviously have different opinions as to the future. Economists are also famous for hedging their bets.

I can tell you this. London was not worried about any threat from the euro. We were all bloody sad that the FRF, NLG, BEF, ITL, PTE, ATS, IEP, ESP, FIM, and then GRD plus the SIT now disappeared. That used to be our bread & butter. Trading all those European currencies against the DEM. Now there is only EUR/USD. So traders have to look to trade EEMEA currencies like PLN, CZK, HUF, SKK and RUB to name a few to replace that trading revenue.

So show me a banker or broker that does not like volatility? Without it there is no money to be made. Traders will be just as happy to trade OIL in EUR as in USD.

But as I said earlier, Syria is openly selling OIL in EUR and so far they have not been bombed or invaded AND so far NO other producer has followed suit. A hundred quotes from a hundred sources do not add up to one concrete action. If it has not taken place, it has not taken place.

Sorry, I wanted to answer some of your other questions, halycon, but I kind of got side tracked there. Maybe later.

But the world will stop pricing oil & gas, lumber, base metals, agricultural commodities in USD when they start doing deals in RUB, CNY, JPY, CAD, AUD, NOK, EUR, etc.

And then those various capital markets will have to grow-up and mature, so that they will be able to absorb those inflows and outflows from trade without distorting the local economy. That means a lot of central bankers will have to step-up to the plate and be prepared supervise their local markets, while at the same time liberalizing them, so that trade can take place.

In the meantime, countries with infant capital markets like Russia and China are still not likely to trade with one another in RUB or CNY, so what's left? Actions speak louder than words.

By the way, so long as we are talking about the 70s, Nixon and Kissinger were both obviously paranoid and more than slightly mad.

Richard Nixon and Henry Kissinger

The poison, if not the fruitfulness

Meanness and mistrust marked relations between the two men who dominated American foreign policy in the early 1970s

Richard Nixon and Henry Kissinger

by **MrBill** » Wed 23 May 2007, 04:25:33

halcyon wrote:

- Why does US seem to like it's currency get devaluated at this stage (if it's already in triple deficit and gains no big export benefit with it's own exports being relatively small)? => Could there a big financial move being planned? Some kind of "financial/currency switch" not completely dissimilar to what the Bretton=>Dollar-commodity move was?

- If on the long term, the Dollar-only commodity pricing system is under attack, how can US keep exporting dollars? Is there an additional option available to them?

- What will happen when the yen carry trade / stoozing ends? Can any other currency take over the role of Yen? If not, will all inflated asset classes just drop in value in a major way? Big losses for lenders? What does this mean for the world economy (as opposed to just asset evaluation)?

You asked earlier how Japan could fund the yen carry trade, keep interest rates low AND avoid high consumer price inflation? That is a tricky question.

I think it is because a) most of that excess yen liquidity gets sold to buy other assets, not reinvested in Japan's local economy, and b) that prices were so high in Japan before the bubble burst that there was really only one way for prices to go and that was down. It is hard to have inflation stemming from low interest rates when consumers are saddled with debts and struggling to service them. Perhaps a lesson for the Fed.

The USA is in a financial mess. I personally blame ALL of the US' current problems on a TWO PARTY STATE that shares power as opposed to a true multi-party democracy where voters are given a real choice. As in a 2-party state there is no incentive for either party to reform itself, and instead they engage in partisan politics as well as fighting over the swing voter. This not only hampers change, but gives special interest groups and lobbies extra leverage over the political process if they can deliver the votes. But I am not an American, so my interest is more how US politics effects the world and not how Americans choose to govern themselves.

I personally do not think there is any way this side of Hades that the USA can dig their way out of the massive current account and budget deficits as well as pay for the unfunded future liabilities. And I do not think that countries like Japan or China would let them any way, so in a zero sum game, if the USA cuts back spending to pay back debt then that means less growth in Asian exports, slower growth and fewer jobs.

So what is the alternative? Some sort of systemic meltdown that effects everyone. And one that no one can prevent. All easy solutions have already been tried and found wanting.

We may be talking about a Japan style decade long recession or an Argentine type financial implosion on a grander scale? I simply do not know? But it will reverberate through the entire financial system and not be restricted to US markets alone. We really do all eat from the same rice bowl.

by **Petrodollar** » Wed 23 May 2007, 10:54:16

Halycon asked:

If on the long term, the Dollar-only commodity pricing system is under attack, how can US keep exporting dollars? Is there an additional option available to them?

Well, one strategy is the "strong medicine" approach that Paul Volcker delivered from 1979 to 1981, where US interest rates went briefly up to 20 or 21%. Looking at internal US Tresaury documents from 1978, one can not help but wonder if this strategy was done to appease Saudi Arabia and the OPEC producers who were discussing selling oil in three currencies (dollar, yen and mark).

I say this because the Saudi Finance minister was promised that the dollar's falling value was about to be reversed (with overtones that this message came from President Carter himself), and that Saudi Arabia needed to be patient with the US dollar, but first it needed to squash Kuwait's proposal for a basket of currencies. Perhaps its coincidental, but I do find it quite interesting that what Volcker did to the interest rates in 1979-1980 was percisely what was promised by the US Tresaury Sec Blumenthal in 1978 in his meeting with the Saudi Finance minister...

Of course the problem with the "strong medicine" approach today is the debt ratios of the US gov't, US corporations and especially US citizens are far worse than they were 27 years ago when this strategy to increase the dollar's valuation was employed by the Federal Reserve. I simply don't see Bernacke doing this.

The more likely outcome is that the dollar's commodity pricing will give way to a basket of currencies, with the euro as the obvious alternative for oil pricing and transactions for oil exporters outside the US sphere of control, and of course Putin wants rubles for Russia's oil exports to China and the EU. Here's an article that explores the issue you have raised:

http://archives.tcm.ie/businesspost/200 ... ry2097.asp

Dollar may lose its reserve status

Sunday, February 06, 2005 - By Matthew Lynn

Oil, metals and even aircraft may one day be priced in euros, not dollars.

Dream on? As the dollar stays weak on foreign-exchange markets, with little sign of a sustained recovery, there is speculation that at some point commodity prices will drop the US currency.

If that happens, it would herald a wider realignment of the global financial system - and would indicate that the dollar's reign as the world's reserve currency is coming to a close.

It is too early to conclude that the dollar is finished, yet the challenge is real and growing. The world may well be set for a period during which the dollar and the euro compete for reserve status - hardly a promising situation for global stability.

The dollar is being shunned for obvious reasons. The trade deficit grew to a record $609 billion last year, and George W Bush's administration expects the budget shortfall to reach a record $427 billion in the year ending in September.

The New York Board of Trade's Dollar Index, which measures the dollar against a basket of six currencies, has dropped 18 per cent since the end of 2001.

There are three key responses to the changing status of the dollar in the global financial system. Central banks may shift their reserves out of dollars. The Asian currencies could end their pegs to the US currency. And lastly, we could witness a breakdown in the pricing of commodities in dollars.

Central banks are already slowly raising the proportion of their reserves in euros and reducing their dependency on dollars.

That is likely to continue. Yet it will be a slow process - not least because no central bank will want to dump dollars into an already fragile market.

Asian pegs

Asian nations may or may not end their dollar pegs. But politics as much as economics will play the main role in those decisions. {of course China de-pegged from the dollar 5 months after this article was written...}

That leaves commodity prices. If the dollar's unique status is indeed coming to an end, that is where we will see it first.

“It is crucial to the dollar's dominant role as a reserve currency that dollar pricing of oil should continue,” said Stephen Lewis, economist at London-based Monument Securities, in a recent analysis of the currency.

But is there a realistic chance of oil or any other major commodity switching its pricing into euros?

Last month, Hamad al-Sayari, the governor of the Saudi Arabian Monetary Agency, caused a ripple in the market by saying he thought the role of euros in central-bank reserves would increase in the future, according to the Jeddah-based English-language daily Arab News.

More pertinently, he said it didn't matter much whether oil was priced in dollars or euros.

Bookkeeping matter

It might not matter to him, but it does to everyone else. Take a look at the issue from the perspective of an oil producer - or a producer of any other major commodity.

At one level, which currency you price your products in is largely a matter of book keeping. The Saudis can price their oil in dollars, or the South Africans their gold, or the French all those new Airbus SAS aircraft, without it making much difference to their actual income.

Actually, the currency used for the world's largest and most imporatant commodities market matters a lot from the currency issuer's perspective - the Federal Reserve - who knows that as long as global oil demand increases by approx. 2% per year, the demand for monopoly petrodollars to complete the transactions for the global "oil bill" means an automatic demand for dollars to the tune of about $1.8 trillion per year @ $60 per barrel....regardless of the dollar's valuation to other major currencies and regardless of the performance of the US economy.

Since the petrodollar recycling system was implemented, the Fed has the ability to greatly expand the US credit supply via the exportation of dollars/petrodollars abroad, thereby allowing the US gov't to do unique things like facilitate domestic growth through debt-financing, build an empire of 737 global military bases, fund huge tax cuts for the top 2% of the population, etc.

In fact, using a theoretical extreme, due to its monopoly pricing and transaction role, the demand for over $1 trillion petrodollars would still exist even of the continental United States were to sink entirely into the ocean like the fabled Lost city of Atlantis...that is the beauty of the petrodollar recycling system and having OPEC demand dollars and dollars only for their global transactions/settlements (per the 1975 OPEC agreement at the behest of our "good friends," the House of Saud).

Yes, of course this is an extreme example, but again, this issue is important from the issuer of the monopoly petrocurrency - the Federal Reserve - and I think this point is often lost in the discussion. Under the 1975 agreement, there is an automatic global demand for various highly liquid, dollar-denominated assets to pay the global "oil bill." This helped "save" the dollar from the dollar crisis that was created after the collapse of the Bretton Woods Agreement in 1971, and the "strong medicine" of the late 1970s helped solidify the system by indebting many nations to the IMF for their petrodollar loans - debt to be repaid in dollars, BTW.

Anyhow, back to the article that discusses your question...

As soon as the dollars come in, they can sell them for whatever currency they want. {this is MrBill's point}

If you are uncertain about the future price that your product is likely to command, then you can buy and sell currencies in the futures market. Just because you price a product in a currency, you aren't compelled to hold that currency.

In the medium term, however, it does matter. The producers of any product are looking for high and stable prices. If your product is priced in a permanently weak currency, then you have to keep raising the prices. That is far from satisfactory. At some point, the temptation to switch to a stronger currency will become irresistible.

Breaking ranks?

Commodity pricing also matters to the currency markets. The fact that commodities are priced in dollars is one of the key sources of that currency's strength. Everyone buying big-ticket items such as oil, metals or aircraft must buy dollars for their purchases. That is a major source of demand for the currency.{I think MrBill might disagree with this statement, but I don't}

Who will be the first to break ranks? Russian oil must be one candidate - most of it is sold in Europe anyway. Airbus aircraft must be another - the bulk of its costs are in euros, and it has the luxury of now being the dominant producer in its industry.

But nobody should hold their breath. “Maybe one day,” says Airbus spokeswoman Barbara Kracht in an e-mailed response to questions. “The point is that it is the customers who decide, and for the time being they are asking for quotations in dollars.”

Decline or rout?

True enough. You need to hold a very strong market position to impose a new currency on your industry.

Much depends on the future path of the dollar. It has been weak for about three years now. So far, producers have responded with higher prices. {for US consumers, as my German friend mentioned last week that petrol prices in Germany have remained more stable due to the euro's ongoing strength relative to the dollar}

Two more years of dollar weakness and they may well decide to take more radical action.

It will only take one commodity producer to break ranks for the move to be widely imitated. At that point, the dollar's decline could well turn into a rout. Commodity pricing is now the weakest line of dollar defence. {Along with Peak Oil, the loss of dollar's monopoly pricing role for oil trade is why the US is trying to economically strangle Iran, and probably why the US has also launched a New Cold War against Russia...not to mention the ongoing tragedy within Iraq...}

Matthew Lynn is a Bloomberg News columnist.

Hope that info helped...and supports my view that the dollar's monoply pricing of commodities and world reserve currency status is following the same pattern as the former world reserve currency, the Sterling Pound, which began to lose its status during the 1920s and 1930s...but this time I predict a basket of world reserve/petrocurrencies will be the outcome...the transition will not be easy, and more violence is likely due to this currency conflict and the imminent peak in global oil production. As for this question

Is there an additional option available to them?

Yes, to learn from history and not engage in this behavior:

Great Powers in relative decline instinctively respond by spending more on ‘security,’ and thereby divert potential resources from ‘investment’ and compound their long-term dilemma.

— Historian Paul Kennedy describing “imperial overstretch” in The Rise and Fall of Great Powers: Economic Change and Military Conflict from 1500 to 2000

by **MrBill** » Thu 24 May 2007, 03:59:21

petrodollar wrote:

Actually, the currency used for the world's largest and most imporatant commodities market matters a lot from the currency issuer's perspective - the Federal Reserve - who knows that as long as global oil demand increases by approx. 2% per year, the demand for monopoly petrodollars to complete the transactions for the global "oil bill" means an automatic demand for dollars to the tune of about $1.8 trillion per year @ $60 per barrel....regardless of the dollar's valuation to other major currencies and regardless of the performance of the US economy.

What is wrong with your math?

Well, to start with you straight-line extrapolate $60 per barrel x 85 mbpd x 365 = approx. $1.8 trillion per year roughly.

But of course that is the selling price of crude or the gross revenue from which you have to deduct the cost of production and all crude consumed locally and not exported.

As oil producers use energy to produce energy that cost has to be deducted from the headline gross sales.

Further as there are other costs involved in the exploration, drilling, extraction, transport, refining and distribution of oil into products - that are paid for in local currency - those costs have to be deducted from the headline amount as well.

Because of course when an oil producer sells crude in US dollars they have to turn around and sell those dollars to pay for their costs of production including paying local salaries, royalties, repaying their cost of capital and distributing any left-over profits to their shareholders even if that shareholder is a national goverment as in the case of NOCs.

So the total demand for US dollars to pay for crude is not in fact $1.8 trillion or so, but much less. I would estimate that based on $10 per barrel margins that the net demand is closer to $310 billion net of costs that need to be reconverted back into local currency. It is still a handsome sum to be sure, but your numbers are simply misleading.

The Kuwait Thread (merged)

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Re: Kuwait drops dollar peg

Who is online