US dollar hedgemony nonsense
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.
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
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.
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
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
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
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...
@MrBill. It is strange to me how you seem to feel the necessity to attack the messenger while trying to make your point.
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.
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.
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.
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.
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.
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?
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.
Syria switched to euro sales and the world did not end NOR did the others follow.
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.
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).
MrBill:
No one is going to sell comparable oil below its market value in rubles or dollars or euros.
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?
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.
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.
What matters is then what does the seller do with the USD they receive when they sell OIL?
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
Exporter sells OIL to buy USD
AND
Exporter sells USD to buy USD-denominated assets, creating extra demand for USD assets.
The FED does not devalue the USD by simply printing money.
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.
[list]Printing too much money supply will lead to asset price inflation because those extra USD have to flow somewhere.
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.
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.
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.
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.
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.
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.
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.
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.
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!
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.
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.
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.
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.
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.
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.
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.
MrBill:
[list]That we are all in this mess together?
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).
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
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
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
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
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.
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
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
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
- 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)?
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?
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.
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.
Is there an additional option available to them?
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
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.
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