The Oil Drum

10 comments on Two assignments for the evening...

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Jack on August 25, 2005 - 6:00pm

The fixation on the dollar pricing of oil is mixing too many conspiracy theories. I mentioned on an earlier thread that the dollar price is just a price.

The US benefits from the role of the dollar as the world's currency because it eliminates exchange rate risk and because the massive amount of funds invested in US assets provides inexpensive capital. But this has nothing to do with the price on oil invoices.

Oil producing countries hold a balance of currencies based on what balance of risk and return they want to hold. The reason that China and other countries hold dollars is because it is in their best interest to do so. It is regarded as safe, provides a decent return and sterilizes their economies against inflation. These long term holding of dollars are what is significant.

If Country A needs to convert into dollars to buy oil from Country B, Country B will just use the dollar to purchase what ever other currency they want to balance their asset base. The only beneficiaries would be the Forex traders.

In reality, I find it very hard to believe that European countries pay for oil in dollars. I think the price is in dollars, but Iran, Saudi, etc. are free to accept Euros, Yuan, rice, weapons or whatever they want. If Saudi quotes oil in Euros, fine. They can still accept payment in dollars. Otherwise, they will pay transaction costs when they convert back to dollars to invest in the US.

The idea that the US dominates the world because of carry trade on dollar transactions doesn't make much sense.

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Ripley on August 25, 2005 - 8:21pm

I agree, but the dollar vs. oil raises a larger point. Oil could be viewed as the anti-dollar, or even something that should be a store of value, like money used to be in the olden days.

Brad Setser [regmonitor.com, Nouriel Roubini's site, which is how I found The Oil Drum] and several other good economists [not like that Freakanomics guy!] are extremely worried that the US trade deficit is getting so large that we won't be able to pay it back, or even export more stuff of whatever it is we still make here.

They call the current monetary system "Bretton Woods II," and feel that it unstable as Bretton Woods I turned out to be when Nixon took us off the gold standard in 1971. I haven't seen any goldbugs at this site, but I think you could make a good argument that oil is better than gold, because it has more intrinsic value and is also less subject to central bank or government manipulation.

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Jack on August 25, 2005 - 9:03pm

I also like the Setser/Roubini sites and agree that the dollar is likely to weaken over time given the current account imbalance. In that regard, oil futures could be seen as betting on increasing oil prices, weakening dollar, or both. However, currencies do take some time to return to mean and the dollar has been strong this year, although we all had the same information in January.

My point was to debunk the commonly thrown around myth that pricing oil is dollars is a cornerstone of dollar hegemony and that the US would attack countries that considered pricing in other currencies. The price is just a price, it doesn't say much about who holds which currency or have much influence. The US wouldn't really care if oil was priced in Euros and could still make payments in dollars.

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spooky on August 26, 2005 - 4:59am

Why do you asume that they will always revert and invest in the US??

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Jack on August 26, 2005 - 7:16am

I don't think anyone here is assuming that the investments will always revert to the dollar. In fact a partial basis of Ripley's concern appears to be that eventually they will not.

My point was that the reversion to investment in the dollar assets is what they have been doing. That is an investment choice and has nothing to do with the currency oil is priced in. Even if oil is priced and paid for in dollars, oil producing nations can convert and invest in Euro assets.