Two assignments for the evening...
Posted by Prof. Goose on August 25, 2005 - 6:31pm
First, Halfin in the "Econbrowser: The PR of PO" thread cites the new post by Levitt which says:
That is why water, oxygen, and sunshine, all incredibly value [sic] products, are virtually free to consumers: it is cheap or free to supply to them. And that is why we use a lot of gas and oil, but not many rickshaws at current prices.I suppose we should go over and tell him why he's wrong again...even if this post of his is more amenable to the possibilities he was so easy to dismiss in his last post.
Second, for your consideration, this article on the implications of the Iranian Oil Bourse was sent in by reader Karl S. As he said in the email to us: "Here's an item of great interest despite its flaws."
Could the proposed Iranian oil bourse (IOB) become the catalyst for a significant blow to the influential position the US dollar enjoys? Manifold supply fears have driven the price of crude oil to its recent high of US$67.10 - only a notch below its highest price in inflation-adjusted dollar terms. With the world facing a daily bill of roughly $5.5 billion for crude oil at current price levels, it becomes apparent that sellers and purchasers of the black gold are looking into all ways that could lead to a financial improvement on their respective sides.Update [2005-8-25 19:8:47 by Prof. Goose]:On the same topic, here's an interesting (and related) post by Ryan McGreal at RaisetheHammer.
“This order [i.e. capitalism] is now bound to the technical and economic conditions of machine production which today determine the lives of all the individuals who are born into this mechanism, not only those directly concerned with the economic acquisition, with irresistible force. Perhaps it will so determine them until the last ton of fossilized coal is burnt.”
—Max Weber, 1905
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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.
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.
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.
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.
"China, the new industrial giant, has officially declared that it will diversify a part of its forex holdings into oil by building a strategic petroleum reserve. Construction of storage tanks has begun this year and will take several years until completion."
I thought that they had already finished construction and were starting to fill it later this year. The author makes it sound like its years away from being completed. Does anyone know the facts?
PhilipMartin: The petrodollar issue typically refers to the 1970s when the world was awash in excess reserves held by oil producing nations. That is not the case today. Japan alone holds more dollars than all Middle East oil producers combined. The UK, China, Belgium, Luxemburg, Canada, Netherlands, Switzerland, Germany, Ireland, Taiwan and a group of banking centers all hold larger reserves of US currencies than all ME oil producers combined.
ME producers are already investing less in the US. Current reserves earned by ME oil countries have partially gone to paying down debt and investing in the ME. Witness stock market booms in ME countries.
However, your basic point is still right, it's just that the dollars we are talking about are not petrodollars. If Japan, the UK and China (the big three holder of US currency assets - in that order), were to invest elsewhere, the US would suffer.
However, we need to go back to why they invest in US assets. Especially in the case of Japan and China, there is a huge exchange rate motivation. If China took their money out of the US they would either have to invest inside or outside of China. In either case their exchange rates would skyrocket vis-a-vis the dollar and their export driven economy would stall. This impact would be greater if the reserves were invested in China. This is a huge over simplification and misses issues such as availability of other assets, capital losses on the dollar during the transition, potential reaction by the US, etc.
Two points standout: First, countries hold US dollar assets because it serves their needs as much as ours. They can not pull out without losing the benefit that made them invest in the first place. Second, ME Oil producers are a tiny fraction of US dollar reserve holders.