Inspired by a CNN report of oil sheiks threatening to quote oil prices in euros instead of dollars, it is worth repeating something I have said for a long time. “Don’t get your shorts in a twist.” It matters less than you think, and the major damage is in the optics, not the economics.
The main thing to realize is that oil traders don’t care what currency you use to pay for your boatload of crude. Well, within reason they don’t. They too have access to banks with foreign exchange rate screens on the Internet, and will be happy to accept any hard currency that can be readily converted to whatever they actually want. Yes, they take euros and yen as well as dollars.
What really matters for us is whether they HOLD their earnings in dollars (dollar bank accounts, dollar treasury bonds, dollar CD’s or dollar stock shares, etc.). Even if somebody pays for their crude oil in dollars, if the oil country turns around and uses that money to buy, say, German government bonds denominated in euros, then the value of the euro is strengthened and the dollar is weakened. It is exactly the same logic that is at play in the sometimes scary scenarios of the Chinese government selling off all their holdings of dollar assets and crashing the world economy. (Relax, even if they shift out of dollars, they aren’t going to do it overnight – It really will be far more boring than a James Bond movie), What matters at the end of the day is people’s holdings, not the price tag on what they are buying.
But if the sheiks start quoting oil prices in euros, get ready for a lot of moaning and whining about the decline of the dollar and the loss of US prestige. And that is real – It is a symbol of how our completely insane economic policy of pretending we can buy anything we want (wars, huge tax cuts spring to mind), and not pay for it, really does have consequences. The world doesn't trust us to run our economy with a steady hand, and that is the root of the problem. The boring staid "German central banker" types inspire more confidence than our guys, and they don’t want the prices quoted for the things they buy to gyrate wildly because the US doesn’t know what a steady, stable economic policy looks like (at least not until last November)
Interestingly, if you look at a history of world oil prices over the past 10 or 20 years, you can immediately see that the euro equivalent price of oil was way more stable than the dollar price for long periods of time. Why? Because the fluctuations in the dollar price of oil had more to do with fluctuations in the value of the dollar than they did with actual supply and demand for oil. With oil exporters wanting a more or less stable revenue stream (and able to enforce it with their market power), they simply made sure the real price in euros stayed flat.
Even so, it is true that the fluctuations over the past two years have been more dominated by supply and demand than exchange rate changes. Nobody should need convincing by now that sharp ups and downs are entirely possible, even probable over the next few years, but it wont really matter what currency the price is quoted in. Hey, if they start quoting oil in euros we might even get people to understand exchange rates! Well… Nah. The news producers are just going to have to do a little arithmetic before reporting to us what oil prices did today.
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