Dollars and Rials and Bourses, oh my!

August 31, 2009 1:18 PM

What difference does it make to the United States economy whether oil is traded or denominated in the US dollar or in other currencies?

I often hear it said that oil is globally traded and denominated in US dollars and that the US economy would suffer greatly if countries were to trade oil in other currencies. Is this true? If so, why and how would it harm our economy?

posted by Juffo-Wup to work & money (11 comments total)

The USD has been called the world's reserve currency since World War II because it has been viewed as the most stable currency. Some argue that this is now changing, due in part to the massive amounts of debt recently issued by the US government.

Were oil or other commodities to start trading in currencies other than the USD, the theory is that this would undermine confidence in what has for the past several decades been the world's reserve currency, with concomitant deleterious effects on the US economy.

Whether any of this will come to pass is, I believe, conjecture at this point.

Other have argued that China's economic performance over the past decade is a bubble waiting to pop, and, when it does, the US economy will look that much stronger.
posted by dfriedman at 1:25 PM on August 31

Countries currently have to buy dollars to purchase oil, if nobody wants to buy our dollars then their value plummets and we can't buy anything from anywhere else (or sommit like that)
posted by zeoslap at 1:54 PM on August 31

It really doesn't matter whether oil is denominated in potatoes or pork bellies, other than the fact it might secondarily represent distrust of dollars. Markets would still clear with the same relative values.
posted by JackFlash at 1:55 PM on August 31

The wikipedia article on petrodollar warfare provides the information you are looking for.
posted by Houstonian at 1:56 PM on August 31 [1 favorite]

The wikipedia link above explains it better than I did.
posted by dfriedman at 2:00 PM on August 31 [1 favorite]

Well, this is all back of the napkin, but at least one figure from 2007 indicates global oil production at 81.533 million barrels of oil per day. Conservatively, presuming that the daily figure doesn't include weekends, this puts annual output at just over 21 billion barels per year.
Multiply that by the approximate spot price of $70/bbl, and you have something like $1.4 trillion, give or take. Considering the seemingly minor movements in dollar vs. euro or dollar vs. any world-class currency, value of one day's oil production might fluctuate on the order of half a precent, or a little less than $30 billion a day.
Oil prices have gone through demand-based paroxysms much worse than those induced by currency weakness or strength, but moving off the dollar would hurt the currency most in terms of exchange risk. If you're the world's largest consumer of butter, say, and every time you want butter you have to convert your dollars to euros, you can bet your sweet bippy that the value of butter will skyrocket in terms of volatility masqueraded as *seasonal trends*. The demand for oil is pretty consistent, barring unusual seasonality due to weather and the like. Frankly I'd like to see us off the dollar for oil and other commodities. Think of the economies we can destroy!
posted by nj_subgenius at 2:25 PM on August 31

Assume that some component of the current global demand for dollars is driven solely by the need to acquire oil. Euros and yen have to convert first to dollars, then to buy oil. The oil producing countries therefore accumulate only dollars. The dollars have to be used for something, so they buy dollar-denominated assets like US govt. bonds, US corporate bonds, or significant minority ownership in companies like Disney and Citibank. They buy US real estate. Anything priced in dollars.

If oil was denominated in anything other than dollars, then this component of dollar demand would disappear. The oil-producing countries would accumulate a basket of other currencies which they would use to buy assets denominated in those currencies. But all that demand for dollar-denominated assets would vanish. The supply wouldn't change, but the decline in demand results in a lower value for the dollar. So in terms of dollars, the value of the dollar would decrease, resulting in higher dollar prices for imported goods in the US (like oil) and simultaneously lower the prices of dollar denominated assets exported overseas.

It would also force the government pay a higher interest rate on bonds to attract the same number of buyers. This limits deficit spending, which is all the spending the government does.
posted by Pastabagel at 2:37 PM on August 31

The price of oil (on most major markets) may be denominated in dollars, but there is no reason for anyone to be forced to buy it in dollars. That a lot (most?) of the oil trade is carried out in dollars is so for the same reason that most world trade is: it is the de-facto world reserve currency and so highly trusted for international exchanges.

But lots of the oil trade is not transacted with US dollars. For instance, as it turns out, the largest foreign source of US oil is Canada. This is (largely) bought in Canadian dollars, and people worry about its distortive effects on the Canadian economy (the so-called Dutch disease).
posted by bumpkin at 3:45 PM on August 31

You might also note that the Wikipedia article on petrodollar warfare linked above is couched as a hypothesis, and is quite rightly tagged "conspiracy theory"....
posted by bumpkin at 3:48 PM on August 31

I often hear it said that oil is globally traded and denominated in US dollars and that the US economy would suffer greatly if countries were to trade oil in other currencies. Is this true? If so, why and how would it harm our economy?

Trading oil in dollars is a trailing indicator -- it confirms something that either we already know, or shows us what has already happened.

Think strategically here. If traders are using dollars, it's because they think dollars are the very best, most stable currency. If they're trading in dollars, it's because the U.S. government is doing good things and the economy is in good shape.

Moreover, there's a multiplicative factor. To trade, traders must have dollars, which they have to buy, making the currency even more valuable. And it makes it even more stable, because now it's being spread around and diversified and stuffed into banks everywhere in the world. Each dollar out there is a tiny little loan to the U.S. government. Again, this is a good thing.

If trade is done in Euros, or Yen, or Widgets, it will have meant, for whatever reason, the traders have stopped loving the U.S. dollar. They don't trust the dollar. Somebody else can give them a better deal, and/or they think the economy will turn to shit pretty soon. The trailing indicator is showing us that we suck.

And then that multiplicative is working the other way -- to not trade in dollars, you're not buying dollars, which means you're not making those tiny little loans to the U.S. treasury.
posted by Cool Papa Bell at 4:01 PM on August 31

Look at the British Pound circa 1900 and about 1990. That the difference in a nutshell.

What Cool Papa Bell said about the oil thing being a trailing indicator is dead on. The other thing to remember is that if they stop using dollars, the demand for dollars goes down, so the value of the dollar goes down, which makes it a kind of vicious cycle.
posted by Kid Charlemagne at 7:01 PM on August 31