Monday, March 13, 2006

Oil Bourse To Trade In Euros
Will The US Dollar Status Be Compromised

I know it is difficult enough to differentiate between Iran and Iraq. Iraq is where the US soldiers have been stationed way too long. Iran is the country with the better football team and White House is suspicious of their involvement in nuclear whatchammacallit. Some have called the recent grouses White House has with Iran as having more to do with the Iranian government starting a Tehran oil bourse. It is supposed to be operational, maybe by the end of March or early April. The other thing which caused some domino-kind-of-panic among critics was the detail that oil will be traded in Euros and not US dollars in the bourse.

Firstly, the US have already be at loggerheads with Iran for sometime, not just recent months. President George W Bush declared in his January 2002 State of the Union address to Congress in which he labeled Iran, along with Iraq and North Korea, as a member of the "axis of evil" trio. This was well before anyone in Tehran was even considering establishing an oil bourse to trade oil in various currencies.

Some believe that, should the Teheran bourse takes off, oil nations (especially those bullied by the US foreign policies) would trade in Euros, and that might cause a depletion of importance for the US dollars. Already much of today's petrodollars are being recycled back to buy US Treasuries. Would the bourse stop the buying of US Treasuries? I think those oil nations that do buy US Treasuries will keep buying US Treasuries, while those who have an axe to grind with US foreign policy do not even buy US Treasuries now - so the proposition does not hold water. Plus, there is a misconception to what is termed as "petrodollars". It does not just mean oil earnings being used to buy US Treasuries. Petrodollars really mean the excess profits being recycled back to the financial centers in HK, London and New York, to be lent out in US dollar form to other "investing units" to buy US dollar denominated assets. More significantly, the petrodollars is also recycled through the big banks to be lent out in US dollar loans to impoverished or oil-deficient Third World countries.

For the bourse to do real damage, it has to take off in a big way. More participation by important oil nations. The bourse do give the players an alternative, an option which certainly must rub the White House up the wrong way. But is it big enough?

It is one thing to have a bristled political relations between two countries, but this may be the sort of thing that makes push coming to shoves, leading to blows??!! One has to remember that oil is denominated and quoted in US dollars for convenience. Since the oil shock of the 70's, many countries have shifted their oil buying in their own currencies. This is especially true for Germany, Japan and France - when oil price can jump with such volatility, the last thing you need is another fluctuating factor (US dollar). It is more prudent to lessen the risk by buying oil in your own currency. Hence the importance of oil being traded in US dollars in present days has been overstated.

Back in the early 70's, the oil shock which sent oil prices rising by 300%-400%, helped propel the world's demand for US dollars, thanks to oil being traded in US dollars. But that view does not hold up in 1979 when Iran's Ayatollah Khomeini rose to power and caused another round of oil price hike. This time the US dollars actually fell as foreign nations dumped US dollars to protest US foreign policy of Jimmy Carter. That was so bad that Carter had to bring in the superman-Volcker to steady the ship. Volcker allowed interest rates to rise to stabilise the US dollar. That led to widespread higher global interest rates and global recession and unemployment. Since then major countries have a better understanding of how the US dollar is inter-connected to the global economic fortunes - whether you like it or not. This is another reason why a US dollar collapse is not likely in the present times (a weaker US dollar yes, not a halved US dollar) - globalisation of trade have been so prevalent and pervasive over the last 15 years. A similar round of what happened with the Carter-Volcker situation today would be exaggerated a few times over the world.

The US dollar is a reserve currency. You get that status not by a vote at a United Nations meeting. You have to fight for it. You have to go to war for it. You have to have the economic and military leadership to maintain it. You can go do things in the name of "democracy" but in the end its the reserve currency benefits that hold the country together. The US dollar is a paper currency, i.e. not back by "tangible stuff" like many others. While the US dollar is not backed by gold, it is backed by some 130 military bases globally. No one likes to hear it, or even preach it, but reserve status is economic power, and the right to dominate the global economic process. You can't wrench that away from the US by just an oil bourse. Call them the big bully but thats the way the world turns (for now).

That's why, while the Euro have risen in prominence, it is still a long way off to even challange the US dollar as a viable alternative. Will the European Union have sufficient solidarity to take up global military leadership? EU military spending is just a little more than 10% of the US. Greenpeace influenced, left leaning blocks... just do not add up to superpower. Although they can start by issuing and creating as deep as possible a Euro-denominated bond market and papers.

While we criticise the US for consuming more than they deserve; and we criticise them for allowing the trade deficit thing to get out of hand; and that they are just printing paper money to pay for stuff - at the end of the day, the US already "paid" and "backed" their currency in many other ways, which we are unwilling or too embarressed to acknowledge. Seen in that light, the new oil bourse in Teheran would not even bother the White House or US dollar one bit. Like an ant bite to an elephant.

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