[MrBill]

$this->bbcode_second_pass_quote('', 'F')urther evidence that Russia is gravitating toward a petroeuro system was provided by Lukoil vice president Leonid Fedun, who stated that the transaction cost for the switch would be minimal at just 0.08 percent. Fedun said, ‘There is no problem .... If the state decides to do this, then we will support this initiative. From the point of view of the [Russian] economy, there’s no difference.’

This Moscow Times article included comments from Yevgeny Gavrilenkov, chief economist at Troika Dialog, stating that debate is growing on a move toward the euro as Russia mulls siding with the EU: “Such an idea is really possible. Why not? More than half of Russia’s oil trade is with Europe. But there will be great opposition to this from the United States.”

[MrBill]

$this->bbcode_second_pass_quote('', '�')�� looking at the statistics of crude oil exports, one notes that the Euro-zone is an even larger importer of oil and petroleum products than the US.

From the EU’s point of view, it is clear that Europe would prefer to see payments for oil shift from the dollar to the euro, which effectively removed the currency risk.

[Petrodollar]

This article also uses some very flawed logic, along with a false dilemma by equating an oil currency switch to an "Arab oil embargo," but this honest, if somewhat right-wing individual, makes some interesting points about the dollar's demand/liqudity value in a petroeuro enviroment ...

http://www.prudentbear.com/archive_comm ... _idx=25491

Oil, the Dollar, and US Prosperity
August 11, 2003

Richard Benson is president of Specialty Finance Group, LLC , offering diversified investment banking services.

Like many Americans, I greatly enjoy air conditioning in the summer, heat in the winter, and gas for my sport utility vehicle. I also happen to enjoy traveling to those civilized lands that take modern conveniences for granted - such prosperity takes a lot of energy.

In the United States, we stopped being energy independent many years ago. The rest of the world, including Europe and Asia, also come up empty in the energy department. Russia has enough oil to export for a few years until their economy develops; Japan has zilch, and China and India can never, on their own, meet the need for oil to accommodate over 2 billion drivers.

If you take the time to examine a simple map of where the Oil Reserves are in the world, you’ll notice that two-thirds of the reserves sit in the Middle East, with a massive concentration in Iraq, Kuwait, and Saudi Arabia.

The Dollar has grown to be the world currency for settling debts, and, with around 75% of foreign central banks holding their currency in reserves, the Dollar is still the World Reserve Currency. Only recently has the Euro come into existence as a possible viable alternative as a financial asset, that can be used to settle accounts, and store value.

The level of prosperity in the United States has, in no small measure, been helped by the fact that we have run massive deficits with the rest of the world. The US has been able to run up over $3 Trillion in debts to purchase goods and services from abroad that have yet to be paid for really. The world has been willing to accept dollar assets as investments and Asia remains delighted to have their Central banks buy Treasury and Agency securities because the United States is sending Asia our manufacturing jobs. However, at some point, the day will come when foreign dollar asset holders will want to spend their dollar reserves on something of value. There is only one thing that has universal value to all modern economies – OIL!

In the real world (which is a long way from Hollywood and the Liberal Media), the one factor underpinning American prosperity is keeping the dollar the World Reserve Currency. This can only be done if the oil producing states keep oil priced in dollars, and all their currency reserves in dollar assets. If anything put the final nail in Saddam Hussein’s coffin, it was his move to start selling oil for Euros.

The US is the sole super power and we control and dictate to the Middle East oil producers. America has the power to change rulers if they can’t follow the “straight line” the US dictates. America’s prosperity depends on this. Moreover, Europe wants to be warm in the winter and we don’t want to go down a road that leads to conflict with Asia over oil. It remains in our interest, as well as the rest of the world’s, that the US insures that oil is available to all, at a reasonable price.

Removing a bloody tyrant in Iraq is certainly better for the world than seeing what might happen in Japan and China if they started freezing in the winter. Real wars are fought over oil. Germany invaded Russia for the oil in the Caucasus.

Japan bombed Pearl Harbor because the US cut off their oil. Those were real wars because the national interest, and the right to survive, were at stake (the Vietnam War was a disaster because there was no real national interest served by slaughtering peasants and American troops). The war in Iraq is a sideshow by comparison but it offers huge national interest.

At present, we notice that many US citizens are exercising their “freedom of screech” to politicize the fact that the current President miss-stated the case for immediate war with Iraq. Perhaps the President should be praised for “doing what was right” for America’s interests, even though the Administration could be faulted for the “way it was done”. I, for one, would not want to bring back an Arab oil embargo and long lines at the gas pump.

Governments have secrets. If politicians always told the truth, there wouldn’t be any secrets. So, if governments are to keep secrets, how can you fault a politician for not telling the whole truth? We would assert that the President failed to present the real case for Iraq, which is: 1) prosperity for America based on controlling Middle East oil, and on maintaining the Dollar as the World Reserve Currency, and 2) peace and stability, which the guaranteed access to oil brings to the world.

We believe that the US Treasury deficit, and the US Trade deficits, are massive stock and credit bubbles, courtesy of the Federal Reserve. These deficits will cause significant disruption to the value of the Dollar and to US prosperity, all on their own. We do not need to give up de facto control over Middle East Oil, which in turn underpins the Dollar as the World Reserve Currency. Such action, which may be welcomed by the Liberal Media, would quickly end America’s role as an economic super power and lead to the sudden and permanent demise of our prosperity.

If foreign central banks could no longer believe that holding Dollars guarantees access to oil, there would be no real reason to hold Dollars. With the US running deficits of 5% for budget and trade, in the real world the Dollar would collapse, along with our bond market, stock market, real estate market, and economic way of life.

We believe, like George Soros believes, that the dollar will weaken on fundamental grounds. Unlike Mr. Soros, we do not wish to see a catastrophic “dollar crash” (his motives should be questioned after having made $1 Billion after having helped crash the Pound). If the dollar cratered, even a “limousine liberal” could only afford a Kia.

###

...{For the record, I advocate the dollar and euro be placed in a trading band with 1:1 parity valuation, and a dual-OPEC oil transaction currency arrangement. That should reduce further petrodollar warfare, and of course, the RNB will likely need to become a third oil transaction currency at some point in the future, but the immediate issue is b/t the US and EU...}

[MrBill]

$this->bbcode_second_pass_quote('', '.')..{For the record, I advocate the dollar and euro be placed in a trading band with 1:1 parity valuation, and a dual-OPEC oil transaction currency arrangement. That should reduce further petrodollar warfare, and of course, the RNB will likely need to become a third oil transaction currency at some point in the future, but the immediate issue is b/t the US and EU...}

[Petrodollar]

Any comments on the bolded sentences in Mr. Benson's article regarding the dollar's role as the World's Reserve currency, underpinned by petrodollar recycling?

[MrBill]

$this->bbcode_second_pass_quote('', 'A')ny comments on the bolded sentences in Mr. Benson's article regarding the dollar's role as the World's Reserve currency, underpinned by petrodollar recycling?

[MrBill]

$this->bbcode_second_pass_quote('', 'I')f foreign central banks could no longer believe that holding Dollars guarantees access to oil, there would be no real reason to hold Dollars. With the US running deficits of 5% for budget and trade, in the real world the Dollar would collapse, along with our bond market, stock market, real estate market, and economic way of life

[MrBill]

$this->bbcode_second_pass_quote('', 'W')hat do you think about oil companies? Most of the integrateds have a barrel of oil behind every $12-$25 of market cap along with refining capacity. Admittedly, the oil will get delivered over the course of 20 years and extraction costs will make the reserves more akin to options than futures, but it seems like a good deal for someone who just wants to hedge their energy needs?

Also, have you figured out how to buy any Yuan? Is it some insider secret?

[DigitalCubano]

$this->bbcode_second_pass_quote('MrBill', '')$this->bbcode_second_pass_quote('', 'A')nd that investors are not smart enough to learn the truth, so they continue to buy US treasuries in what appears a very deep and liquid market, but it isn't? Do you believe that foreign fund managers, maybe a French investment banker who does not even like America, isn't smart enough to see through the smoke & mirrors and vote with his wallet - shorting US securities and buying euro denominated assets? He has every incentive to make as much money as possible and give America a black eye at the same time. Why wouldn't he?

[DigitalCubano]

Question: I once read that one of the various reasons for holding Dollars in reserve is to hedge against sudden spikes in the price of oil. That would suggest that the Dollar has practically become a derivative of oil. Is this correct?

[MrBill]

$this->bbcode_second_pass_quote('', 'Q')uestion: I once read that one of the various reasons for holding Dollars in reserve is to hedge against sudden spikes in the price of oil. That would suggest that the Dollar has practically become a derivative of oil. Is this correct?

[Petrodollar]

...an exert from my book as an fyi...

In 2004 several surprising stories appeared in the foreign media that addressed the complex issues of OPEC’s momentum toward a potential petroeuro, giving further credence to Turk’s theory that OPEC may be tacitly pricing oil in the euro. [1] The following commentary from February 2004 reinforced this assertion:

'The average price for the Organization of Petroleum Exporting Countries’ basket of seven benchmark crudes slipped by 8¢ to $30.44/bbl Thursday.

‘The value of the OPEC basket has been above the $22–28 target range for 108 trading days over the past 8 months,’ Horsnell noted. ‘Over the same period, the value of the OPEC basket in euros has stayed within a 22–28 euros band on all but just 2 trading days, and on those 2 days it was below the band.’

He said, ‘This is of course just a rather bizarre statistical coincidence. It certainly does not imply that the target band has been secretly switched into euros or that the dollar has lot its primacy in the oil market.’ [2]

Whether this observation was a “bizarre statistical coincidence” or purposeful design, it is clear that OPEC members are trying to maintain their purchasing power in the face of a devalued dollar. The question is, Can OPEC be motivated to continue pricing oil exclusively in dollars if under threat from neoconservative unilateralism, or will they gradually move toward a formal euro pricing mechanism? The likely answer to that question was addressed in the following excerpt from a Toronto newspaper, the Globe and Mail, in January 2004:

'OPEC is considering a move away from using the US dollar — and to the euro — to set its price targets for crude oil, the highest-profile manifestation of the debilitating effect of depreciation on the greenback’s standing as the currency of international commerce.

Several members of the Organization of Petroleum Exporting Countries are seeking formal talks on using the euro, as well as the US dollar, when determining price targets for crude, a senior oil minister within the cartel said Monday. ‘There are countries that are proposing this,’ Venezuela’s Oil Minister Rafael Ramirez said in Caracas. ‘It’s out there, under discussion.’ Mr. Ramirez did not specify which OPEC members are pushing the proposal, but much of the impetus is believed to come from Persian Gulf producers."

The November 2004 Center of American Progress’s study of the dollar, euro, and price of crude oil illustrated that oil prices and the dollar’s valuation are now moving in the opposite direction. The economist who analysed this reached the same conclusion previously noted:

"To compensate for this loss of buying power, [oil producers] may have raised the dollar price for oil. As a result, while oil prices in dollars rose by 162 percent from their low point in January 2002, they climbed by less than half that rate measured in euros, 77 percent. At that rate, oil prices would have only risen to $34 per barrel in October 2004, instead of the actual $52, without changes in the dollar’s value.” [3]

Since 2002–2003, American energy consumers have felt the effects of higher oil prices far more than EU consumers. This is the opposite of what one would expect if OPEC were pricing oil trades solely on the US dollar. While it is very doubtful that all ten OPEC countries (excluding Iraq) would voluntarily chose to abandon the dollar completely, it is increasingly likely that they, along with Russia, will continue to pursue methods to retain their holdings by shifting currencies in their central banks, increasing the price within the pricing band, or formally denominating oil sales in a basket of currencies.

OPEC contemplated this last option in early as the 1970s, following the collapse of the Bretton Woods Agreement, and ongoing macroeconomic trends will result in a formal announcement to price oil a basket of currencies. [4] The dollar’s accelerating decline makes this inevitable. This is yet another reason why reducing excessive consumption and subsequently the level of imported energy is in the long-term economic and national security interests of the US.


Footnotes:
[1] James Turk, “OPEC Has Already Turned to the Euro,” GoldMoney, February 18, 2004, http://goldmoney.com/en/commentary/2004-02-18.html

[2] Sam Fletcher, “Crude Futures Prices Rise in Shortened NYMEX Session,” Oil and Gas Exchange, February 20, 2004

[3] Christian E. Weller and Scott Lilly, “Oil Prices Up, Dollar Down: Coincidence?” Center for American Progress, November 30, 2004, http://www.americanprogress.org/site/pp ... F&b=258795

[4] Faisal Islam, “When Will We Buy Oil in Euros?” Observer, February 23, 2003, http://www.observer.co.uk/business/stor ... 67,00.html.

[MrBill]

$this->bbcode_second_pass_quote('', '"')To compensate for this loss of buying power, [oil producers] may have raised the dollar price for oil. As a result, while oil prices in dollars rose by 162 percent from their low point in January 2002, they climbed by less than half that rate measured in euros, 77 percent. At that rate, oil prices would have only risen to $34 per barrel in October 2004, instead of the actual $52, without changes in the dollar’s value.” [3]

Since 2002–2003, American energy consumers have felt the effects of higher oil prices far more than EU consumers. This is the opposite of what one would expect if OPEC were pricing oil trades solely on the US dollar. While it is very doubtful that all ten OPEC countries (excluding Iraq) would voluntarily chose to abandon the dollar completely, it is increasingly likely that they, along with Russia, will continue to pursue methods to retain their holdings by shifting currencies in their central banks, increasing the price within the pricing band, or formally denominating oil sales in a basket of currencies.

[tokyo_to_motueka]

very good article in the Guardian linked from LATOC (thanks Matt!).
Larry Elliott is starting to sound like Stephen Roach...
but he is really just analysing what the IMF is saying about the US economy, and, well, it's starting to sound quite ominous.
like the IMF economists are bracing for when TSHTF.
you know, like...Stephen Roach

We can do this the nice way ... or the nasty way
Larry Elliott, economics editor
Tuesday September 27, 2005
The Guardian

$this->bbcode_second_pass_quote('', 'T')o trigger a crisis, holders of US assets don't necessarily need to sell them; all they need to do is to stop buying more. To be sure, the US can be allowed to continue along its current path, with the cooperation of the central banks of China, Japan and other Asian countries, but this would mean an even bigger adjustment in exchange rates when the day of reckoning finally arrived, and an even bigger haircut for those awash with US assets.

Apart from the dire consequences for the global economy that would result from a disorderly unwinding of the imbalances, there are two additional causes for concern. One is that while the IMF has analysed the dilemma with aplomb, neither it nor any other body involved in global economic governance seems to have the clout to do anything about preventing a meltdown. There is a vacuum that needs to be filled and urgently.

The second concern is this: underlying the policy recommendations of just about every global analyst is the belief that the rest of the world needs to emulate the economic model of the US. The calls for structural reform in Japan and Europe stem from the belief that the Americans and the other "Anglo-Saxon" economies have the sort of flexibility that breeds success. Yet that hardly squares with the IMF's notion that the US economy could be going down the pan at any moment. As Mark Weisbrot of the Centre for Economic and Policy Research, a Washington-based thinktank, points out, nor does it square with the long-term needs of sustainability. Europe's energy consumption per head is half that of the US: Weisbrot says the idea that the Europeans should work longer so that they can buy more things is dangerous and he's right.

Perhaps the Germans were a lot smarter than they've been given credit for in their scepticism about the need for neo-liberal structural reform.

[CARVER]

$this->bbcode_second_pass_quote('MrBill', '.').. Far from getting a free ride on the back of oil, America pays more for the stuff than Europe or Asia because the dollar has been weakening.

[DigitalCubano]

Mr. Bill, you seem to offer some compelling arguments about how the dollar has devalued relative to other currencies over the course of the past quarter century. That said, I am confused about how so many people can still contend that a) prior to this past recession, the US was pursuing a strong dollar policy and b) that the Dollar has been overvalued for some time now, explaining both the globalization push and our appetite for importing consumables.

What am I missing? Because of my work, I am switching from a heavy background in engineering and applied math to finance theory. However, sometimes I still feel like I can't see the forest for the trees. So, any help in reconciling my understanding of the above is greatly appreciated!

[MrBill]

I think this is the nut of the argument. There are no easy answers. You cannot separate the value of the dollar from the value of oil. Nor is that to say that the dollar is strong because the price of oil went up. It has not. The dollar is in a state of decline, punctuated by brief rallies. I wish my PC was networked with my Reuters so that I could post some charts for illustration. I will have to work on that.

In the meantime, let us say for argument's sake that one barrel of oil is worth $65 and the dollar is worth 1.2000 against the euro and 115 against the yen.

One barrel costs $65 for the American, EUR54.17 for the European, and JPY 7475 for the Japanese consumer. Let's get this straight. No one is paying for their gasoline in gold or going down to the service station for work for 5-6 hours for a tank of gas. They are all paying in their home currencies which are printed by their national bank.

Fast forward one year. Oil prices are high, so demand goes down slightly and this time next year we find the price unchanged at $65 per barrel. However, Bush pushed through tax cuts and borrowed another $500 million to pay for Iraq, Katerina, etc. So, everyone at Peak Oil said enough is enough and they sold their dollars to buy euros and yen. Now the dollar is worth 1.4000 against the euro and 98.50 against the yen. The dollar has lost about 14-15% of its external value against the euro and the yen. The US still imports at least 60% of its energy needs the same as before. It has to buy oil, but so do Europe and Japan. Nothing has changed except for the value of the dollar.

Americans still pay $65 for their barrel of oil. However, Europeans only pay EUR46.43 and the Japanese only pay JPY 6403. The European saves EUR 7.74 while the Japanese pay JPY 1072 less for the same amount of oil. They are better off. The American is not better off he still pays the same while his competitors pay less. And, as the Japanese buy America's debt they either get the same amount of US debt for less yen or they can buy more US debt.

Meanwhile, the US government happily prints money to make up this short fall. Inflation goes up, so not only do Americans now pay more for their gasoline relative to the Europeans and the Japanese, but they have less money to buy imports from the Europeans and the Japanese because inflation is higher, interest rates are higher to attract foreign capital to subsidize the deficit, and as Americans pay more for their gas than Europe or Japan their consumers have less money for other things like BMWs and Toyotas.

Fast forward two years from now. Oil is still $65 due to that lower demand and new supply coming online. America is still running a budget and trade deficit, but to pay for it interest rates are higher again and the dollar is weaker still. Say 1.600 and 72.50 or another 15%. I think at this point the Arabs are very unhappy about pricing oil in dollars and the Japanese are no longer keen to buy US debt. Then interest rates have to go significantly higher causing a recession or stagflation or the US would have to take the unbelievable step of issuing debt in euros or yen. This is the end game.

I hardly call this a free ride just because the transaction and price discovery mechanism are in dollars. It comes down to purchasing power parity of the dollar versus the euro and the yen. However, a stronger euro and yen will also tend to lower their own domestic inflation and hurt their export industries. They may experience just as much pain as America if it goes thud!

[MrBill]

$this->bbcode_second_pass_quote('', 'W')hat am I missing? Because of my work, I am switching from a heavy background in engineering and applied math to finance theory.

[abelardlindsay]

$this->bbcode_second_pass_quote('MrBill', '')$this->bbcode_second_pass_quote('', 'A')nd that investors are not smart enough to learn the truth, so they continue to buy US treasuries in what appears a very deep and liquid market, but it isn't?

[MrBill]

$this->bbcode_second_pass_quote('', 'D')on't even think of putting your money in Russia. If you make too much you'll wind up in jail or on Putin's S*** list just like Berezovsky and Khodorkovsky.