Dr.Masih Rezvani

Why is oil priced and traded in U.S. dollars?

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Why is oil priced and traded in U.S. dollars?

Oil is priced in dollars because through Bretton Woods the dollar was pegged to gold and everything else was essentially pegged or floated to the dollar. The world was flooded with dollars after WWII which partially led to the present American consumerism, but it also enabled the world to essentially use the dollar as they would gold. Reserves soon played a role and in order to maintain stability the gold window was closed and eventually the US went off the gold standard all together. In the meantime though, oil, which is a global commodity, was traded using the dollar which drastically simplified the whole system. The system has remained in place due to inertia. 

In order to change the currency used, the world would have to be flooded with a different currency (which doesn't make sense since the US has the world's largest economy except for perhaps the Euro which is extremely unstable) and while the Fed may whit away the value of the dollar, it's highly unlikely that it will default and therefore it is not susceptible realistically to any speculative attacks. While currencies such as the Euro hold a substantial percentage of reserve holdings, the dollar is still THE reserve currency and those holding dollars wouldn't want to see their holdings drop in value from a drop in demand (it's bad enough for them that QE3 is skyrocketing the supply and at some point it could possibly be abandoned, but not until a certain level of desperation kicks in). 

Under the present circumstances, the only realistic alternative would be to have a somewhat balanced basket of currencies including the dollar be the drivers of world trade, but then do you buy oil with yen one week and pounds the next? A basket of currencies is inherently unstable from a global perspective since the constant shifting of portfolios would add volatility to the market. Granted, the Federal Reserve has somewhat of a blank check, but there is no perfect system. If not the dollar, what currency? In addition, how do you transfer from a system based on one currency to one based on another smoothly? 

An analogy I would make is look at Russia with the New Economic Policy in 1921 and then following the collapse of the Soviet Union. In one case the shift was to a command economy and the other it was a shift away (although Putin still has his hands in the oil industry through companies like Gazprom) but both put considerable strains on the economy. This actually brings up another point though, if the shift away from the dollar were to occur it would likely stem largely from Russia's initiatives. Regardless, there's too much at stake with the oil trade to risk a global fiasco in order to change currencies. The price of American hegemony in the currency realm is still the cheapest option to other countries for the time being at least.

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More and more oil producing and oil consuming countries walk away from the USD since the US government is using the USD as a weapon (US sanctions) in order to fight for pure US interests only.

China is trading crude since a few months in RMB and the volume is strongly growing. More and more Arab countries trade oil in EUR. 

By the way the EUR is not less stable than the USD. Just check data, you will find USD traded against EUR 1.55 to 1 about 6 years ago and now it is 1.12 to. This is mainly driven  by the different interest rates: 10 years souvereign bond in US provides currently a return of 1.5% /a. In Germany, France and the Netherlands you have a negative return for 10 years souvereign bonds, in Germany currently -0.55% / a return. This means that you have to pay 5.5% if you lend the German state money for zero interest. Is this not a sign that global finance marktes have very high trust in the EUR?

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Let's not forget the Petrodollar recycling of US Treasuries by KSA which was the lynchpin for a long time.  The problem for China is that they only have their sweatshop to trade on, what do they produce otherwise?  What is the RMB based on?  The Euro is even worse, it's backed by no ability to tax and spend at all, it's just a bureaucratic invention.  Who will pay back Euro bonds?  All currencies are an illusion, gold and oil are real.

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in two words: Henry Kissinger

https://www.bloomberg.com/news/features/2016-05-30/the-untold-story-behind-saudi-arabia-s-41-year-u-s-debt-secret

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18 hours ago, wrs said:

Let's not forget the Petrodollar recycling of US Treasuries by KSA which was the lynchpin for a long time.  The problem for China is that they only have their sweatshop to trade on, what do they produce otherwise?  What is the RMB based on?  The Euro is even worse, it's backed by no ability to tax and spend at all, it's just a bureaucratic invention.  Who will pay back Euro bonds?  All currencies are an illusion, gold and oil are real.

I disagree with your view on the RMB and the EURO.

China has the third largest GDP in the world with 16,1 % (2019 estim.) after Europe with 16.3% (2018) and USA with 25,1 % (2019 estim.). Growth of Chinese GDP is much higher than US, ca 6% compared to ca. 2.5 % in US. China is the largest purchaser of crude oil in the world. http://statisticstimes.com/economy/projected-world-gdp-ranking.php

What is the RMB based on ? What is the USD based on ?

19,2 TUSD national US debt, tendency strongly growing. China is the largest lender to USA. The ratio of US national debt to GDP was 109,5% in 2018. Chinese national debt was 5.2 TUSD in 2018, a ratio of national debt to GDP of 54,4% only.

http://worldpopulationreview.com/countries/countries-by-national-debt/

 

China had 3,1 TUSD foreign exchange reserves (June 2019), USA had 0,13 TUSD foreign exchange reserves only (January 2019).

https://en.wikipedia.org/wiki/List_of_countries_by_foreign-exchange_reserves

 

Eurobonds, like any bond in any other currency, have to be payed back by the debtor, e.g. state or company. Like with any debt the creditworthiness of the debtor is relevant. The European central bank does not emit any bonds.

By the way the Euro is the second largest reserve currency in the world. The RMB is member of the global reserve currencies since 2 years only, currently number five, with a CAGR of its share of 40% over the last two years.

 

I fully agree with you that assets (e.g. real estate, gold) are much better than money. The value of the latter is based on a social promise only.

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