Sunday, June 1, 2008

On Dollars and Dinars

50-Cent shoots a video featuring the Euro, the Canadian dollar trades for more than a U$ while oil zooms over $135/barrel. Since the Bretton Woods agreement over 60 years ago tying the value of the U$ to gold and all other currencies to the U$, the USA has been the unquestioned economic superpower. While the gold standard was abandoned, many nations have maintained some kind of peg to the value of the dollar and most of the world's commodities are priced in U$. It's becoming increasing clear however that this policy is adding to other nation's economic problems more that helping. Dollar flight has been underway for much of the decade, but the worst is yet to come.

Most of the world is still priced in dollars, from oil to rice, but the rising cost to other nations is threatening to end this system. From Russia to Kuwait, countries are cutting their ties to the greenback one by one. Why? Quite simply they've lost faith in it's value. Meanwhile the price of importing from other countries has risen, fueling inflationary pressure beyond “acceptable” levels. Russia abandoned it's effort to tie the ruble's movement to the dollar in 2005. The second largest exporter of oil also wants to sell it to Europe priced in euros. The Eurozone is the largest source of imports for OPEC nations, so a nation like Saudi Arabia pays more for, say, French oil equipment which is of course priced in ever more expensive euros. In gulf nations, where the economies are booming due to rising oil prices, they are also forced to cut interest rates in line with US central bank due to the dollar peg, further adding to inflation. I'm sure these countries see the vicious cycle of higher oil prices leading to higher US deficits leading to a weaker dollar leading to higher oil prices, so why do they keep the peg?

On May 21st, 2007 Kuwait cut it's peg to the US buck. One could almost feel the shiver going up the spine of the American economy that is so dependent on oil imports from the region. Remember Bush visiting the Middle East a few months ago to supposedly ask for more oil and to be seen as supporting the Israeli-Palestinian peace process. Well, he was politely refused the oil and the Israelis stepped up their military operations in the occupied territories and tightened it's blockade of Gaza just three days after Bush left Jerusalem. But what he did accomplish was an agreement to maintain the pricing of oil in US dollars, for now. Even with prices spiralling out of control, causing migrant worker riots in Dubai as inflation is at it's highest level in 19 years in the UAE and at 16 year highs in Saudi and Oman they are toeing the line. The question is how long will these countries be happy watching the value of their trillion dollar investment in US Treasuries and securities erode?

It's not hard to see why it's so important for the US to maintain the pricing system in dollars. Let's imagine for a moment a world where prices were in other currencies and currencies such as the Chinese yuan weren't tied to the dollar, something many would like to see change to address the trade deficit. Every day the US needs to borrow to keep running, to fight two losing wars, to buy more oil from the Middle East and buy more Chinese products. Much of this debt is financed by the Chinese and other foreign countries. So while the US is busy printing money and pushing the dollar down, they are driving the growth of China and the Middle East, helping push their currencies higher. This of course in turn makes it more expensive to borrow tomorrow as the comparative values of the foreign currencies and the dollar move in opposite directions. Now, the economic argument would normally be that currency valuations will eventually cause buying behaviour patterns to change, but America is addicted to both oil and Walmart, spelling doom for the economy.

In 1971 the Gold Standard was abandoned, leaving an economic system based on fiat money, where there is no commodity backing up the value of currency, only the faith that people have in its value. Shortly thereafter a deal was struck with the Saudi's to conduct oil transactions only in dollars, thus was born the petrodollar era. If oil suddenly stopped being traded exclusively in US bucks, the dollar would no longer serve as the international currency which would force the US to reduce its trade deficits by becoming an export nation again, something I don't see happening. The route they've chosen is to maintain the system with an iron fist. In September 2000, Saddam Hussein may have sealed his fate by announcing that Iraq was no longer going to conduct oil transactions in dollars. The often delayed Iranian Oil Bourse finally opened in February of this year (despite some cable problems) with petroleum trading for non-dollar currencies, hmmm, I wonder what will happen next?


Michal said...

Most probably we shall see a rapid increase in activity of Iranian terrorists. Needless to say, something will have to be done to fight it. A war, perhaps?