Oil economics, the US, and Iran
or, An economics primer for kevvyd
Dan posted an article a few days ago that pointed out the possibility that the current American pre-occupation with Iran might have an economic reason. The basic gist of the argument is that the Iranian government is planning to start up a new bourse, or market, for oil later this month, and might sell the oil in euros, not US dollars. Having a geology background and owning a car, I understand something about oil, but the economics of the issue went right by me. So I did some reading and here is what I have managed to tease out for those that are interested.
The root of the discussion really is the maintenance of foreign exchange reserves by most nations, which by and large are in American dollars. My first question was, why does a nation need to hold foreign currency in the first place? The simple answers, the one I looked for, is a purely defensive one. If a company or country decides to make a run on your currency, it is wise to have some foreign funds, which we hope are not being simultaneously devalued, to buy up your currency and temporarily "float" it until the heat is off. Then, during the good times between currency attacks, you simply stockpile some foreign currency for the next attack. But which currency to buy? Generally speaking, the currency that you trade in the most internationally is the one that could cost you the most in a devaluation struggle, so that's the one you hold. Also, since you're using it to buy stuff anyway, it's good policy to have some of it lying around.
Now, to oil. Since 1972, oil has been sold internationally in US dollars. As even George Bush seems to know, the use and purchase of oil is critical to all developed and most developing nations. Since oil underpins many economies, it makes sense that a devaluation crisis between your currency and the American dollar would be unhealthy for you, because you gotta have that black love, so the US dollar is by far the most commonly-held foreign currency in the world. In a sense, oil has become the new gold since the collapse of Bretton Woods in 1971.
The massive investment by the international community in US-dollar assets allows the US to run a huge trade deficit without putting at risk the stability of its currency. If oil were to suddenly start to trade in another currency, say the euro, countries would be forced to protect themselves against the euro as they are currently doing the US dollar. This would drain investments from the US dollar into euros and result in its devaluation due to decreased demand. The US might well find themselves in the situation of having to transfer assets into euros then in order to protect their currency, and buy oil, and a nasty cycle develops.
Nasty enough to go to war, or the edge thereof? Maybe. The US went to war with Iraq, the only country to dare sell oil in euros, and then two months after taking Bagdhad, converted the sale of Iraqi oil back to dollars. This, perhaps is a strong argument as to how seriously they take this.
The question then becomes, "how likely is an Iranian bourse to succeed?" This is open to discussion, but the stability and oil reserves required to run a successful oil bourse might not be present in Iran, and the New York and London exchanges are too well established. Or so is the argument presented here. However, if other oil-producing nations decide to sell only through an Iranian bourse, who really knows?
If nothing else, it makes the Iranian crisis potentially more consequential.
If anyone knows anything about this topic, please comment. This is pretty interesting stuff and extremely important, and my grasp of economics is somewhat, uh, loose, shall we say.
Dan posted an article a few days ago that pointed out the possibility that the current American pre-occupation with Iran might have an economic reason. The basic gist of the argument is that the Iranian government is planning to start up a new bourse, or market, for oil later this month, and might sell the oil in euros, not US dollars. Having a geology background and owning a car, I understand something about oil, but the economics of the issue went right by me. So I did some reading and here is what I have managed to tease out for those that are interested.
The root of the discussion really is the maintenance of foreign exchange reserves by most nations, which by and large are in American dollars. My first question was, why does a nation need to hold foreign currency in the first place? The simple answers, the one I looked for, is a purely defensive one. If a company or country decides to make a run on your currency, it is wise to have some foreign funds, which we hope are not being simultaneously devalued, to buy up your currency and temporarily "float" it until the heat is off. Then, during the good times between currency attacks, you simply stockpile some foreign currency for the next attack. But which currency to buy? Generally speaking, the currency that you trade in the most internationally is the one that could cost you the most in a devaluation struggle, so that's the one you hold. Also, since you're using it to buy stuff anyway, it's good policy to have some of it lying around.
Now, to oil. Since 1972, oil has been sold internationally in US dollars. As even George Bush seems to know, the use and purchase of oil is critical to all developed and most developing nations. Since oil underpins many economies, it makes sense that a devaluation crisis between your currency and the American dollar would be unhealthy for you, because you gotta have that black love, so the US dollar is by far the most commonly-held foreign currency in the world. In a sense, oil has become the new gold since the collapse of Bretton Woods in 1971.
The massive investment by the international community in US-dollar assets allows the US to run a huge trade deficit without putting at risk the stability of its currency. If oil were to suddenly start to trade in another currency, say the euro, countries would be forced to protect themselves against the euro as they are currently doing the US dollar. This would drain investments from the US dollar into euros and result in its devaluation due to decreased demand. The US might well find themselves in the situation of having to transfer assets into euros then in order to protect their currency, and buy oil, and a nasty cycle develops.
Nasty enough to go to war, or the edge thereof? Maybe. The US went to war with Iraq, the only country to dare sell oil in euros, and then two months after taking Bagdhad, converted the sale of Iraqi oil back to dollars. This, perhaps is a strong argument as to how seriously they take this.
The question then becomes, "how likely is an Iranian bourse to succeed?" This is open to discussion, but the stability and oil reserves required to run a successful oil bourse might not be present in Iran, and the New York and London exchanges are too well established. Or so is the argument presented here. However, if other oil-producing nations decide to sell only through an Iranian bourse, who really knows?
If nothing else, it makes the Iranian crisis potentially more consequential.
If anyone knows anything about this topic, please comment. This is pretty interesting stuff and extremely important, and my grasp of economics is somewhat, uh, loose, shall we say.
Well, IIRC, isn't Venezuela one of the OPEC nations? They might have reasons to go with Iraq on this one. The major kicker is what happens over the next few years with Saudi Arabia - if the House of Saud falls, and a Islamic theocracy takes over, the U.S. could be in trouble - especially since Bush just went to Congress to have the U.S. debt limit raised.
Posted by
Dan |
Mon Mar 06, 05:24:00 PM
Venezuela might very well be interested. I found that the DailyKos article I cited had rational arguments against the establishment or success of a Bourse, but it didn't take into account that some countries would sign up just for political reasons.
This is really a sticky wicket. It's hard to see the Americans cutting a deal with Iran, but it might be the only option aside from a war that they can't afford to fight.
Posted by
kevvyd |
Mon Mar 06, 05:39:00 PM
Well, not really related, but kinda, is Andrew Sullivan's latest column in Time, where he says one of the errors the Neocons made in Iraq was underestimating the degree of resentment in the rest of the world of American hegemony, which I think is the same error the article writer makes - he's assuming that other countries will just go along with the dominance of the American dollar in the oil market. Considering that Eurospace is talking about putting up a Satellite system to rival the U.S.'s GPS system, the EU may very well decide to take the risk
Posted by
Dan |
Mon Mar 06, 06:18:00 PM
I don't think that the European Union would actually go for the euro as a world standard, at least not for a while. The ramifications of the economic instability that would result from dropping the US dollar will last for years, and might not be good for anyone.
Posted by
kevvyd |
Mon Mar 06, 07:24:00 PM
Oh it's way more than pensions and investments, Paul; it's everything. The price of just about everything in Canada is contingent upon the relationship of the Canadian and US dollars. God knows what will actually happen, but it's safe to say that our economy sinks or swims with the American's.
If this were to lead to an international move away from the American dollar to something else, I dread to think what would happen to the US, and by extension us. I might come off like Chicken Little here, but we might be looking at something like the collapse of the Soviet bloc in scale, I dunno.
That's why I want people that know about this stuff to chime in - I'm really interested in the mechanisms at work and kind of freaked by the possibilities.
Posted by
kevvyd |
Mon Mar 06, 10:33:00 PM