Death of the Petrodollar?

[boneyard bill]

As a result of the Russian annexation of Crimea, the US threatened Russia with economic sanctions. Putin responded by threatening to bring down the US dollar. So far Western sanctions have been trivial, but Putin appears to be proceeding apace with his response, and it doesn't look trivial at all.

On the heels of Russia's potential "holy grail" gas deal with China, the news of a Russia-Iran oil "barter" deal, it appears the US is starting to get very concerned about its almighty Petrodollar

Russia seems perfectly happy to telegraph that it is just as willing to use barter (and "heaven forbid" gold) and shortly other "regional" currencies, as it is to use the US Dollar, hardly the intended outcome of the western blocakde, which appears to have just backfired and further impacted the untouchable status of the Petrodollar.

The existence of “petrodollars” is one of the pillars of America's economic might because it creates a significant external demand for American currency, allowing the US to accumulate enormous debts without defaulting. If a Japanese buyer want to buy a barrel of Saudi oil, he has to pay in dollars even if no American oil company ever touches the said barrel. Dollar has held a dominant position in global trading for such a long time that even Gazprom's natural gas contracts for Europe are priced and paid for in US dollars. Until recently, a significant part of EU-China trade had been priced in dollars.

As a result of WW II, most of the monetary gold in the world had ended up in the US. As a result, the major industrial powers forged the Bretton Woods Agreement, which provided that the US dollar would be backed by gold, but other countries would back their currencies with the dollar. (This agreement only applied to central banks because the US had left the gold standard domestically in 1933).

But in 1971, the US was faced with a run on gold. After a couple of de-valuations had failed to stop the run, the US opted to let the dollar float. The original intent, apparently, was to return to the gold standard at the point where the price of gold leveled off. It never leveled off, however. It just kept going up. (Eventually it would peak at $850 in the late seventies). But the question arose of just how long foreign central banks would continue to hold dollars if they couldn't be redeemed for gold. If they chose to spend those dollars, the dollar could plummet on international markets and send the cost of imports sky-high. So, in 1973, Nixon reached an agreement with Saudi Arabia to accept only dollars for its oil in exchange for US guarantees of Saudi security. The deal was later extended to other OPEC countries. This was the birth of the petrodollar. (It also explains why we went into the Gulf War. Saddam wasn't an "aggressor" when he fought a war with Iran, which wasn't a member of OPEC, but he was when he attacked Kuwait and threatened Saudi Arabia).

Consequently, demand for dollars on the international market would remain high because they were needed to buy oil.

However, in 1973, Saudi Arabia was the world's largest oil producer. Now, Saudi Arabian production is down, and Russia leads the world in oil production. Moreover, the proposed deal with Iran would add 500,000 barrels a day to the Russian production, and Russia now seems prepared to sell this oil on the world market for any reasonable currency.

If you don't need dollars to buy oil is there any reason to hold dollars at all? Certainly, the low interest rate on US Treasury bonds doesn't provide much of an incentive to invest the money there.

This might not bring down the petrodollar all by itself but other questions remain.

It can be said that the US sanctions have opened a Pandora's box of troubles for the American currency. The Russian retaliation will surely be unpleasant for Washington, but what happens if other oil producers and consumers decide to follow the example set by Russia? During the last month, China opened two centers to process yuan-denominated trade flows, one in London and one in Frankfurt. Are the Chinese preparing a similar move against the greenback? We'll soon find out.

http://www.zerohedge.com/news/2014-04-04/us-threatens-russia-sanctions-over-petrodollar-busting-deal

The prospect that other countries might follow suit and accept other currencies for their oil could de-throne the petro-dollar altogether. China could also play a major role. Unlike Russia, which has everything to gain and little to lose by the fall of the petrodollar, China has to worry about causing a depression in its leading export market. The Chinese are also the largest holders of US debt so the fall of the dollar would also suppress the value of their holdings.

On the other hand, China has been a leader in seeking alternatives to the dollar by opening up currency swap agreements with other countries. Such agreements by-pass the dollar in currency exchange settlements.

From the Chinese point of view, it may be a bit early to try to bring down the dollar, but it is on their agenda so they might decide to strike while the iron is hot and join the Russians in this effort. The only barrier would appear to be the lack of a market exchange mechanism, but Russia is building one and China already has one.

If the dollar falls, import prices would increase substantially, and the US would have an even more difficult time selling its debt overseas. The Fed could buy the debt, but that would cause even more inflation. So rising interest rates would probably also be a necessity. Ultimately, the solution might be for the US government to default on its debt which is usually the result of borrow and spend policies in any case. The petrodollar has just enabled us to get away with such a policy for much longer than normal.

 

[laughing dog]

Putin's threat is laughable. The Russian economy is much closer to a meltdown than the US's. Anything Putin tries to bring the dollar down would destroy what's left of his economy. Like it or not, the USA is still the largest economic power in the world today, and is likely to stay that way from some time.

 

[boneyard bill]

Putin's threat is laughable. The Russian economy is much closer to a meltdown than the US's. Anything Putin tries to bring the dollar down would destroy what's left of his economy. Like it or not, the USA is still the largest economic power in the world today, and is likely to stay that way from some time.

Definitely a head-in-the sand approach. The dollar's role as the reserve currency has been in a steady decline even without being pushed. Russia's economy is largely dependent on exports of oil, gas, and high-tech weaponry. Good luck getting anyone to boycott their oil and gas, and, humanity being what it is, weapons have always been highly desired.

But what happens if all those countries holding US dollars start to spend them instead? There are as many dollars overseas as in the US. The dollar would decline significantly on the international market and the price of imports would spike upward. There would be no corresponding increase in wages so the US standard of living would decline. Meanwhile, we would have a hard time borrowing money to fund our deficits so there would have to be massive spending cuts or massive tax increases or both. Indeed, it's even possible that we wouldn't even be able to roll over existing debt. In that case we would probably have to default.

 

[laughing dog]

Definitely a head-in-the sand approach. The dollar's role as the reserve currency has been in a steady decline even without being pushed. Russia's economy is largely dependent on exports of oil, gas, and high-tech weaponry. Good luck getting anyone to boycott their oil and gas, and, humanity being what it is, weapons have always been highly desired.

You've been peddling this chicken little "sky is falling" nonsense for years, and none of the predicted dire consequences occur.

But what happens if all those countries holding US dollars start to spend them instead? There are as many dollars overseas as in the US. The dollar would decline significantly on the international market and the price of imports would spike upward. There would be no corresponding increase in wages so the US standard of living would decline. Meanwhile, we would have a hard time borrowing money to fund our deficits so there would have to be massive spending cuts or massive tax increases or both. Indeed, it's even possible that we wouldn't even be able to roll over existing debt. In that case we would probably have to default.

If all those countries holding US dollars started to spend them on US exports, then your analysis falls apart. But then again, it all those foreign holders of US dollars have never tried to "spend" them all at once nor is there any reason to suspect that will occur in during our life times, so your "sky is falling" prediction is unconvincing.

 

[boneyard bill]

You've been peddling this chicken little "sky is falling" nonsense for years, and none of the predicted dire consequences occur.
If all those countries holding US dollars started to spend them on US exports, then your analysis falls apart. But then again, it all those foreign holders of US dollars have never tried to "spend" them all at once nor is there any reason to suspect that will occur in during our life times, so your "sky is falling" prediction is unconvincing.

As usual you have mis-stated my claim. I claimed, even before Obama was re-elected, that we would have another major downturn "within the next presidential term." So there are really several years yet for this to come true. I did not predict that such a downturn would include the collapse of the dollar although I contended that that was a possibility.

Nothing that has happened so far would lead me to change that point of view. If anything, the fundamentals have gotten worse.

While I felt that there was time to save the dollar and still think there might be time to do that, there have simply been no efforts to do so. Everything we have done has made matters worse, and there does not appear to be any political will to tackle the problem. Both Washington and New York seem content to run out the clock and hope it doesn't happen on their watch.

The fear isn't that these countries will spend their dollars in the US. We don't have anything they want. The will spend them in other countries until nobody wants all those dollars, and it will drive the dollar down on international markets.

It's not that the dollar hasn't been getting weaker all along. It's just more or less a race to the bottom so far. Other countries have inflated their currencies as well. But if those reserve dollars get into circulation, it could drive the dollar far below our competitors.

 

[laughing dog]

As usual you have mis-stated my claim. I claimed, even before Obama was re-elected, that we would have another major downturn "within the next presidential term." So there are really several years yet for this to come true. I did not predict that such a downturn would include the collapse of the dollar although I contended that that was a possibility.....

Your predictions predate Obama's initial election. All of your fear-based predictions have yet to pan out. That suggests your fears are typically unfounded.

 

[boneyard bill]

Your predictions predate Obama's initial election. All of your fear-based predictions have yet to pan out. That suggests your fears are typically unfounded.

So you're claiming that I predicted another meltdown before the first meltdown occurred?

 

[laughing dog]

So you're claiming that I predicted another meltdown before the first meltdown occurred?

Another example of your wishful thinking. You make false dire predictions.

 

[wufwugy]

The petrodollar theory is specious. The USD strength doesn't come from petro but from the US economy as a whole. The debt issue has little to do with investment choices of other countries, and most everything to do with poor NGDP growth and too high of costs for some social programs. A weaker USD would likely be a boon to the US anyways. If the petrodollar is anything, it's probably the US subsidizing stability for the globe, just like the military does

 

[boneyard bill]

The petrodollar theory is specious. The USD strength doesn't come from petro but from the US economy as a whole. The debt issue has little to do with investment choices of other countries, and most everything to do with poor NGDP growth and too high of costs for some social programs. A weaker USD would likely be a boon to the US anyways. If the petrodollar is anything, it's probably the US subsidizing stability for the globe, just like the military does

I don't know where you get this from. If foreign countries do not need dollars to buy oil, why should they hold them? The interest rate on US Treasuries is virtually zero when you adjust for inflation, so there are better things they can do with those dollars - like spend them. The petrodollar is the world's reserve currency because it is a petrodollar.

The US economy is very weak. How can it sustain the dollar? If the dollar is based on the US economy, it should fall. And certainly, the debt issue is an issue if other countries don't expect that they will get paid back.

One simple example. China has ceased to buy new US debt, but she continues to roll over existing debt. In addition to new debt of $1 trillion a year, we also have to re-finance $3 trillion of old debt. What if China refused to re-finance that debt? We would be in a world of shit. We're still dependent on China and Japan (mostly) to keep re-financing our old debt.

So all of things are most definitely relevant.

A declining dollar would hurt the US economy seriously. It doesn't do much to improve the balance of trade, but that is a different argument.

 

[wufwugy]

I don't know where you get this from. If foreign countries do not need dollars to buy oil, why should they hold them? The interest rate on US Treasuries is virtually zero when you adjust for inflation, so there are better things they can do with those dollars - like spend them. The petrodollar is the world's reserve currency because it is a petrodollar.

The US economy is very weak. How can it sustain the dollar? If the dollar is based on the US economy, it should fall. And certainly, the debt issue is an issue if other countries don't expect that they will get paid back.

One simple example. China has ceased to buy new US debt, but she continues to roll over existing debt. In addition to new debt of $1 trillion a year, we also have to re-finance $3 trillion of old debt. What if China refused to re-finance that debt? We would be in a world of shit. We're still dependent on China and Japan (mostly) to keep re-financing our old debt.

So all of things are most definitely relevant.

A declining dollar would hurt the US economy seriously. It doesn't do much to improve the balance of trade, but that is a different argument.

The US economy isn't weak relative to others. The combined size and strength makes it the safest investment by a lot. Foreign interests like holding USD for that reason regardless of any petro affiliation

China would suffer far more by not refinancing than the US. Capital floods to the US for reasons like this. The US economy is still the top dog by a lot. The EU is in crisis because it doesn't have fiscal unity, and China has even worse problems. The US has enough size and unity that it can basically shrug off any sort of feasible "economic warfare" that another country might engage in. But again, they won't engage in any because it would hurt them significantly more

Perhaps what makes the US look so bad to you is you're holding it up against an ideal. Compared to an ideal economy, of course it looks weak. But fortunately for us, the economy doesn't so much get its strength from relation to an ideal, but relation to other economies. The dollar will only begin being an unattractive investment when there's another country that boasts the sort of economic unity and utility that the US does. So far, none come close. Perhaps in the latter half of the century this will become an issue, as the EU may become a federation or China may have high enough per capita living standards to make the US government no longer the safest investment

 

[boneyard bill]

The US economy isn't weak relative to others. The combined size and strength makes it the safest investment by a lot. Foreign interests like holding USD for that reason regardless of any petro affiliation

China would suffer far more by not refinancing than the US. Capital floods to the US for reasons like this. The US economy is still the top dog by a lot. The EU is in crisis because it doesn't have fiscal unity, and China has even worse problems. The US has enough size and unity that it can basically shrug off any sort of feasible "economic warfare" that another country might engage in. But again, they won't engage in any because it would hurt them significantly more

Perhaps what makes the US look so bad to you is you're holding it up against an ideal. Compared to an ideal economy, of course it looks weak. But fortunately for us, the economy doesn't so much get its strength from relation to an ideal, but relation to other economies. The dollar will only begin being an unattractive investment when there's another country that boasts the sort of economic unity and utility that the US does. So far, none come close. Perhaps in the latter half of the century this will become an issue, as the EU may become a federation or China may have high enough per capita living standards to make the US government no longer the safest investment

The fundamentals of the US economy are weak. Much weaker than the EU. If we were in the EU, we would be one of the PIIGS. Our dollar is weak and getting weaker. Yes, the Economic Stabilization Fund in Washington, D.C. is able to prop it up for the moment, but how long is very uncertain.

I'm not suggesting that China would wage economic war on the dollar. I was just pointing out how perilous the dollar is. If China decides she doesn't want to buy any more US debt, it will likely be because others have decided not to as well. Since we have to borrow overseas just to maintain the debt, we are very vulnerable.

It's the same with nations as with individuals. Lots of individuals have decided that no currency is any good and neither is a security that is denominated in those currencies so they buy gold as the ultimate hedge. A lot of people still don't believe that but the number that do is growing. If you reach a critical point, gold will skyrocket. The dollar is in the same situation. Foreign nations holding dollars could easily decide to convert them into hard assets i.e. spend them. If they don't need them to buy oil, there is no need to hold them, and the strength of the US economy is cold comfort for those who do.

 

[funinspace]

Note: I am not backing the idea of the Petro dollar crashin-n-burnin next month or year.

I do agree with laughing dog, in that Russia is not an economic threat to the US. However, the era of the US having the highest GDP is nearing an end over the next few years to maybe a decade depending on what one thinks of China’s numbers. The below sounds reasonable enough, in projecting that China will take the mantle in 2019, during the term of the next President.
http://www.economist.com/blogs/graphicdetail/2013/11/chinese-and-american-gdp-forecasts

Given where things now stand, what would have to happen over the rest of the decade for our original forecast to come true? By our calculations, growth would have to average almost 7.1% in China until the end of the decade. In America, it would have to average 2.4%. Over the same period, inflation would need to be 4% a year in China and just over 1.4% in America. Finally, the yuan would have to appreciate by almost 2.9% a year on average against the dollar. With that combination of assumptions, China would overtake America in 2019, as originally projected.

Eventually, China’s economy along with other parts of Asia, will get big enough that there will be less interest and attraction to the US. Whether that will be in a decade or 25 years I have no idea. Whether the economic shift will be dramatic or a slow creep I have no idea. If the world slips into a full depression, the dynamics could shift more rapidly. The US GDP surpassed the UK GDP around 1870, and the British Empires GDP during WWI. Yet, it wasn’t until the middle of WWII that the world probably figured out that the US was the top dog.

 

[ksen]

Wouldn't a cheaper dollar help our trade balance as well as make it possible to pay down debt with cheaper dollars?

 

[Tom Sawyer]

Wouldn't a cheaper dollar help our trade balance as well as make it possible to pay down debt with cheaper dollars?

It would be nice to pull an Argentina and then pay off the Chinese by giving them a two-for-one coupon at a local McDonalds.

 

[arkirk]

I don't know where you get this from. If foreign countries do not need dollars to buy oil, why should they hold them? The interest rate on US Treasuries is virtually zero when you adjust for inflation, so there are better things they can do with those dollars - like spend them. The petrodollar is the world's reserve currency because it is a petrodollar.

The US economy is very weak. How can it sustain the dollar? If the dollar is based on the US economy, it should fall. And certainly, the debt issue is an issue if other countries don't expect that they will get paid back.

One simple example. China has ceased to buy new US debt, but she continues to roll over existing debt. In addition to new debt of $1 trillion a year, we also have to re-finance $3 trillion of old debt. What if China refused to re-finance that debt? We would be in a world of shit. We're still dependent on China and Japan (mostly) to keep re-financing our old debt.

So all of things are most definitely relevant.

A declining dollar would hurt the US economy seriously. It doesn't do much to improve the balance of trade, but that is a different argument.

We have had ample warning that Petro anything isn't going to be in the future...if we have one at all. You can get a jittery about the details of the death of the Petro driven economy, and point fingers to your heart's content. The capitalists are all over the place...Russia, the U.S., etc. They have ridden this resource to all sorts of unlikely places and endangered our future with their infantile antics to a point where the latest news is no longer news at all...more like simply the daily tragedy for millions of people.

The answer however is not to prop up this Petro monopoly on our society but to undo it. My feeling is that the petrochemical industry has built its own demise and with it, the demise possibly of millions of people relying on food produced largely by petrochemical means. Societies all over the world have been utterly at the mercy of the petrochemical industry for everything from food to jobs to housing to law and order. At the same time, this life giving industry has been destroying huge swaths of our environment to keep itself in control. These destroyed portions of our earth could have been resources we could use to pull ourselves out of our Petro hole by our bootstraps, but in today's world, they are often hopelessly polluted with very persistent industrial contaminants. This was a major concern of Norman Cousins while he was still alive. The fulminating increase of the presence of these chemicals in our environment (rather than deep within the earth's crust or, in the case of some species, simply not synthesized at all) is a threat that has been little considered by our leaders and those who control commerce. The so-called petrodollar has driven environmental negligence and it is my fear, as it was Norman Cousins,' that we very well may have driven ourselves to a point where recovery will be difficult if not impossible.

Every society when it fails, does so because it did not consider something it was doing was altering the environment in a negative way. Nature keeps every factor in play all the time. I have watched my society bide its time in comfort and indulging in petty conflicts dividing up something that must be abandoned in short order ALL OF MY LIFE. So, needless to say, I do not regret the demise of the petrodollar or its influence on society. I do however feel this demise needs to be met with socially and technologically sound responses. Every day we see massive resources poured into the continuation of the petrodollar economy instead of alternatives that could improve billions of lives.

So far, petrodollars have only helped petrodollar accumulations and not society at large. Those in control of petrodollars so far show no sense of urgency in abandoning the current polluting and socially destructive aspects of their industry and are now engaged in a kind of epic attack on the environment world wide to keep in power.

 

[ksen]

It would be nice to pull an Argentina and then pay off the Chinese by giving them a two-for-one coupon at a local McDonalds.

I was thinking Panda Express but Micky D's works too.

 

[Tom Sawyer]

I was thinking Panda Express but Micky D's works too.

Oh snap, that's much better. Pay off the Chinese government with fake Chinese food. That's just rubbing salt in the wound and makes the insult much worse.

Great idea!

 

[boneyard bill]

Wouldn't a cheaper dollar help our trade balance as well as make it possible to pay down debt with cheaper dollars?

It would help pay our debt with cheaper dollars, but that is exactly the source of it's instability. Who wants to get paid back in cheaper dollars? So the answer is to dump dollars altogether. But that would crash the dollar and produce exactly those cheaper dollars you don't want paid back in. So the natural response would likely be to dump dollars slowly so you get as much back as you can before it crashes. (When I say "dump" dollars" I meant refuse to roll-over existing debt as well as not buying new debt). But, of course, this is an unstable situation. If everyone starts dumping dollars slowly, it adds up to a big dump of dollars and then the avalanche begins as everyone tries to get out.

With respect to our exports, a cheaper dollar will result in more exports measured in dollars. The prices of US products will decline relative to our competitors. But the increase in exports measured in foreign currency might now be so great. For example, if we sell 1,000 cars to Canada at $20,000 per car, and the US and Can. dollar are equal, then we have earned $20 million in foreign exchange (i.e. Canadian dollars), but what happens if the Canadian dollar doubles in value compared to the US? Our cars now cost $10,000 Canadian.

Will still get $20 million in US dollars, but we've only earned $10 million $Can. So we now have to sell twice as many cars to the same $20 million in foreign exchange. So what is the point of exports? It isn't to "produce jobs in America" as many people claim. If that's your objective, why do any foreign trade at all? No. The point of exports is to pay for imports. The point of import is to gain access to cheaper stuff than we can make here.

In addition to that, you have to factor in the higher price of imported raw materials. So that car that we export to Canada won't go decline to $10,000 Canadian. Let's say that the price goes up to $US 24,000 due to the increased cost of raw materials energy because of the dollar devaluation. So now that car would
cost $CAN 12,000. So we would have more than double our sales to Canada to earn as much foreign exchange as we had earned before the devaluation. So it's very problematic that a devaluation would help our balance of trade. I could very well hurt it.

Meanwhile, the cost imports has risen dramatically in the US which would result in the serious decline in the US standard of living.

 

[boneyard bill]

We have had ample warning that Petro anything isn't going to be in the future...if we have one at all. You can get a jittery about the details of the death of the Petro driven economy, and point fingers to your heart's content. The capitalists are all over the place...Russia, the U.S., etc. They have ridden this resource to all sorts of unlikely places and endangered our future with their infantile antics to a point where the latest news is no longer news at all...more like simply the daily tragedy for millions of people.

The answer however is not to prop up this Petro monopoly on our society but to undo it. My feeling is that the petrochemical industry has built its own demise and with it, the demise possibly of millions of people relying on food produced largely by petrochemical means. Societies all over the world have been utterly at the mercy of the petrochemical industry for everything from food to jobs to housing to law and order. At the same time, this life giving industry has been destroying huge swaths of our environment to keep itself in control. These destroyed portions of our earth could have been resources we could use to pull ourselves out of our Petro hole by our bootstraps, but in today's world, they are often hopelessly polluted with very persistent industrial contaminants. This was a major concern of Norman Cousins while he was still alive. The fulminating increase of the presence of these chemicals in our environment (rather than deep within the earth's crust or, in the case of some species, simply not synthesized at all) is a threat that has been little considered by our leaders and those who control commerce. The so-called petrodollar has driven environmental negligence and it is my fear, as it was Norman Cousins,' that we very well may have driven ourselves to a point where recovery will be difficult if not impossible.

Every society when it fails, does so because it did not consider something it was doing was altering the environment in a negative way. Nature keeps every factor in play all the time. I have watched my society bide its time in comfort and indulging in petty conflicts dividing up something that must be abandoned in short order ALL OF MY LIFE. So, needless to say, I do not regret the demise of the petrodollar or its influence on society. I do however feel this demise needs to be met with socially and technologically sound responses. Every day we see massive resources poured into the continuation of the petrodollar economy instead of alternatives that could improve billions of lives.

So far, petrodollars have only helped petrodollar accumulations and not society at large. Those in control of petrodollars so far show no sense of urgency in abandoning the current polluting and socially destructive aspects of their industry and are now engaged in a kind of epic attack on the environment world wide to keep in power.

Perhaps, but the petrodollar has nothing to do with that. The dollar was once backed by gold. Now essentially, it is backed by petroleum because dollars are needed to buy the petroleum. If dollars are no longer needed, the petroleum will still get bought. The petrodollar has nothing to do with oil company profits or the desires and need for petroleum world-wide. That is a completely different issue.

The shift from weak density carbon to high density carbon has been a great boon to the world economically. Without it the world's population would be much smaller and still much poorer. The advantages for humanity have been immense, and there is no alternative any where near as economical or nearly as abundant as oil and gas. This condition isn't going to go away any time soon, and if it did, the alternative would be grinding poverty and back-breaking human manual labor.