Archive for November 18th, 2007

Chavez, Ahmadinejah and pricing oil in dollars: Does it really matter?

November 18, 2007

We have all caught the controversy at the OPEC summit as to whether oil
should or not be priced in dollars. The controversy led by the
President of Venezuela and the President of Iran was left out of the
conclusion of the meeting, with Saudi Arabia refusing to consider the
I have actually wondered about this issue
quiet a bit and have read many opinions abut the subject to make sure I
understood it correctly and the answer seems to be that in reality it
matters very little whether oil is priced in one currency or the other
in the medium term, what matters is what currency oil exporting
countries are paid in and what currency they keep the proceeds in.
oil is traded on one currency or another is simply a matter of what has
been traditionally done in pricing the commodity. But the price of the commodity itself
has to do with the relative value of oil for the importers, supply and
demand, and its value is balanced by the movement of currencies. For
the US oil has gone up much more simply because in real terms, while
oil has gone up, Europeans for example, have seen it go up less due to
the appreciation of the euro with respect to the dollar. Traders
instantly go from one currency to another and determine how much a
barrel of oil is worth and that is what really matters.
really matters then, is what countries do with money received from
their oil exports. There are two very simple examples to this:
1) Imagine the oil future markets announces today that all of oil will
begin trading in euros tomorrow. (A difficult proposition, OPEC could
set up an alternate market in euros, but let’s assume the extreme) In
reality, nothing will happen tomorrow, maybe a small psychological
downdraft on the dollar in the currency markets, but oil tomorrow will
begin trading at Friday’s close divided by whatever the euro rate of
exchange is at the opening.
Case 2) Imagine
that the oil exporting countries tomorrow announce that they will get
rid of all of their dollars and convert them to euros. In this case,
the dollar will suffer a huge drop tomorrow, which will have a strong
impact on the price of oil and that impact will be much larger than
changing what the futures markets do in Case 1).
what really matters is what countries that hold the dollar reserves due
to oil exports do with their money. So the proposal the Iranian and
Venezuelan Presidents should have made, but couldn’t because it is none
of their business even if they understood the issue, is that OPEC
countries all decide to hold their international reserves in euros.
is interesting is that both Venezuelan and Iran seem to already have
done that, Chavez claiming it has switched most of Venezuela’s reserves
to euros and Iran reportedly having 85% of its reserves in currencies other than the dollar.
the end, countries should make of this a dynamic process, they should
not be making bets on whether the euro or the Yuan are going to
appreciate or not, that may be trading or close to gambling, but make a
rational evaluation of what the terms of trade for each country’s
economy is. That is, determine the various relationships each country
has in terms of trading partners and investments and then set your
reserves to a basket of currencies that best matches that. In this
manner, if currencies change there is no real economic impact on your
The only real significance in having
oil trade in US dollars that is important to the dollar is that clearly
if you enter into an oil futures contract in dollars, during the life
of that contract, the amount of the contract is locked in to the US
currency. Thus, the amount traded in the oil futures market is in some
sense not available to be switched into euros and thus provides a
temporary stabilizing factor on the value of the US$. You could of
course, also hedge your currency buying a futures contract to preserve
the value of your future in the currency of your country.
in the end, both President Chavez and Ahmadinejah are acting on their
political beliefs and the limited timing they have had as
“President-traders” in which the euro has done nothing but revalue
itself against the US currency since they have been Presidents. But
these things come in swings and the euro may be close to the end of its
run. Simply stated, it is the Asian economies that have become more
important in the world, not Europe. Europe has, in my opinion, economic
problems as important or significant as the US. Unemployment is worse
and its competitiveness vis a vis the US is diminished. Nevertheless,
the euro has revalued quite a bit, while Asian currencies have not
revalued as much because the Government’s of many Asian economies exert
some control on the exchange rate. But that is exactly the way Asian
economies have dealt with the increase in the price of oil: They have
revalued their currencies in order to reduce the impact on internal
inflation of oil imports.
There is additional
evidence that the euro has gone too far. Real State prices in Europe
are really getting out of whack. Apartments in downtown Stockholm go
for 14,000 euros a squared meter, in Madrid its 10,000-14,000 euros per
square meter and in Amsterdam, real state price recently hit its highest level ever adjusted for inflation,
reaching the equivalent value it had in 1736, destroying the myth that
real state always go up in real value and proving the wisdom that in
investments all we know that in the long term, we are all dead.
comparison, I just found in a website an apartment in Park Ave in
Manhattan that came to around US$ 6,000 per square meter, close to
Moscow prices (which are only slightly lower than New York) than to
those of large European cities.
This discrepancy
suggests that while the euro may be going up for little while, this has
little basis on fundamentals and the discrepancy is getting too large
to stay that way.
Thus, the President’s of Iran
and Venezuela, if they really understand the problem, are simply
playing with politics. And in the end, if the euro corrects, they may
be playing with fire, as this will severely undermine the international
reserves of both countries. Curiously, the two countries seem to have
very similar economic problems, perhaps because everything is done in
the name of politics and not on the rationality of economic thinking.