Wednesday, October 12, 2022

The End Of The Dollar's Oil Anchor?

The recent decision by OPEC+ to curtail crude oil production infuriated the United States, since it was engineered by Saudi Arabia and Russia acting in concert.  President Biden announced that "there will be consequences for Saudi Arabia", without going into detail. A serious break in the decades-old close relationship between the US and SA will be a watershed event and a turning point in the global financial/monetary status quo. 

The dollar has been "anchored" to crude oil ever since the FDR-Ibn Saud meeting aboard USS Quincy on Feb. 14, 1945.  Even though the minutes remain sealed to this day, it is obvious that the Saudis agreed to price their crude in US dollars in exchange for a military security guarantee.  This gave the US an enormous advantage: a national currency that became the global reserve currency literally overnight in a world dependent on ever rising oil imports payable only in dollars.

The ability to mint/issue the global reserve currency has been the absolute necessary condition for all empires throughout history.  Athenians had the silver tetradrachm, Romans/Byzantines minted gold aureus and solidus, the Spanish had silver reals, the British gold sovereigns and paper pounds.  These empires ended with massive devaluations of their currency, be it by adulterating their coinage or by allowing their fiat currency to lose purchasing power (ie "print" more than the rest of the world wanted to absorb/use).

If the US decides to break completely with SA, what will happen to the dollar's crude oil anchor? Could the Saudis decide to start pricing their oil in another currency, or a basket of currencies?  It would make sense, anyway, since the US is no longer the world's largest economy - China is now #2 in nominal terms and #1 in purchasing power parity terms.  More importantly, the US is now far behind the EU and China as an oil importer: the EU imports 14 million barrels/day, China 11 mbbl and the US only 6 mbbl.

Just going by this admittedly simple yardstick, crude oil should be priced in a notional currency basket made up of 45% euros, 35% yuan and only 20% dollars.  That would be anathema to the US, of course, and it's not exactly that simple, anyway.  But it provides a guideline, a direction of where things could go - once they get going.

Currency wars may be in our near future. Actually, they are already happening. Just ask the Brits.

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