Re: [OPE-L] Boneheads, Iraq and the Artificial Dollar

From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Sat Feb 25 2006 - 11:58:25 EST

Dear Hans,

Perhaps  the  important issue is not the pricing of oil in dollars in itself.
I think your post underlines just that.

The real issue may be foreign-currency reserves, though
this too may prove to be a red herring.

Selling its Treasury debt into the foreign exchange market,
the US relies on most reserves being held into dollars. Should
Venezuela, Iran and ultimately China break away  and create a
real worldwide flight of foreign exchange
reserves from the dollar into the euro, that would probably
depress the value of the dollar. Already OPEC has already substantially
reduced its dollar holdings.

With ever reduced foreign exchange dollar holdings the US Treasury
will have to sell debt into a smaller international supply of dollars.
The dollar would weaken, no?

The US probably takes Venezuela's and Iran's intentions to
price oil in euros as a declaration of war  because
that decision serves as a prelude to a drastic downsizing of dollars
in their foreign exchange reserves. And with the US is quite vulnerable
given the size of its deficits.

But just what advantage the US government and financial system
receive from the preponderance of dollars in foreign exchange reserves
and just what the US has to lose from further diversification have
to be quantified. And I don't know of any analysis which does that.

Yours, Rakesh

>------- Start of forwarded message -------
>From: "Hans G. Ehrbar" <>
>Date: Mon, 20 Feb 2006 12:43:51 -0700
>The bonehead article gives the following quote:
>>  If other nations have to hoard dollars to buy oil, then they
>>  want to use that hoard for other trading too. This fact
>>  gives America a huge trading advantage and helps make it the
>>  dominant economy in the world."
>and tries to refute it with the argument that the
>transactions costs are so minimal that nobody has to hoard
>dollars to buy oil, and that it is also irrelevant
>for the other trading whether the reserves are kept
>in dollars or in other currencies.
>My response: it is true that nobody *has* to keep their
>hoards (foreign currency reserves) denominated in dollars;
>they could, with only a minimal additional cost, also keep
>it in other currencies (and China and Venezuela have
>recently started to do just that).  But it is a matter of
>fact that most countries *do* hold their reserves in
>dollars: not because they are forced to do so by stringent
>economic incentives, but because it is a little more
>convenient and buys a little more security against military
>aggression by the US (and perhaps there is some
>behind-the-scenes diplomatic prodding too).  And since
>every nation is keeping large dollar hoards, the dollar becomes
>the logical choice for settling payments when imports and
>exports do not quite match etc.  This, in turn, allows the
>US to acquire considerable amounts of real wealth by issuing
>paper dollars.  In other words, small causes have large
>effects because these small causes act as a signal
>coordinating everybody's activity.
>- --
>Hans G. Ehrbar
>Economics Department, University of Utah     (801) 581 7797 (my office)
>1645 Campus Center Dr., Rm 308               (801) 581 7481 (econ office)
>Salt Lake City    UT 84112-9300              (801) 585 5649 (FAX)
>------- End of forwarded message -------

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