Krugman on petrodollar and euros

From: Rakesh Bhandari (rakeshb@STANFORD.EDU)
Date: Thu Jul 29 2004 - 16:04:15 EDT

Here's Krugman's refutation that Cyrus, Paolo Giusanni and others
have found persuasive.
Yours, RB


I've been getting a number of emails from people suggesting to me
that this impending war is all about money - specifically, to ensure
that the dollar, and not the euro, remains the world's #1 currency.
The idea is that the US economy will be in danger if OPEC members
start demanding payment in euros rather than dollars.

With respect to my correspondents, this isn't a plausible argument.
It's politically implausible  - who, exactly, in this administration
is supposed to be thinking about the role of the dollar as a key
currency? The same people who invited the author of The Bible Code to
brief the Pentagon? And anyway, the economics are wrong.

Remember the three roles of money: medium of exchange, unit of
account, store of value. The dollar plays all three roles to some
extent on world markets. It's a medium of exchange: people converting
Brazilian reais to Malaysian ringgits (or rather banks making trades
in the FX market) normally do so through two transactions against the
dollar. It's a unit of account: although most world prices are set in
other currencies, the share of prices in both financial and goods
markets specified in dollars is larger than you would expect from the
raw economic weight of the United States. And the dollar is a store
of value: the Fed estimates that about 60 percent of US currency  -
that is, actual pieces of green paper - is held outside the US.

But why does all this matter? Does it give the US a special advantage
in the world? Well, yes - but not nearly as big an advantage as
people imagine. And a change in how OPEC gets paid would make very
little difference.

The US advantage comes to the extent - and only to the extent - that
the international role of the dollar lets us borrow money more
cheaply than we otherwise could. One component of that is clear:
because foreigners hold a lot of dollar bills, which pay no interest,
we in effect get a free loan of that much money.

Dollar-denominated bank accounts also provide a bit of an
interest-free loan, because they are ultimately backed by deposits at
the Federal Reserve. But most of the accounts held by foreigners have
very fractional backing - they're typically eurodollar accounts,
which are only partly backed by accounts in the US, which are in turn
only partly backed by deposits.

It's also possible that even our interest-bearing debt commands a
better price - i.e., a lower interest rate - because of the dollar's
special role. But there doesn't seem to be any evidence of that, and
it's not likely to be more than marginal. (Also, the US isn't the
only country that can issue dollar-denominated bonds.)

So the main thing is cash overseas - $300-350 billion of bills,
mostly in large denominations, hidden under beds, being transferred
among criminals, etc.. At an interest rate of 4 percent - say that's
a normal rate - this is a subsidy to the US of $12-14 billion per
year. Small change, for a $10 trillion economy. It's not even a
significant part of our current account deficit.

Moreover, would a change in OPEC settlements really affect this?

There's probably some link between the dollar's role as unit of
account/medium of exchange and its role as store of value. But when
we say that Saudi Arabia is paid in dollars, what we mean is that oil
is paid for with a wire transfer from a London bank, with the sum
denominated in dollars. It doesn't mean that green pieces of paper
change hands, or even that there is a stash of green paper somewhere
being held to back the transaction. What really matters for the cash
held overseas is which currency people who don't trust their native
currencies think is a good bet. Rumor has it that the Russian mafiya
is switching to euros, since Europe is where ill-gotten Russian gains
get banked or spent; if so, that's a much bigger deal for seignorage
than pricing of Persian Gulf oil.

So this particular conspiracy theory is wrong. Sorry.

Of course, you may well ask, why then are these people so determined
to have their war? The answer is because. Just because.

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