Hey Everybody,
I have a great question from a reader to share with you, dealing with last week's article on the relationship between oil and the U.S. Dollar. If I didn't get to your question this week, don't worry, I'll get to it soon. Keep 'em coming. Let's get to it!
Q) Thanks for your informative article, but I'd like to ask, why have the oil producing countries been reluctant to switch from the dollar as the trading currency despite this loss of value to a more stable currency like the euro? Also some countries including China have been threatening for quite some time now to scale their USD holdings to euro, but they are not doing it. What's the big deal? If they did this the dollar would greatly appreciate.
Ed Ponsi) Thank you for your question. Actually, if China and the oil producing countries move away from the USD, this would accelerate the U.S. currency's decline. Imagine that you own tens of millions of shares of a stock that just keeps declining in value. You want to sell your shares, but you are concerned because if you begin to sell in large quantity, you will drive the price lower due to the size of your position. Also, if the market catches wind that a large seller is dumping shares, other traders will sell their shares, possibly causing the stock to collapse.
This is similar to the situation that many countries now find themselves in regarding the greenback. Many of the oil producing countries are flush with U.S. Dollars, which the U.S. has sent to them in return for their oil. China holds over 1.3 trillion dollars worth of foreign reserves, most of it in U.S. Dollar denominated assets. These countries dislike the fact that the USD keeps falling, but they are caught between a rock and a hard place – if they sell in meaningful quantity, they will depress the dollar even further, and lower the value of their holdings. Also, many of the Middle Eastern currencies, such as the Saudi Riyal, the United Arab Emirates Dirham, and the Jordanian Dinar, are pegged to or closely mimic the U.S. Dollar. So if panic selling occurs in the U.S. Dollar, these currencies will suffer as well.
In fact, while the Saudis have made it a point not to emphasize the weakness of the U.S. currency, other world leaders less friendly to the U.S. are laughing with glee at the demise of the dollar. The only OPEC countries that have officially endorsed moving away from accepting U.S. Dollars in exchange for oil are Venezuela and Iran – not exactly good friends of the United States. Iran's Ahmadinejad, who in the past has called the dollar a "worthless piece of paper," and Venezuela's Chavez want to dump the USD in part because it would injure the currency further, thus damaging the prestige and power of the U.S. If that is not a reason for the United States to protect the value of its currency, I don't know what is.
