Pricing oil in dollars

By Thomas Lifson

Hugo Chavez and Mahmoud Ahmedinejad, neither of whom has ever demonstrated much economic sophistication, contended at the recent OPEC Summit that the weak dollar is at the root of high oil prices.

"The dollar is in free fall, everyone should be worried about it," Mr. Chávez told reporters here. "The fall of the dollar is not the fall of the dollar - it's the fall of the American empire."

During a news conference after the meeting, Mr. Ahmadinejad added: "The U.S. dollar has no economic value."

While it is true that when the dollar declines relative to the euro and other currencies oil prices in dollars rise faster than in those other currencies, prices are determined by supply and demand. A move to price oil in terms of a market basket of other currencies or in euros would not in itself affect the price of oil.

Anti-Chavez Venezuelan blogger Miguel aptly summarizes the real issue:

What really matters then, is what countries do with money received from their oil exports. There are two very simple examples to this:

Case 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).

Thus, 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.

What 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 recent decline in the value of the dollar seems to have unnerved some Americans and emboldened less economically sophisticated enemies, but it is a boon for American exporters, and underlies our continuing economic strength.