The horizon is not so far as we can see, but as far as we can imagine

What Not Buying Oil With Dollars Means

The big news yesterday on the financial front was the Independent’s claim that Gulf Arabs and France, Japan, Russia and Japan were planning to move from buying oil in dollars to buying it in a basket of currencies, including gold and a new universal currency shared by the Gulf nations.

Buying oil in dollars is one of the foundations of the dollar’s role as the world’s primary reserve currency.  Because the the dollar is the world’s primary reserve currency Americans have been able to borrow money for significantly less than other countries are able to.  This has both made America more prosperous, and through the perverse incentives of cheap money, helped lead to the high indebtedness of American citizens and the financial crisis.

In addition, buying oil in dollars is one of the things which allowed strong dollar policies to drive the price of oil down.  Making dollars extremely scarce in the 80’s and nineties was one key factor leading to a price per barrel under $20.  Oil prices started their rise upwards after Greenspan’s Federal Reserve let loose the money spigot in the Asian crisis and the Long Term Capital fiasco.  Greenspan essentially never took his foot off the pedal from that point onwards, and oil prices soared, until last year at one point they were over $150/barrel.

So one consequence of going off the dollar is that a major benefit of the strong dollar play is taken off the table, and the US loses its ability to control the price of oil.  Since at this time, contrary to what the Feds are saying, a strong dollar play isn’t in the cards (the US needs to borrow way too much money) that’s not a big deal in the short run—in the long run it is.

But buying oil in dollars isn’t the only thing that underpins the dollar as the world’s reserve currency and to understand what buying oil in something other than dollars would mean we need to understand what else makes, or perhaps more accurately, made, the dollar so important.

Technological Revolutions: Remember the internet boom of the nineties?  Remember the way that money flooded in from the rest of the world to buy up internet stocks?  Sure, most of them turned out to be worthless, but some didn’t.  When the US was the nation most likely to create the next technological revolution you needed dollars so that when it occurred you could buy in on the ground floor.  Whether microcomputers in the 80’s or the internet in the 90’s, odds were that America was going to create the next big tech.  So foreigners needed to be in the dollar.

At this point the US is the undisputed leader in almost nothing except military tech.  As expected, US dominance of the arms sales market continues to increase, but the US can’t live on weapon sales alone.  In most other fields, including telecom, the internet, large chunks of biotech, renewable energy, ground transportation and so on the US now lags other modern economies.

The structure of the US economy, with a few large oligopolistic firms dominating the market in key fields needn’t necessarily mean no technological advances, after all Japan and Korea certainly have high concentrations of large firms, but US firms such as the telecom giants essentially don’t engage in research, don’t believe in upgrading infrastructure more than they have to and are rent seeking corporations—they provide an inferior product to a captive audience (as with insurance companies) knowing that Americans have no other options.  If they fail, they expect the US government to bail them out with huge subsidies.

This structure means that the US,  is unlikely to be the home of the next great technological revolution.  The next tech reveolution could happen in the US, with the right policies, but the Obama administration has not engaged in those policies, instead spending trillions on propping up failed business models.

Consumers of Last and Main Resort: For decades now Americans have bought a ton of consumer goods, from cars to electronics to clothes.  As time went by, more and more of these goods were bought from foreign countries, and more and more of it was bought on credit.  America and Americans have been the engine of development for Japan, the Asian Tigers, and most recently, China.  China, Japan and Korea, in particular, used mercantalist policies—that is to say they generally used trade barriers to protect their internal economy and subsidies to help their exports.  China’s main trade barrier and subsidy is its massive interventions to keep the Yuan cheap against the dollar, an intervention which has amounted to as much as 10% of China’s GDP.

That intervention has left China with a huge number of dollars denominated assets.  In effect the Chinese loaned America the money to consume Chinese goods, which simultaneously made American manufactured goods uncompetitive which meant that manufacturing employment in American dropped like a rock while new factories opened in China rather than the US.  In exchange for the money they loaned America, China industrialized.  Even if they don’t get most of the money back (and they won’t) it was a good deal for them.  As for Americans, well, Americans were able to live above their means—those who didn’t lose their jobs, anyway.

Many countries export a lot to the US.  While US consumers have pulled back significantly, they still consume a lot.  There is, as yet, no replacement for the US consumer.  China and other countries may wish there was, but there isn’t.

The American Security Product: One of the main reasons other countries were willing to, in effect subsidize the US, for decades, is that it provided the common security product—against the Soviets, then against real rogue nations, and always against pirates.

In particular, America’s navy is as large as the next 13 navies combined.   The US was responsible for keeping the world’s shipping lines open, and it was the core of the NATO hammer when a problem needed to be dealt with (for example, Serbia in the late nineties.)

But lately the US hasn’t been delivering the product in a way that the rest of the world appreciates.  Most of “old” Europe (ie. the countries with money and power) opposed it.  So did most of Asia. So did America’s allies in the Middle East.  Once in Iraq, the US couldn’t be defunded for fear of Iraq splintering, but now that it’s clear the US is leaving anyway, the possibility exists.

And then there’s the Somali pirates.  Because most of the US navy was occupied with the wars in Afghanistan, Pakistan and Iraq, the Somali pirates got completely out of hand and the US Navy didn’t do anything about it for a long long time.  When the issue was finally dealt with, the US navy was only one of a number of navies doing so.  The US let it get out of control, and then wasn’t key to fighting it.

Now that the US no longer protects very well against the Soviets, rogue nations or pirates, and now that joint naval operations are how the Somali pirates are being dealt with, the rest of the world is wondering whether it’s worth paying for a US military which doesn’t do what they want it to do.  Only the Afghan war, which has elite support in Europe (though not popular) makes some think that perhaps the US is worth keeping on as the world’s policeman.

Buying Key Technologies Took Dollars:  Yet another reason folks wanted to have lots of dollars and access to dollars was that you needed dollars to buy certain goods.  For decades the only good commercial jet liners were Americans.  Key computer technologies needed to be bought in dollars.  Intellectual property needed to be bought in dollars.  The best military technology had to be (and still has to be) bought in dollars.  And so on.  The US wasn’t just home to the next technological revolution, it was home to all the good things you wanted to buy and which you couldn’t buy in your currency.

This is, with a few exceptions, no longer true.  The Europeans and Japanese can sell you most high end capital goods.  There is no real difference between Airbus and Boeing products (though both are essentially 30 year old technology).  The Chinese can and will sell you middle and low end goods for less than America. You don’t need dollars to buy most of what you need and want, and if something comes up really worth buying (say General Motors) well, if you’re someone who really wants it, like the Chinese, you just won’t be allowed to buy it anyway.  (The Chinese would have loved to buy GM.)

A Safe Haven For Money and For You: For decades, if you wanted a safe place to put your money and put it to work, the US was probably the best.  It was the most stable, it was impossible it could be conquered even if there was a World War III, it was the largest and could absorb the most money.  Likewise, if things went really bad in your country, it was a great place to flee to.

The financial crisis put the wisdom of placing your money in the US in question.  Bush era immigration and travel policies, not rescinded by the Obama administration, put the utility of the US as a safe haven in question as well.  And yet, to an extent, the US retains at least the first role, because there is simply no other country available.  Europe did not avoid the financial crisis, China doesn’t allow that much investment in the country and is an unsafe place to put money, and so on.  So the US retains some safe haven appeal.  At the same time, however, foreign elites have become far more uneasy about the idea and want a different option.  And for themselves, they’d rather vacation, have their second homes and educate their children in Europe.

And at last, back to oil: Of course, the final and in some ways most important reason for the dollar’s reserve currency status is that oil was sold in dollars.  This is a result of a decades long understanding between the key Gulf States, Saudi Arabia and America that the US both underwrote their security and could knock them over any time it wanted.  In exchange for America’s security umbrella and help in maintaining their regimes, oil was priced in dollars.  When they became rich in the 70s, their money flooded primarily through US banks.

Indeed, in prior years, every time an OPEC nation talked about going off the dollar as the currency for buying oil, rumor has it that the Saudis were the ones to spike the move.

Oil is the most important commodity in the world.  Ultimately all economies are underpinned by oil.  Oil is also the most important military resource.  With oil your army can move and fight.  Without it, it can’t.  In many ways WWII was fought for oil and with oil, and the powers with the oil defeated those which didn’t have it.

Which brings us back to the US military product.  As long as oil is priced in dollars, the US military can always function at full capacity, because if push comes to shove, the US can always just print more dollars.

If oil is not priced in dollars, then certain US access to oil is removed—both for the military and for the civilian population. Sure, the US can still print more dollars, but if oil isn’t priced in dollars, well, print too much and you may get inflation, even hyperinflation.  And if the oilarchies don’t approve of a particular military action, well, they can make it much more expensive.

Are the Dollar’s Days as Reserve Currency Over?

No.  They aren’t.  But they are numbered.  They aren’t over because other nations still need the US consumer.  Until the Chinese manage to create a domestic consumer society, both they and other countries can’t cut themselves lose from the US consumer.  What they will do, and what they are doing, is trying to manage how much the US borrows and to take away the US ability control the world’s money supply.  They will still have to keep the US propped up for the time being, because in so doing they are propping up themselves.  And remember always that Chinese citizens aren’t like Americans.  Take their jobs or their land or their hope and they get violent—very violent.  They have, do and will fight both the police and the military.  China’s elites know that if they don’t keep economic growth coming, their heads could literally wind up rolling.

In addition, while no one is happy with the US security product, the fact is that no one can really replace it.  The European military is not strong enough, and their navy does not have the projection ability.  Likewise with the Chinese military, who in any  aren’t trusted half as much as the Europeans, though their moral flexibility is appreciated by many regimes, who still understand you don’t invite China to station large number of troops in your country if you have half a brain.

Likewise, there is simply no replacement for the US as a haven of last resort.  China’s currency and investment controls make it unsuitable.  Europe managed its financial affairs no better than the US over the last decade, although they seem to have learned the regulatory lessons marginally better than the US.  If you need a place to store your money, and put it to work, the US may not look good, but neither does anyone else who is large enough to absorb large amounts of money.

The key break point, the end of the dollar hegemony, will come when the Chinese are able to move to a consumer economy.  At that point, the Chinese will no longer need America as consumers, and they will let the Yuan float.  The devastation this will wreck on the US economy is hard to overstate.  Standards of living will crash.  In the long run, being forced to live within its means, and no longer having to compete against massively subsidized foreign goods may turn out to be good for the US, but that won’t make you feel better as your effective income collapses or you lose your job.

This is probably two economic cycles out.  We’re talking 12 to 16 years.  So there’s time yet.  Probably.

So what does oil not being priced in dollars mean to me now?

Less money for everything.  The US will not be able to afford as large a stimulus as it should have.  It will mean borrowing costs higher than they would otherwise have been and more restricted credit (sure, theoretical interest rates may be low, but can you get a loan at those rates?)  Oil prices, and gas prices will be more volatile for the US than they were before, which is saying something.

And other countries will get more oil, relatively speaking.  Which means they will get more growth.   They will receive more investment from the oilarchies, and the US will receive less.   Relatively speaking the US economy will not be as good as it was.  This is a marginal effect, but marginal effects add up.

This is, in short, not good news.  You won’t be able to say “I lost my job because oil isn’t priced in dollars” but it will be true for some people.  Lower wages, more restricted credit, and more restricted government policy will be the price paid for the massive incompetence which lead to this moment.

And yet this does have a silver lining.  Both for other countries who deserve to be able to pay in their own currencies and for America and Americans, who need to learn to live within their means, to emphasize production again rather than consumption and who need to wean off of oil as much as possible in any case.

But it will hurt.


There’s a phrase for modern PR techniques…


Andrew Sullivan’s Apology Reads Right To Me


  1. Graphs of the price of oil this decade and the value of the euro in dollars have a striking resemblance. Business Model

  2. saw it all coming

    william grieder was warning the usa about stupidity back in the early days of the old newspaper tabloid format of the rolling stone. i was in high school on the way to college and thought at that time: this guy makes a lot of sense.

    well, it is now 30 – 40 years on down the road and i can say with full conviction we were warned about all of this. but nobody paid a lick of attention and now we are certainly f***ed.

    at this point in history all i can say is too bad so sad you had a chance usa / amerikan sheeple but you f***ed it all up.

    good bye and good riddance.

  3. rumor

    Succinct and simply explained, Ian. Well done!

    I don’t suppose you can provide a brief analysis of how the move away from the USD as reserve currency would affect Canada?

  4. Depending on how one looks at it, the US domestic political economy looks very much like an example of a Dutch Disease economy.

    The US primary export, however, is dollars rather than natural resources. Just like any other Dutch Disease economy, the exporting sector (in the US case: banks) has come to dominate the economy and polity while the rest of the economy has degenerated into rentierism.

    If other examples of Dutch Disease economies are anything to go by, there’s no way for the US to recover until the supply or demand of dollars dries up far enough to strip the banks of their power.

  5. Ian Welsh


    less support for the dollar means a lower dollar, which means harder to export to them, at least that’s my first take. Also note that the Canadian dollar is now a petro-currency (not a good thing, imo.) OTOH, some forced diversification away from the US isn’t entirely bad.

    Curmudgeon: interesting way to look at it. I agree that the financial economy needs to be put back in its place, it’s why I was so upset with how the financial crisis was handled (it was a chance to break them, but passed on.)

  6. But of course the political deadlock means that none of this can be avoided.

  7. Ian Welsh

    Well yes, in theory it could be fixed. In practice, the people in a position to do so, won’t.

  8. Lex

    Thank you, Ian. I’ve been tumbling this issue in my head for some time and hoping that someone would write the clear, concise and level-headed summation of the situation that i cannot.

  9. Here’s something I posted at Washington’s blog a couple of days ago about the declining dollar. It’s relevant here.

    According to modern monetary theory (see Bill Mitchell at billyblog), in a fiat system sovereign governments have a monopoly over provisioning their own currency. As a result, only governments can increase or decrease the non-governmental net financial assets of their respective economies, e.g., by spending or taxation. Since there is no issuer of an international currency (disregarding SDR’s for a moment), world trade depends in the issuer of the world’s reserve currency to run constant deficits in order to supply the needed currency for world trade. The US is getting tapped out in that role of the world’s marketplace of last resort and is seeking to devalue its currency to compete in exports and improve its balance. Some experts are estimating that over time, the US would like to devalue by about 30%. Emerging market mercantilism is not working and has to be fixed either by floating rates or dollar devaluation. Since the emerging world is still pegging to the dollar, the dollar must be devalued. (The danger here is a race to the bottom, since no one is able to pick up the US role as world consumer. Update: see Zero Hedge link in my comment above.)

    As a result, there is a move afoot for the increased use of SDR’s to take the pressure off the US dollar and take up the slack in world trade as the restructuring takes place. The days of debt capitalism in the US financing world trade are over. The US consumer is tapped out. This is going to have major implications going forward. The US wants to get aback in the export game instead of being the world’s importer.

    US backing for world currency stuns markets

  10. @Mandos:

    The root of America’s problem is the simultaneous triple collapse of its political system, economic system and civil society. America’s economic problems would be repairable if it had a functioning political system. America’s broken political system would be repairable if it had a strong civil society. Unfortunately for Americans, America has no pillars to lean back on to effect positive reforms. Very few countries have recovered from this kind of triple failure. America is very unlikely to be an exception.

  11. Ian Welsh

    I don’t believe in the “strong dollar” either.

  12. David


    Some years ago I recall reading that the CEO of Intel, Andrew Groves, predicted
    that the standard of living of Americans would go decline by something like 40% in a few decades. Would you agree that this rough estimate is plausible say in 20 years ? Also how would it affect other members of the “dollar bloc” like Australia and New Zealand ? Thanks.

  13. Formerly T-Bear

    @ Curmudgeon

    The root of America’s problem is …

    You’re singing from the gospels again, but don’t forget the collapsed “Forth Pillar” –

    Unremarked is the collapse of LAW, the adhesive that binds, the antidote for might makes right, the sovereign factor of civilization, fundamental requirement for either Republic or Democracy to exist. Without Law, there is no civil safety; without safety, all else is lost.

  14. Ian Welsh


    certainly more than possible. A rough correction 4 years ago would have been 20% or so, but the longer it goes on the worse it will be. Of course, after the crash out there’ll be a chance to build up again, but for those of us who are middle aged or older now, that’s not likely to matter.

    Australia is becoming an economic colony of China – they provide resources to China. I don’t see that changing, and I imagine they’ll just switch patrons more formally. I do think that as China becomes more powerful they will become less generous to their economic allies, but I could be wrong. They will also encourage their own forms of under-development in their periphery, though that’s something Australia should be able to avoid if they’re smart.

    Not sure about New Zealand, just don’t know enough about its economy.

    The movement towards more and more mega-currencies is actually not a good thing, imo, but it is an understandable reaction to the unwillingness to actually properly regulate currency flows. However it will do great damage to many peripheral regions foolish enough to get on board.

  15. earlofhuntingdon

    Benchmarked Crudely – Oil Soon to be Priced in Non-Dollars

    I’ll leave it to our resident economists to comment about what this coordinated move away from the dollar really means, both for our long term economic outlook and for our short term “jobless” recovery. The UK’s Independent took note of one reaction the last time an Arab state priced its oil in a non-dollar currency:

    Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

    How obtuse. Everyone knows our invasion of Iraq – and the incessant Village rumblings that we do “the same” to Iran ( whatever that is; they must think we achieved victory ) – knows that we did so to enhance the world’s freedom from fear and to maintain the purity of our precious bodily fluids. It had nothing whatever to do with oil.

  16. Looking at world trade as a sort of giant Monopoly game, it’s easy to see why the dollar is in trouble. In the Monopoly game, all the players are given a stake of cash to start with. The game then gives them trading opportunities to increase (or loose) that stake. But in this world’s Monopoly game, one player, the USA, had the privilege of printing the money.

    The USA abused that privilege. When they became a weak trader, they just printed dollars instead of delivering something of value in trades. As a result, the other players in the game are logically crying foul and looking for another game.

    The dollar came to become the reserve currency because it was the medium of exchange of a nation that responsibly traded things of value. When that quit happening, the dollar quit happening.

    Any medium of exchange is governed by the relation DEFAULT = INTEREST + INFLATION. The medium’s manager lends money to traders in exchange for a promise to return it when the trade is completed. If a trader fails, he doesn’t return the money and the medium manager notes the DEFAULT. He must collect INTEREST equal to this DEFAULT or INFLATION occurs and responsible traders are unfairly penalized.

    The USA has not followed this relation. The USA government is the leading deadbeat trader. They have been DEFAULTing at increasing levels. They haven’t been collecting INTEREST to mop up those DEFAULTs. Hyper-INFLATION will naturally ensue.

    Todd Marshall
    Plantersville, TX

  17. Darryl F Clayton

    Mr Welsh,
    I have a question may be silly or not, but, Does it matter WHERE the dollars are, or just the Amount of dollars?

  18. Ian Welsh

    Darryl, it does matter where the dollars are (who has them) and more importantly, what they’re used for. Recycling dollars into debt isn’t the same as buying American products or services, for example.

  19. While some countries might have caught up a bit with the US in the internet industry, the US is still the clear leader and to say it lags behind other countries is false. Whether you believe the facebook/twitter hype or not, they are the latest and greatest web apps to come out of the US and they’ll be more after them.

  20. Ian Welsh

    And here’s what’s happening elsewhere in the developed world

    Starting in July, telecommunication companies in the northern European nation will be required to provide all 5.2 million citizens with Internet connection that runs at speeds of at least 1 megabit per second.

    The one-megabit mandate, however, is simply an intermediary step, said Laura Vilkkonen, the legislative counselor for the Ministry of Transport and Communications.

    The country is aiming for speeds that are 100 times faster — 100 megabit per second — for all by 2015.

  21. Yes, I’m part Finnish and lived in Helsinki in 2000. The telecom infrastructure there is amazing but when it comes to the internet, the truly innovative sites like kiva, samasource’s, amazon ec2, friendfeed, etc are coming out of the US, where many people I know here have 25 megabit connections today.

  22. Ian Welsh

    And the majority of people don’t, and figures show that broadband penetration and speed in the US massively lags other developed countries. However you’re right on internet software innovation, it’s one of the few bright spots. Mea culpa, I’ll be more precise in in the future.

  23. I should write Robert Fisk and thank him for stimulating this comment on dollars for oil and larger global dynamics. Lets assume that everything you’ve outlined is 100% accurate.

    What happens if we no longer need oil — for anything and we have a cheap, domestic alternative for all of our power? This model shows the land space required for solar power to provide all energy needs by 2030. – . The model doesn’t take into account the recent discovery out of MIT for conserving solar power over night, which would reduce the land mass requirements significantly (It was made public domain immediately).

    It might serve as the “great equalizer” for the world economy and it would certainly prevent the collapse of world society from the inevitable eco catastrophes that the industrialization of China and India guarantee.

  24. Ian Welsh


    what the US economy absolutely needs is to turn energy into capital – something that isn’t bottlenecked by physical reserves, can be created in-country and which is subject to scale (ie. the more you make, the less it costs). Do that and you can have widespread prosperity again. It’s not the only thing required, but it is a necessary condition, it MUST be done.

    So yes, things like that plan above change the game completely. The key, again, is for energy to become a capital item, not a resource.

    The technology is mostly here. With a significant investment it can be done. It is what I wanted the stimulus to be-a multi-year commitment to refit every building to save energy, and to push alternative sources of energy, to move from planes to high speed trains, to refit the car fleet, and so on. That’s a stimulus which would have worked.

    Alas, that would require some of the “vision thing”, which Obama, for all his high flown rhetoric, has as much of a deficit in as the elder Bush did. (To be fair to the man, Bush Jr. had plenty of vision. Moronic, stupid vision. But vision.)

    It would also require an understanding of how the economy actually works, something which Summers, Bernanke and co. for all their academic credentials, have never exhibited. (I sometimes think it is /because/ of their academic credentials.)

  25. Thanks so much for this reply! Very helpful.

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