As we’re all constantly being told, the oil price has rocketed since the whole War on Terror/bombing-the-Middle-East thing kicked off. It’s worth remembering that much of this price rise is fictional.
The red line in the chart below shows the price of oil in US$; the blue line shows the price in euros. As you can see, the difference is striking. Measured in dollars, oil prices have risen 89% since January 2000. Measured in euros, they have risen just 50%. The contrast is even sharper since the beginning of 2003: dollar oil prices are up 44%, while euro prices are up just 15%.
In other words, oil prices appear to be rising far more than they really are because of the magical collapsing dollar. This is a helpful illusion for the US administration: they can pretend to Americans that oil is more expensive at the pumps because of complicated geopolitical issues, rather than because the value of a dollar has fallen 39% since the President’s inauguration.
Well up to a point John. Oil is quoted in dollars after all. It would be fairer to use a basked currency, say the SDR, or even a consumption-weighted price, which of course given China and the US both use dollars, would look much like the dollar price chart.
I think John’s got it the wrong way around. The price of oil (which is almost exclusively traded in dollars) has risen, but the dollar’s concurrent collapse has depressed the euro price. If oil were traded in euro, the euro price would have risen.
Oil is indeed traded in dollars. However, the aim of people who sell oil is to maximise the amount of goods and services they obtain in exchange for their oil – not to maximise the amount of green bits of paper they obtain.
If the amount of goods and services you can buy with a US$ falls, then the amount of US$ for which you will be willing to sell a barrel of oil (ceteris paribus) will rise, to keep the amount of goods and services that you obtain in exchange for your barrel of oil constant.
Matt is correct that it would be more honest to show the chart in terms of a weighted basket of currencies – however, that would’ve been less interesting (anyway, the euro is no *more* arbitrary a currency in which to denominate oil prices than the US$).
I don’t think we can present these relationships as one-way.
It’s worth remembering that trading oil in US$ gives the US a number of big benefits. It creates demand for dollars as everybody has to buy dollars before they can buy oil and so keeps the dollar stronger than it would be. People don’t aim to maximise their dollars, but are forced to by the need to buy oil.
It also cushions the US economy from currency fluctuations.
If we traded in euro (as Saddam’s Iraq briefly did) the dollar would almost certainly collapse and the US$ price of oil would go through the roof.
anyway, the euro is no *more* arbitrary a currency in which to denominate oil prices than the US$
No, I think it is; it’s a much less-used international trade currency and as Matt says, the two biggest oil importers pay for their oil in dollar-linked currencies. If I was in combative mood, I’d also question John’s statement about the relative attractiveness of goods and services versus green bits of paper; the main oil exporters are the Arab oil states plus Russia, who might be quite happy to accumulate US assets for all sorts of geopolitical reasons. Also (see below) the big futures contracts are US$ denominated, which means that the carry relationship in oil futures is determined by the US interest rate rather than the ECB one.
by the way, Stephen, you’ve fallen prey to a couple of urban myths. People do not have to be net purchasers of dollars in order to buy oil; if you phone up Shell and say you’ve got a billion Ukrainian hryvnia, they will sell you some oil. In any case, even if you did have to buy dollars to buy oil, I doubt this would boost the US dollar as the sellers of oil would then want to convert your dollars back into kroner, pounds, roubles, dhirams or bolivars.
The only reason people believe all these odd things about oil is that the main oil futures contracts (NYMEX West Texas and IPE Brent) are denominated in US$. They are demoninated in US$ because the most likely reason that someone would be purchasing them would be because they are in the business of shipping oil to people who want it, and a random "person who wants oil" is more likely than not to be paying for it in US$. But there are smaller and less liquid oil futures which trade in all sorts of currencies. The US economy is mainly cushioned from currency fluctuations because it is actually a surprisingly closed economy (trade is about 10% of GDP).
John – not only do you have an annoying feature that deletes your posts, if you type a comment in and forget to put your name it tells you, then deletes the comment when you go back.
I had written a beautifully lucid and intelligent comment on exchange rates, based on a piece in The Economist. But it’s gone now, and I’m off to sulk.