Saturday, February 9, 2008

Paper Tiger

According to this story appearing today, the Secretary-General of OPEC now foresees a time within the decade when oil will no longer be priced in dollars. Like kicking a lumbering giant who has fallen down, this ill- (or well-) timed disclosure could send the U.S. economy further into a severe tailspin. If not immediately, it presages the end of the American Century and the final destruction of an already broken and broke U.S. economy.

The reasons for this are complicated, but the success of the U.S. effort following WW II to convince OPEC to price all oil sales in dollars has allowed the U.S. extraordinary benefits over the half century since the agreement. Forming the world's "reserve currency," the resulting demand for U.S. dollars for the purchase of oil forces nations to purchase U.S. currency, encourages oil-producing nations to recycle those petrodollars into the purchase of U.S. treasury bonds, keeps domestic U.S. interest rates and inflation low, and allows the U.S. to maintain enormous trade deficits that would be untenable for any other nation. As described by one helpful (if somewhat outdated) 2003 website posted by The Center for Contemporary Conflict - the research institute of the Naval Postgraduate School's Department of National Security Affairs - the benefit of for the nation whose currency serves as the "reserve currency" is a form of "seignorage." According to the CCC, "this is perhaps the most important advantage of having other countries hold one's currency. These countries must give up real goods and services or ownership of the real capital stock, in order to add to the currency balances that they use...." Moreover, "most foreign central banks and other investors hold their dollars in the form of interest paying treasury bills. To the extent that the reserve currency role of the dollar allows the U.S. Treasury to pay a lower interest rate on its liabilities than most other borrowers, the difference is a further source of seignorage." In short, every purchase of oil priced in dollars subsidizes the U.S. economy, a nearly invisible but powerful form of tribute that the Empire has extracted from its protectorates.

Were OPEC to begin selling oil priced solely in Euros, those benefits would evaporate overnight and the U.S. could no longer be able to maintain its current account deficit. It is estimated that the dollar could lose nearly half of its international value as a result of the switch, and that money (foreign and domestic) would flow out the U.S. financial markets and treasury bonds as if the Hoover Dam had sprung a leak. According to one scenario that even the skeptical CCC acknowledges to be plausible (even in spite of its skepticism that OPEC would switch to Euros, a skepticism that may have been justified in 2003 but now which can hardly be maintained), such a switch would result in the collapse of the U.S. economy:

"The effect of an OPEC switch to the euro would be that oil-consuming nations would have to flush dollars out of their (central bank) reserve funds and replace these with euros. The dollar would crash anywhere from 20-40% in value and the consequences would be those one could expect from any currency collapse and massive inflation (think Argentina currency crisis, for example). You'd have foreign funds stream out of the U.S. stock markets and dollar denominated assets, there'd surely be a run on the banks much like the 1930s, the current account deficit would become unserviceable, the budget deficit would go into default, and so on."

In other words, we would suddenly be forced to confront the fact that we are really broke, with no means of any longer convincing foreign governments to continue to sell us things of value for now-worthless paper. Our current "market volatility" would look tame by comparison: the U.S. markets would plummet, investment capital would dry up, businesses would shut down by the thousands, unemployment and inflation would skyrocket, and it's quite likely that martial law would follow the unrest of a population wholly unaccustomed to hardship, unable to make or do anything for themselves, and bereft of actual communities that would in themselves represent a store of value. Our worthless suburbs would become ghettos, inescapable due to their distance from any commercial or urban centers in the absence of a cheap and steady supply of petroleum. It would be morning in America - that is, time to wake up from the slumberland of the American dream.

The "smart money" has been expatriating its money for a number of years now in anticipation of this moment. Those in the know - like Dick Cheney, that old oil man, and Jim Rogers, George Soros's business partner and investor extraordinare - have stashed their funds in foreign currencies, particularly those of "Old Europe" and China. Once again, it will be the chumps like you and me (and worse still, our kids) who are stuck holding a bunch of IOUs and no way to pay them back. This time, though, we won't be able to call on the help of "" We'll have nowhere to go, only currency that won't buy a loaf of bread and a government that won't be able to print dollars fast enough, even if there were bread to buy.

UPDATE (5/08): More on the "fading glory" of the dollar's reserve status - and the central importance of "seignorage" - on the Bloomberg website. Its conclusion: "It isn't ordained that the dollar surrender its position as the world's go-to currency. Yet if Americans insist on living beyond their means, eschew sound fiscal policies, ignore the greenback's weakness and remain tempted by protectionism, the dollar will in small bites begin to mimic the British pound -- the currency of a once proud but spent imperial power."

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