Thursday 9 January 2020

How Long the Dollar as World Currency?

BTL in a recent post, Anon asked for views on how much of the present ME unpleasantness is explained by US desire to maintain the dollar as the currency in which the world buys oil?   Anon went on to mention that Gaddafi head been mooting a barter scheme to circumvent dealing in dollars before his demise.

This is quite a long post so I'll summarise here: not really plausible, IMHO

It's not an academic response, nor does it contain any quantified macro-economics (my being in neither profession): but after a career in pragmatic multinational micro-economics - the energy business - I do have a number of practical observations.

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1.  Liquidity / critical mass is vital in every sector.  Nothing stymies business worse than non-fungibility and non-convertability.   Needless to say, if anything that has "currency" today is doing a halfway satisfactory job in the market, that militates strongly against the adoption of anything else.  The intertia / barriers to entry & exit are great.

2.  There have long been plenty of national-pride-based attempts to drag the commercial world away from Anglo-US dominance of the instruments of liquidity.  In my own sphere: many countries hate having their oil priced against Brent (which almost all crude oil is, except US production), let alone in dollars; and there have been attempts to establish marker-prices for other blends, and to have them traded in other financial centres.  Kuwait Blend; Urals Blend, Dubai ... they come along, they get reduced to a basis-differential against Brent, and the world carries on.  And this despite apparently formidable technical difficulties in maintaining "Brent" as a marker (due to terminally declining North Sea production).  But the clever chaps in London cunningly keep extending the definition of the blend and - thus far - they've had total success.

Likewise, and to Anon's question, lots of folks have dreamed of having oil - even just their own local production grades - priced in their own currencies.  You might justly argue that provided there is full FX convertability between those currencies and USD, what's to stop them?  Answer: nothing - except it would be entirely empty.  The whole business world speaks English (and reads the FT), not Russian or Mandarin.  Arbitrage ensures "their" price would always be (Brent USD +/- basis)*FX.

As regards barter schemes ... well, money was invented, partly because there are distinct, nay fatal limitations as to what barter can achieve.  So I don't think Gaddafi represented any kind of threat to dollar oil trade.   BTW, the Russians have tried to sell gas to China in complex packages with industrial equipment - but the Chinese are having none of it!  Cash on the nail, so far as they are concerned.

3.  Some things do change & evolve: but typically only for very good reasons (which do not include national pride).  Example: the first natural gas trading hub in Europe was the UK's "NBP", and European gas prices for many years were given as NBP (+/- basis).  How logical was this, when the UK isn't remotely the centre of gravity of European gas movements, and the Eu deals mostly in EUR?  Very logical indeed - when only the UK's gas market was truly liquid.  However, over time, unsurprisingly several other hubs emerged as the rest of the EU belatedly caught up on gas trading (well, sort-of), one of which - the Dutch TTF -  was very much closer to the continental centre of gravity than our peripheral island market.  A German hub would have been just as likely a candidate: but the Germans genuinely don't understand how markets work, and screwed up their market design.  The Dutch are much better at it: and so today the TTF is more usually given as reference point for "the gas price in Europe".  (By the way, NBP and TTF trade at incredibly high correlations and the basis differential is always easily rationalised - as you'd expect, because they are both liquid, and generally inter-connected physically.)

4.  So: given that things can change over time and with good fundamental reasons, who's to rule out everything coming under Chinese hegemony in the long run, when their economy becomes dominant?  Well, in the very long run, maybe.  But right now they don't really understand markets either, nor indeed quite How The World Works.  Case in point: they'd spent years cultivating Gaddafi (for his oil), and were gobsmacked when "the West" just did away with him one day.   WTF?, you could hear them saying.   And, to their disgust, right now large & mainstream Chinese firms are obliged to, errrr, kowtow to US sanctions on Iran, much as they'd like to exploit the situation commercially. 

Of course, they hate this stuff and have every intention of supplanting it.  One day.  And who knows, maybe Trump will so overplay his hand, he'll help them accelerate the process.

Then again, the French have long hated the use of the English language everywhere - and most specifically in the organs and councils of the EU.  Tough titty, mes braves; not even Brexit is going to change that. 

No lengthy post is complete without an army anecdote.  All army vehicles come with a comprehensive toolkit.  But as I quickly discovered when becoming responsible for a troop of 30 vehicles, there's only one item out of a dozen or so that's ever taken out of the box, and which is permanently going missing - the Spanner Adjustable.  

Yes: some things turn out to be Really Useful.  The English language, the Brent oil contract, and the Almighty USD are excellent examples.  The clever Chinese will need to come up with something even better if they want any of them to be superceded.



Matt said...

What is it with toolkits and being stingy.
In my industry (telecoms) the company always insists on having only a small number of shared toolkits for the engineers.
Invariably (like the army) the only useful tools in there are missing as they have been half-inched by the last person who used them.

andrew said...

Not possible this year.

However by 2040, if the us carries on like this, things will have changed.

The usd became what it is because a lot of other countries needed to borrow money.
Later on the rest of the world wanted us raw and manufactured materials.
The us chose to denominate those goods in usd.

Much is made of how the usd is a neutral floating liquid currency, but that is through the lens of what is right for the us is right for the world.

Now china has the money other countries want and also produces the goods other countries want.

All it takes is an act of will on the chinese and there would be 2 world currencies.

Just not yet.

BlokeInBrum said...

The bedrock of contracts and agreements is the rectitude and integrity of the power behind them.

America has the industrial and fiscal might to be a world currency, but it is also backed by an independent judicial system which, compared to the rest of the world is transparent and fair. And stable too.

Contracts awarded now, will by and large, still be enforceable in 30 years time and on the same basis as they were originally granted.

England / The City of London is still a world power in the fiscal realm also because of our strong property rights and the stability of our political & legal system.

This is the major failure of other countries such as Russia and China. Yes, they may have the wealth and the resources but they lack the political and judicial stability.
No-one is going to invest billions in a country where you could lose everything simply if you fall out with your best buddy - Putin etc...

Nick Drew said...

@ the major failure of other countries such as Russia and China ... they lack the political and judicial stability

Agreed, BiB - and it's a strong related factor. I gather "rule of law" is one of the Great Unmentionables in China, which says it all

Whilst not for one second denying its huge, general importance as a backdrop, it doesn't precisely map onto the currency issue specifically, though. E.g., last year I worked on a major asset sale. The assets were not in the UK. None of the bidders was a UK company.

Yet every aspect (except physical DD - actually kicking the tyres with a real boot) was conducted in London. And ... everything in EUR. It's London because of all the things you listed, & critical mass of professioal services - but not, in this case, USD or GBP.

Anonymous said...

Thanks ND - and BiB, our "our strong property rights and the stability of our political & legal system" very much depend on what the FT called "intergenerational solidarity". That may not be a given in the future, given that native Brits are projected to become a minority by 2050, only 30 years away. Demography is destiny.

(The same will apply to the US of course, and probably Germany. I can't see much in the way of a Han Chinese century.)

BlokeInBrum said...

ND. - I seem to recall you blogging in the past about corruption (or lack of) in Britain compared to other countries.
It certainly occurs, but not generally in the outright blatant ingrained way it does in other places, ie. Russia.
I think part of that is down to the kind of traditional paternalism that existed in the past where the Lord of the Manor looked after his workers, whether they be in his Mills, stately home or as tenants on his farm.
There were in many also a deeply ingrained religious background, mostly Protestant or Methodist, sometimes Quaker.
People such as Lord Leverhulme or the Cadbury family went to great lengths to try and improve the lot of ordinary people. There was a sense of obligation which ran both ways in society.
The end result has been a high trust, low crime, low corruption society, which unfortunately has been and is being eroded away over time.

Demographics is destiny. If we keep importing third world people and attitudes, we will end up a third world country ourselves.
The first obligation of the Government is to protect our borders end ensure our collective defense.

The second ought to be a fair, just and transparent Legal system where all are treated equally under the Law. We already got this right from Magna Carta onwards with our common law system. But it needs to be defended and improved. Allowing ourselves to be governed by multiple laws created in different jurisdictions by unelected and unacountable people is eroding trust in the system.
We cannot have a system where Laws are subjectively applied or where justice can only be obtained by those with deep pockets or political connections.

This is why I voted for Brexit.
It gives us a chance to stop the erosion in trust in our political and judicial system, if we have people of integrity with the will to reform things for the greater good.

Will it happen? The jurys out. But we have a chance. I certainly want my kids to grow up in a better, fairer, more prosperous country.

Off topic -

Everyone and their dog is now offering meat free versions of their food.
First Greggs with their meat free sausage rolls, now Burger King and MacDonalds.
Who's coordinating this, because I doubt this is just happening simultaneously by accident. Or is it simply the free market reacting to demographic or cultural changes?

Anonymous said...

"Everyone and their dog is now offering meat free versions of their food.
First Greggs with their meat free sausage rolls, now Burger King and MacDonalds."

There IS a veggie market amongst the young, our daughter is off-and-on veggie and so are a lot of friends, its not like the 70s when Cranks in Cov Garden (and Neals Yard?) was the only veggie restaurant and us hippies all had their cookbook.

But young people are impressionable, and if you read the Guardian or watch BBC you'll be told how

a) meat is bad for the planet
b) eating bugs/insects is the way forward, alongside living in "pods"
c) having babies is bad for the planet (only applies to Europeans)

"Who's coordinating this?"

Same people who give us adverts where every family is racially mixed?