The oil-dollar nexus is one of the foundations of the world economy but lately there has been a disturbance in the force. A combination of old enemies and Islamic states are trying to break the balance.
The US Dollar has been the reserve currency of the world since the end of WW2 (Bretton Woods Agreement). Do you realize this was only 72 years ago? Being the world’s reserve currency is powerful – it has allowed us to transfer our debt to the rest of the world. If a country wants to conduct international trade it needs to buy US Dollars. It didn’t matter that the US wasn’t balancing the budget because we could always print more money. Normally this would devalue the currency however, when countries are forced to buy Dollars to buy oil, and hold Dollars, it has the effect of propping up the US Dollar creating a stronger currency than we would otherwise have. The other effect is that it has allowed the US to run an almost permanent trade deficit without major short term political consequences.
In the last great global depression (in 1931) the UK lost its status as the world reserve currency. It lost its status when it tried to reflate its economy by abandoning the gold standard. (Sound familiar?) Nixon thought he could cleverly avoid any consequences and still fund the Vietnam War by doing a deal with the House of Saud (Saudi Arabia) to insist that oil was purchased in US Dollars from OPEC countries. The drop in oil prices was the opening salvo showing the demise of OPEC, and with it the deal that kept the US Dollar at the heart of world trade.
Some of the major global oil producers such as Russia and Iran have started insisting that oil is purchased in Euros and have started building up major euro reserves. Iran also wants to recover tens of billions of dollars it is owed by India and other buyers of its oil in Euros as it ramps up production with the goal of reducing its dependence on the U.S. Dollar following last month’s sanctions relief. This is one of the reasons why despite the Euro going negative the dark side of the force is steadily increasing its use of the Euro.
The world is starting to get very interesting and financial tensions and fault lines are rising. No one knows how this will play out. One thing is for sure; the next US President better understand the force of finance and be able to restore balance. If he or she just relies on the dark emperor of Goldman Sachs to show us the path to more leverage… we are all doomed.
(as Yoda says)
A capitalists strength flows from the Force. But beware of the dark side. Deficits, Leverage, Aggression; the dark side of the Force are they. Easily the currency flows, quick to join you in a fight. If once you start down the dark path, forever will it dominate your destiny, consume you it will, as it did the Fed’s apprentice.”
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