The Diminishing Demand For Dollars (Part I)

By Cedric Muhammad | Last updated: Dec 28, 2007 - 2:35:00 PM

Commodities and Currencies: The Diminishing Demand For Dollars (Part I)

Iran has completely stopped selling oil in U.S. dollar.
Iranian Student’s News Agency (ISNA), December 8, 2007

Russian oil firm Rosneft will follow the lead of Gazprom and LUKOIL to sell crude in rubles amid the ongoing depreciation of the dollar ... Russia’s largest independent oil producer, LUKOIL earlier announced that the company will switch to the ruble in its gas and crude deals within two years.
PressTV, December 14, 2007

As (Robert) Mundell saw the United States devalue its dollar, its unit of account, in December 1971, he surmised that it would be only a matter of time before the oil exporters would find the dollars they received buying fewer goods, and that the dollar financial assets they held--claims on future real goods--would also be worth less. They would ask more dollars per barrel to maintain the terms of trade.
Jude Wanniski, “The Way The World Works”

The recently reported announcements by leading oil officials in Iran and Russia, that both countries have already, or intend to stop accepting dollars as payment for the oil they produce is increasingly the talk of the international financial media, leading oil observers, multi-national corporations and the so-called “conspiracy theory” community.

Even rapper Jay-Z, by giving the image of his preference for euro currency�in his video for �Blue Magic��over the American dollar represents a microcosm of the same debate.

Whatever interest, station, or school of thought one represents, there seems no denying that a major shift in economic and financial power is underway over the dual issues of the rising price of oil and the falling value of the dollar, which at present, are essentially the same thing.

Two questions are on the minds of many within the previously described groups: First, just how serious is the movement away from the dollar? Second, toward what medium of exchange is that movement headed?

First, let’s look deeper into the nature of money.

Money generally has three principal attributes and functions. It serves us as a unit of account, the store of wealth and the medium of exchange.

Money as the unit of account: Money, as a defined currency, is the means by which members of an economy measure their labor, skills, talent, wealth, and brainpower (Read the Honorable Elijah Muhammad’s September 17, 1960 article, What Must Be Done With The Negro? in order to learn the critical nature of these five economic elements: labor, talent, skills, wealth, and brainpower). The unit of account allows a market or centrally planned economy to determine what the labor, skills, talent, wealth, and brainpower of its different members and society as a whole—whether barber, doctor, athlete, scientist, and government—are worth in terms of another entity, currency.

Money as the store of wealth: Money allows for these five economic elements to be represented and to “exist” in the form of another entity, currency.

Money as a medium of exchange: Money allows for the trading of these economic elements by individual parties, members of society, or between nations, through the use of a another entity, currency.

Leaders, economists, financiers, consumers, producers, and governments all recognize the three roles of money—willingly or unwillingly and place different emphasis on these areas at different times.

In a certain context, the Honorable Elijah Muhammad placed greatest emphasis on the function of money as medium of exchange. The late economist Jude Wanniski placed greatest emphasis on the function of money as unit of account. The Muslim historiographer, Ibn Khaldun, elevated the third function of money, writing in his classic, “The Muqaddimah,” that Allah (God) made gold and silver uniquely serve as the best store of wealth.

The recent debate over the role of the U.S. dollar in oil transactions has revolved primarily around the role of money as a medium of exchange and whether or not countries like Iran, Russia, and Venezuela should accept the dollar as the best form of payment in exchange for their services.

Even rapper Jay-Z, by giving the image of his preference for euro currency—in his video for “Blue Magic”—over the American dollar represents a microcosm of the same debate.

Iran, Russia, Venezuela and Jay-Z are all concerned about receiving payment for their products and services in a currency that is increasingly losing its value in terms of other currencies, commodities, and goods and services.

According to the Iranian Student’s News Agency (ISNA), Iranian oil minister Gholam Hussein Nozari said dollar depreciation makes American money “not considered as a trustworthy currency any more.” Therefore ISNA reports that Iran has completely stopped accepting the dollar for oil payments and has asked the oil producing nations in the Organization Of The Petroleum Exporting Countries (OPEC) to determine what currency or medium of exchange would be more “trustworthy.”

Iran’s move immediately hurts the dollar’s image and has the potential to negatively affect its value because it cuts at the heart of what gives a currency its value.

The value of a currency—if not clearly defined and maintained by a credible authority in what is called a fixed exchange rate regime—is determined by the relationship between the supply of that currency (in the case of the America dollar, determined by the Federal Reserve’s control over the ‘printing’ of money or creation of currency) and the demand for that currency (in the case of the American dollar, determined by how often the dollar is used in transactions for goods and services by individuals and institutions).

Because oil is denominated or officially priced in dollars, that important commodity has represented a significant demand for the dollar.

How much?

By my calculation (explained in “Peak Oil, At Our Door,” Final Call, December 4, 2007), the total amount of oil produced this year, on average, would bring back $2,140,725,000,000. That’ s 2 trillion, 140 billion, and 725 million dollars.

According to the United States government’s official determination of Top World Oil Producers and Consumers in 2006 (http://www.eia.doe.gov/emeu/cabs/topworldtables1_2.htm), Iran produces about 4.1 million barrels of oil per day or about 1.513 billion barrels per year. By my computation that means a potential value—if all sold — of $104,417,010,000 or 104 billion 417 million and 10 thousand dollars.

That’s how much less demand for dollars there would be each year, if Iran executes its intentions for a full year.

If Russia’s 9.6 million daily oil barrel production in 2006 were factored into the equation, you would have an additional amount of 3.52 billion barrels per year, and if all sold, over $243 billion in oil transactions no longer denominated in dollars.

If the OPEC nations, as a group, were to follow Iran and Russia’s example, the loss in total dollar demand would be over $695 billion. I calculate 695 billion and 106 million dollars, in one year, no longer transacted in dollars.

How likely is it that OPEC would make such a move?

The publication BusinessWeek just asked that question in a recent November edition.

In an article entitled, “Will OPEC Dump the Dollar?” we read:

“Iran and Venezuela managed to persuade Saudi Arabia to agree to discuss the swooning buck at the next OPEC meeting in Abu Dhabi in December, but engineering a shift to an oil pricing regime based on the euro or another currency anytime soon is far-fetched. ‘The obstacles are overwhelming,’ says Edward Morse, energy economist at Lehman Bros. in New York. He notes that virtually all oil sold today is based on three benchmarks: West Texas Intermediate traded on the NYMEX; Brent traded on the ICE in London; and Middle East Dubai/Oman crudes as assessed by Platts or settled on the Dubai Mercantile Exchange. All are priced in dollars. ‘It is hard to imagine how an exporter and importer of crude oil could agree on mutual terms without pricing off one of these,’ Morse says. Besides, he adds, producers should know ‘it is an illusion to think that you are going to have higher real prices globally by switching currencies.’ Prices, he says, already ‘basically reflect fair market value.’ ”

The point made in BusinessWeek can’t be dismissed.

It is one thing to state you will no longer accept the American dollar, it is another to do the hard work, financial engineering; and exercise the operational unity necessary to build a new economic reality.

At present, by my measure, the OPEC nations don’t demonstrate the necessary commitment, yet.

The revolutionary rhetoric and real moves made away from the dollar, if they are to become credible, long-lasting, and the basis for economic development and growth, have to be married with a deliberate and careful effort to build a competing monetary system.

Like most things in life, this is easier said than done.

What the nations of Iran, Venezuela, and Russia have in mind may have serious consequences for the value of the American dollar, but perhaps not as much as what a much quieter group of nations is discussing on the side.

While the world was focusing its attention on the bold words of Venezuela President Hugo Chavez and Iranian President Mahmoud Ahmadinejad at the Nov. 18 OPEC summit in Riyadh; an emerging and perhaps more significant threat to the American dollar was visible in a less reported December 3-4 meeting of the Gulf Cooperation Council’s (GCC’s) six members: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

The topic of discussion was deciding whether or not these nations should break the link they currently maintain between their currencies and the American dollar, under what is known as a pegged currency rate regime.

Did you know that the enormous simultaneous sale of American dollars and the massive purchase of Gulf country currencies is thought to be the most likely cause of the 1 percent fall of the dollar to a record low of $1.478 to 1 euro on Nov. 20?

Now just imagine if the OPEC and GCC nations stopped accepting payment for oil in dollars, and de-linked their currencies from the dollar respectively, while forming their own monetary union, with a currency backed by gold.

Next Week: The relationship between Federal Reserve monetary policy and the Gulf States’ currency peg to the dollar; and the relationship between international monetary policy and U.S. Treasury holdings by foreign governments.

(Cedric Muhammad is a business and political economist who advises entrepreneurs and small businesses through his company, CM Cap, http://www.cmcap.com/. He can be reached via e-mail at [email protected]. His weekly “Cedric Muhammad and Black Coffee Program” can be viewed every Wednesday from 12 p.m. to 4 p.m. EST at The Black Coffee Channel by visiting www.blackcoffeechannel.com/.)

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