When the whole world (barring a few policy-makers in the US), reeling under $140 a barrel, increasingly pointed finger at the weak dollar as one of the culprits;  the Wall Street Journal came out with an interesting analysis.

The dollar not only showed surprising stability, if measured against the broader currencies beyond the trading currency basket, barring Yuan, it has remained within a range, or appreciated. Many countries faced the possibilities of currency crisis. Many other countries have started showing current account deficits, and are more likely to do so going forward if oil stays at where it is, and even more so if oil further moves up. Around 50 nations, the list growing fast, are facing double digit official inflations, and therefore have tightened interest rates aggressively.

On the other hand, OPEC has increasingly been appealing for dollar stability. If one assumes that OPEC, with the bounty of dollar inflows from its oil exports, would reinvest this money back through SWFs or otherwise, it’s likely that they would get those assets cheaper now, in most places around the world.

So if that’s what a weak dollar and high oil price means – it suits both the OPEC and the US.

The bigger question is the sustainability of that. And that demands an understanding, why for most of the world, with interest rate differentials of 5-10% or even more against the dollar, it’s still not a weak dollar. 

The problem lies with the petro-dollar linkage. Dollar is weak, but oil is super-strong. The combined result is, for most of the world, a stronger dollar, because the weakness of stand-alone dollar is nothing compared to the strength of the petro-dollar.

Take the example of real demand of dollar, against global trade. With oil at $140 a barrel, all importing nations now need a daily amount of around $6.3 billion dollars. This is a ball-park figure, by taking global oil exports at around 45 MBPD. Now if one leaves aside the US, the largest oil importer, who need not earn this dollar as they can print it, the amount comes to $4.6 billion/day.

When oil was at $50, this was at $1.6 billion or so. So, barring the few exporters, rest of the world now needs an additional daily supply of closed to $3 billion. These oil-importing nations need to earn this additional $3 billion daily to meet their daily oil demands.

Wherefrom do these oil-importers get it? Most oil importers are not in a position like China or Japan, running huge trade surpluses. Even when one goes by Japan’s or China’s net oil imports; it would cost them an additional $160 and $120 billions of dollars respectively in oil imports, just because oil moved from $50 to $140.

Traditionally, with average oil price of $50/barrel (assuming), other than the US, rest of the oil-importers needed around $1.6 billion daily to buy their import requirements of oil. Oil is unlike other major categories of trades. Here the dollar moves from a source to a sink. The source is the Federal Reserves, the sink is mostly OPEC members like Saudi Arabia. Imports of Saudi Arabia haven’t gone up much to ensure that this additional dollar remains in circulation.

So the fundamental difference for the rest of the world in (A) Oil at $50 a barrel against (B) oil at $140 a barrel is – it needs an additional daily supply of $ 3 billions, equivalent to a yearly additional supply of $1.1 trillion dollars. At this rate, the forex reserves of emerging nations will wipe out in 3-4 years, however that’s a hypothetical situation. No wonder that many nations have started facing currency crisis.

Take the supply side of dollar against its increased demand only due to oil. The US has maintained more or less a daily average trade deficit of $2 billions over last few years. This also hasn’t gone up as significantly as oil prices went up.

So the simple equation becomes, rest of the world needed a daily supply of $1.6 billion to import around 33 MBPD of oil at $50 a barrel, and US supplied around $2 billion a day. Now the rest of the world demands a daily supply of $4.6 billion or more, dollar supply has remained more or less same at $2 billions. There’s a daily deficit of $2.6 billions. That’s alarming!

Would dollar appreciate or depreciate in such a condition?

King Abdullah announced generous $1.5 billion donations in Jeddah last month for developing and poor nations, to finance energy and developmental projects. It’s a noble move, however one can immediately understand its effectiveness against the problem in hand.

If OPEC indeed cares for the two-thirds or more people of the world, let them trade oil in other currencies as per preference of importers, at least for a few million barrels a day. Otherwise OPEC would support dollar with rock-solid oil and still cry for its stability, knowing fully well fundamental instability of dollar. Even a rate increase by the ECB isn’t likely to weaken dollar much, when the demand for dollar remains twice its supply, due to oil again.

If petro-dollar linkage isn’t diluted and oil continues its run at current rate, there will be dollar with only the US and with the oil exporters. It’s simply not sustainable for both.

OPEC is force feeding junk dollar at a premium to the rest of the world by maintaining controlled supply, and more so by pricing it in dollar.

Ranjit is an Associate Professor at Indian Institute of Foreign Trade, and is the author of the book Wondering Man, Money & Go(l)d.  Opinion is personal, with the assumption that some sort of an equlibrium for global trade for rest of the products and services exist.

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