Swan Song?

“Paper money eventually returns to its intrinsic value – zero.”
—Voltaire

Dollar to Be Replaced in Oil Trading?

In our previous commentary “Dollar Supremacy Slipping?” – we wondered whether the U.S. Dollar’s status as the world’s reserve currency was seriously being threatened. Then, on October 6 things got quite interesting as Robert Fisk reported in The Independent UK:

“In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar. Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars. The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.”[1]

Fisk’s piece suggests the Dollar may no longer be used for the trading of oil by certain countries.[2] If he is right, the Dollar’s supremacy may be threatened because it can be argued the pricing of oil in dollars has helped provide the greenback’s dominance globally.

Denials by the Saudis, Japan, Russia, and Kuwait were immediate.[3] Saudi Central Bank Governor Muhammad al-Jasser went as far as saying Fisk’s article in the The Independent was “absolutely incorrect,” and sources for Fisk’s article were unidentified.[4] It’s our belief however, where there’s smoke – there may also be fire. After all, the Dollar has taken a lot of heat due to the ongoing global financial crisis.[5] And this past June, China and Russia agreed to increase the use of each other’s currencies in trade to lessen reliance on the dollar.[6] The BRIC nations (Brazil, Russia, India, and China) have also discussed buying each other’s bonds and swapping currencies for the same purpose.[7] Based on that information – we don’t believe it’s out of the realm of possibility certain nations are considering a plan which would replace the Dollar in the trading of oil. We’ll keep our “Spock-Eyebrow” raised.

Another Threat to Dollar Domination?

In the Telegraph.co.uk Ambrose Evans-Pritchard makes an interesting case for a reason the Dollar’s supremacy may be ending:

“You can date the end of dollar hegemony from China’s decision last month to sell its first batch of sovereign bonds in Chinese yuan to foreigners… Beijing does not need to raise money abroad since it has $2 trillion (£1.26 trillion) in reserves. The sole purpose is to prepare the way for the emergence of the yuan as a full-fledged global currency… It is this shift in China and other parts of rising Asia and Latin America that threatens dollar domination, not the pricing of oil contracts… it makes little difference whether crude is sold in dollars, euros, or Venetian Ducats. What matters is where OPEC oil producers and rising export powers choose to invest their surpluses. If they cease to rotate this wealth into US Treasuries, mortgage bonds, and other US assets, the dollar must weaken over time.”[8] [Our emphasis added.]

In other words, what’s the incentive to buy U.S. bonds which pay low interest rates – and risk getting paid back in Dollars which are worth far less (due to America’s inflationary monetary policy)? Especially when bonds can be bought from China – who has its fiscal house in far better order. If countries decide to invest their surpluses in Chinese bonds – as opposed to those issued by the U.S. – who will fund our country’s debt? If that scenario unfolds – it’s our opinion the national debt will be primarily financed by the printing press. And we believe that could have devastating consequences for the Dollar.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another. And bull markets are what we hunt.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1. Independent.co.uk; “The Demise of the Dollar”; October 6, 2009
2. Ibid.
3. Bloomberg; “Saudi Central Bank Chief Backs Dollar, Cites Its ‘Convenience’”; October 7, 2009
4. Ibid.
5. Ibid.
6. Ibid.
7. Ibid.
8. Telegraph.co.uk; “China Calls Time on Dollar Hegemony”; October 6, 2009