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Thursday, October 13, 2005 10:53 PM


Oil Priced in Euros. Would it matter?


What would happen if oil were priced in Euros? Lately, everyone seems to be making a big deal out of that idea. Some people even think the war in Iraq was started because of a threat from Saddam Hussein to price oil in Euros. The idea that we went to war to prevent oil from being priced in Euros is laughable. In fact, the idea that it matters at all is completely suspect. Nonetheless, whether or not oil priced in Euros would matter has been the subject of many a heated debate on various message boards that I participate on for quite some time. I now declare victory in the debate.

As proof of my victory claim I offer this news story (with a complete rationale to follow):
Chavez: Venezuela moves reserves to Europe

Venezuela has moved its central bank foreign reserves out of U.S. banks, liquidated its investments in U.S. Treasury securities and placed the funds in Europe, Venezuelan President Hugo Chavez said Friday.

"We've had to move the international reserves from U.S. banks because of the threats," from the U.S., Chavez said during televised remarks from a South American summit in Brazil.

"The reserves we had (invested) in U.S. Treasury bonds, we've sold them and we moved them to Europe and other countries," he said.

Chavez, a sharp critic of what he calls "imperialist" U.S.-style capitalism, has often criticized foreign banks for the power they wield in international financial markets at the expense of poorer countries.

Chavez again proposed the creation of a South American central bank that would hold the foreign exchange reserves of all the central banks in the region.

"I'm ready right now with the Venezuelan central bank ... to move $5 billion (euro4.15 billion) (of Venezuelan reserves), to a South American bank," Chavez said.

Central bank officials could not be immediately reached for more details.

Chavez has also argued against central bank autonomy, saying excess foreign reserves should be spent on economic development projects.

Under his presidency, Venezuela's mostly pro-Chavez Congress changed central bank laws earlier this year so the government could tap reserves for spending, despite criticism that it would lead to devaluation of the local currency and higher inflation.

Every year the central bank must now compute an "optimum" amount of reserves and hand over the rest to a newly created national development fund.

Money held in the fund will be used for overseas purchases and to pay off outstanding debt.

Foreign exchange reserves held by the central bank stood at $30.434 billion (euro25.27 billion) as of Sept. 28, according to central bank data.
Was Chavez able to move his reserves out of US dollars into Euros even with oil priced in dollars? Obviously the answer is yes. Could Saudi Arabia or Iran or China do the same? Of course they could. Would it matter if oil was priced in dollars, Yen, or Swiss Franks? After today it should be perfectly obvious the answer is no. Unfortunately it will not be. I fully expect to see more nonsense about oil priced in Euros within a couple of weeks.

Mish readers, this is the bottom line: Outside of pricing oil in Yap Island stones or some other totally illiquid form, it is 100% meaningless what oil is priced in. If oil was priced in Euros could Venezuela or Saudi Arabia or Japan or China still hold their reserves in US dollars? Of course they could. With that answer in mind, here is the Mish bonus question: Does an oil pricing currency mandate the currency that forex reserves are held in? The bonus question answer should be obvious: "of course not".

Thus we did not go to war because Iraq threatened to price oil in Euros. The idea is totally preposterous but every month that rumor seems to resurface. Whether or not oil is priced in Euros or Dollars or Yen is totally meaningless. Really it is, as Chavez just proved.

If you disagree and still think whether or not oil is priced in Euros is meaningful, then please explain how oil priced in dollars stopped Chavez from pulling all Venezuelan reserves out of US dollars. It can’t be done because it did not stop Chavez one bit. Could Saudi Arabia or China or Japan move all of their reserves out of US dollars tomorrow? Of course they could. Would it take oil to be priced in Euros to do it? Of course not. The idea that oil priced in Euros matters should now be shattered.

The key points that no one seems to understand can be summarized as follows: What oil is priced in is totally meaningless. However, where a country holds their currency reserves is another story. Venezuela has just spoken. Will anyone else be saying the same thing? If no one wants to hold US dollar reserves, the US is in a world of hurt and US interest rates will soar. Regardless of what currency oil is priced in, if foreign countries are willing to hold US dollar reserves then the US dollar is less threatened.

Now that we have resolved the oil pricing issue, we can turn our focus to the real question: Is this the start (or continuation) of a forex reserve trend away from US dollars or is this just random noise from one left wing nut job? In other words, how likely is it that Iran, Saudi Arabia, China, or Japan, or other countries do the same thing? That is the real question. Whether or not oil is priced in Euros vs. US dollars is a meaningless sideshow.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

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