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Sunday, October 28, 2007 11:48 AM


Basket of Insanity at OPEC


I am somewhat leery of this news source, but let's presume for a moment that OPEC will study currency basket for pricing.

OPEC is likely to discuss creating a basket of currencies for oil pricing at its next summit due to the steady decline in the dollar, Venezuela's Energy Minister Rafael Ramirez said.

"The need to establish a basket of currencies ... will probably be a point of discussion in the next OPEC summit," Ramirez told reporters during an evening event in the presidential palace.
Consider for a moment the US Dollar Index
Here are the relative weightings
  • Euro 0.576
  • Yen 0.136
  • Sterling 0.119
  • Canadian Dollar 0.091
  • Swedish Kroner 0.042
  • Swiss Franc 0.036
Imagine that you were to buy gold and had to consider the value of the Swedish Kroner, the Yen, the Pound, etc. No one buys gold this way. Gold is priced in dollars but people go into the nearest gold dealer (or online dealer) and buy gold in whatever currency they want, 24 hours a day, 7 days a week. Pricing gold in a basket of currencies simply makes no sense. The quote is always in one currency, but the currency can be ANY major currency.

Pricing oil in a basket of currencies makes no sense either, even if one eliminates oddballs like the Swedish Kroner. I am assuming that "basket" means some sort of blended price just as the U.S. dollar index is.

People buy things with local currencies. It makes no more sense to price oil in a basket of currencies than it does to price a loaf of bread at the grocery store in a basket of currencies.

I expect dollar bears are gloating over this nonsense. However, even if OPEC was to proceed with this insanity, it simply would not change a thing. In less than a day there would be individual quotes for oil in any and every currency individually, just as there is now.

Practical Example of the Silliness of Basket Pricing

If bread or T-Bone steaks in the U.S. were priced in Euros (or a basket of currencies) tomorrow, would it change the price in dollars? The answer is of course not. All that would happen is that the frequency of quoted price changes would increase.

For example, if T-Bone steaks were advertised at $4.99 lb for a week they would remain on sale at $4.99 lb for as week even though a quote in Euros or a basket of currencies would change daily. It would not make any sense to advertise T-Bone steaks in a basket of currencies because no one is carrying a basket of currencies in their wallet or their checking accounts. It would also be enormously confusing to consumers.

Hopefully, this simple example shows it would actually be complete foolishness for butchers and bakers to price bread and steaks in a basket of currencies. The same applies to oil.

Pricing Units vs. Reserve Units

Pricing oil in Euros or Yen would not matter one bit. Given that currency conversions are instantaneous, 24 hours a day, 7 days a week, as a practical matter oil is already priced in any currency anyone wants. One does not need dollars to buy oil.

Furthermore, if one is sure the Yen or British Pound is going to rise vs. the dollar then one should hold Yen or Pounds (not dollars) to buy oil with. Yes, it really is that simple.

I have said this before and I will keep saying it until everyone understands it: It does not make any difference what currency oil is priced in, and that logic can be expanded to include baskets of currencies.

However, It does however matter where the oil producers hold their reserves. I failed to bring up this point in What Factors are Affecting the U.S. Dollar?

Pricing units are one thing, willingness to hold dollars is another. Indeed, decreasing willingness by the oil producers to hold dollars likely accounts for some of the recent strength of the Euro.

Furthermore, this decreased willingness by the oil producers (and other countries including China) to hold dollars is part of a growing anti-dollar sentiment. Sentiment, at least in the short term, is the most powerful force driving currencies.

Misguided Mad Dash Into Euros

Fundamentally speaking, the ongoing mad dash out of dollars into Euros is misguided.

My rationale is:
1) Europe is printing money faster than the U.S.
2) Credit in Europe is expanding as fast as in the U.S.
3) Interest rates are higher in the U.S. than Europe (at least for now).

A mad dash into Yen would make more sense from a monetary perspective, but that play is avoided because interest rates in Japan are too low.

Eventually, all currencies (except gold) go to zero. The only difference is the speed at which they get there. Warranted or not on relative merits, the U.S. dollar is winning the race among major currency pairs.

Politics Vs. Need

Let's return the article for one last look:

"The need to establish a basket of currencies ... will probably be a point of discussion in the next OPEC summit," Ramirez told reporters during an evening event in the presidential palace.

As discussed above there is absolutely no "need" for OPEC to do anything.

Given that both Venezuela and Iran already hold no dollar reserves, it is highly likely this story is nothing but a political ploy by Venezuela, with no practical relevance.

Ignoring the political aspects, if OPEC actually does have a discussion on pricing oil in a basket of currencies that is not dismissed in 1 minute flat, they are wasting time at best or proving themselves to be complete fools at worst.

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


Copyright 2009 Mike Shedlock. All Rights Reserved.
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