Friday, March 20, 2009

Oil as a Currency

Oil is a currency. It floats in relation to the US dollar and all other paper currencies. This is why it is ridiculous when some say that oil should be traded in other currencies or that the US government has an agenda to keep oil trading in dollars. As I describe in Oil 101 (page 323), the global oil market chooses to trade oil in dollars because it is most efficient that way. Nobody tells oil traders to use dollars, it is simply cheaper for everyone involved to do so.

When the dollar weakens, oil prices rally (all other things being equal). When the dollar strengthens, oil prices fall (all other things being equal).

This wasn't the case before the world moved to benchmark oil pricing. Oil prices used to be fixed in US dollar terms for very long periods of time and it was the the weakness of the dollar in the early 1970s that caused all sort of problems (page 13, Oil 101).

Anyhow, the US government (and by extension us, the people) have decided that we are going to devalue the dollar to reduce our dollar debt burden. Other countries are sure to follow. Inflation is the goal. Printing money ("quantitative easing") is the mechanism.

On Wednesday March 18, 2009, the US Fed announced they intend to release an additional sum of around US$1 trillion of new money supply . The money will be added via the mortgage market. The dollar weakened. Oil appreciated as a currency. Following are two stories I was mentioned in (WSJ - DJN).
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