What Will Happen to the US Dollar?

By Arthur Mansourian

While economists and investors should stay away from listening to rumors, one rumor has many of them worried; that Iran and Venezuela may begin selling their oil in Euros and move away from the US Dollar. These two countries despise USA and its policies, and would do almost anything to harm the country. If such a move is made, it will hurt the US Dollar substantially. If this takes place, the US Dollar may decline 6-8% in a day! This may lead to a flight of investors to the Euro, which would have a serious impact on the world’s economic stage.

However, there are a few reasons why this may not happen:

1. China and Japan hold billions in US Dollar reserves and a drop in the US Dollar will consequently hurt them very badly. It will cause an economic implosion in Japan and will push their economy into a free-fall and a major recession, if not depression. This would be devastating to Japan, which is coming out of a long and dreadful economic doldrums. The impact on China would be less because their currency is pegged artificially to the US Dollar and to other currencies, however, China will still get seriously hurt in the long run. Since these two countries have good relationships with Iran, they will surely be trying to talk Iran out of switching to the Euro, and will try to influence the final decision. However, Iran has recently announced that they will be looking to use the Euro more.

2. The Euro’s increase will be so significant that it will hurt most European countries in their pocket books. Their import of oil will go through the roof and export will come to a halt. Your average German car would go up in price, which may push people to buy luxury Japanese and American cars instead. Case in point; Airbus, the European airplane manufacturer, is in big financial trouble. Among many production and manufacturing problems, its financial woes have been exasperated by the fact that while its cost is based on Euros, its sales is based on US Dollars.

3. No matter what they say and portray, OPEC has never been a unified organization and a dramatic move such as this will not work unless OPEC as a whole decides to do it. There are always a few members who may break ranks, such as Indonesia or Nigeria, and it is unlikely that Saudi Arabia will turn on the US Dollar. Although OPEC has made cuts in oil supplies recently, they have actually cut less output than they said they would.

On the other hand, other recent factors may provide ample proof that the time of the Dollar-priced oil is over:

1. In December 2005, the exchange rate for every one U.S. Dollar was 0.85 Euros. A year later, one U.S. Dollar is only worth 0.75 Euros. Furthermore, the Dollar fell all the way to a 20 month low of 1.32 against the Euro recently. This decline in the market value of the Dollar was mostly due to the fact that consumer confidence and durable-goods orders both fell more sharply than expected. Furthermore, in October, orders for capital goods (not including aircraft and defense) fell 5.1%, the first drop in six months.

2. Reports from this week show that the housing market’s tumble may have an even wider impact on the economy than originally expected by many analysts. New home sales had the first drop in three months in October, falling 3.2%. Also, the unsold stock of existing homes for sale increased to 7.4 months’ supply. For more insight on this, please read the articles posted by Darwinian.

3. There is a potentially positive side to the falling Dollar. A cheaper Dollar makes imports more costly, leading to hope that it might help reduce the US trade deficit. The US trade deficit topped US$700 billion last year and is headed higher this year, heightening pressure on Paulson to make sure key trade partners like China play fair and making Dollar depreciation a virtue if it means fewer imports. The deficit with China alone last year was more than US$200 billion.

These factors are significant in deciding whether it is likely that Iran and Venezuela may make such a move, since a falling Dollar may entice these two countries and others to sell oil in a stronger and more valuable currency – the Euro. If such countries see that the Dollar is not done falling, they may all join the herd and sell out as quickly as they can to cut their own losses.

Interestingly, Ben Bernanke still believes that the economy will enjoy a soft landing. Bernanke also said that inflation remains “uncomfortably high” this week, and that the economy will grow at its sustainable rate in about a year.

Someone is definitely going to be very wrong very soon.


Resources:

1. http://www.bruneitimes.com.bn/details.php?shape_ID=13085
2. http://www.collegian.psu.edu/archive/2006/12/12-08-06tdc/12-08-06dnews-08.asp
3. The Economist December 2nd – 8th 2006, Volume 381 Number 8506