Iranian Oil Bourse

by John Quiggin on February 26, 2006

I got an email asking me about the Iranian Oil Bourse, which is causing great excitement among the Peak Oil crowd. Here’s my draft response. Comments appreciated.

“Bourse” is just another word for “exchange”, and the creation of one in Iran is an attempt to capture more of the economic activity associated with international oil markets and also perhaps to exert more control over oil markets.

The US gains directly from the fact that people hold US currency (since it costs almost nothing to print, but can be used by the US government to buy goods and services – this is called “seignorage”) and indirectly in terms of perceived power and influence from the fact that the $US is the dominant world currency. The switch to euros threatens both. However, the total benefits are not that great. The seignorage benefit to the US from overseas holdings of $US is between $15 billion and $50 billion per year, and the United States has many more important sources of power and influence than the $US.

There is a lot of talk, as in the Peak Oil article linked above, about how Saddam’s switch to euros led to the Iraq War. Actually, as the Iran example shows, overt decisions to switch are usually the result of bad relations with the US, not the cause. Still, this is part of a general pattern of incidents, small in themselves, where aggressive US foreign policy is exacerbating conflict over economic issues, and thereby weakening the US economy.

{ 43 comments }

1

Raw Data 02.27.06 at 12:53 am

Not exactly on point but I think that the key sentence in the “peak oil” article by Petrov is his plaintive suggestion about Bush that “[h]e must have had some other reason to invade Iraq.”

I have long felt the same way: why? Petrov says that it is not about oil per se (I agree) and so suggests that “Benefits from Iraqi oil fields are hardly worth the long-term, multi-year military cost. Instead, Bush must have went into Iraq to defend his Empire.”

“Must have…” I guess others are as mystified as am I.

2

abb1 02.27.06 at 4:27 am

I don’t understand this. Suppose oil is traded only in Mongolian tugriks. So, you take your currency to the forex, exchange it for some tugriks and buy all the oil you need – and then the seller immediately converts tugriks to euros or yuans or whatever. Net benefit for Mongolia? Exactly zero. What difference does it make? It seems to me that as oil exchange currency the US dollar is no more more significant than a subway token.

3

abb1 02.27.06 at 4:42 am

I mean, conversion of whatever currency the buyer has into dollars and then from dollars into whatever currency the seller wants – it’s so fast, it takes minutes or seconds; it’s a computer transaction; there’s no opportunity for the US government to issue additional dollars and collect the tribute in the middle of any particular transaction. And the next transaction will already take into consideration any inflationary actions carried out by the US government. Correct? Where am I wrong here?

4

ajay 02.27.06 at 4:50 am

I agree, abb1. I’ve always wondered about that argument. Sure, if you can only buy oil in tugriks, demand for tugriks goes up because everyone needs to buy them in order to buy oil; but then all the sellers need to sell all their tugriks for dollars or whatever in order to buy the stuff they want, so the demand goes down.

The argument that selling oil in dollars somehow benefits the dollar ignores the fact that the oil producers aren’t just collecting lots of dollar bills in an immense Scrooge McDuck swimming pool – they’re spending the dollars on imports.
But I am not an economist. Someone who is?

5

John Quiggin 02.27.06 at 5:00 am

As I tried, maybe not successfully, to explain, the only thing that yields direct benefits to the US is foreign holdings of US currency (that is, actual dollar bills). These are good for the US because foreigners have to supply goods and services to get pieces of paper.

The general idea is that the more trade is denominated in a given currency, the more prominent the currency and the greater the likely demand for physical holdings of that currency.

But to clarify, there is no direct effect from denominating oil transactions in euros rather than dollars.

6

John Emerson 02.27.06 at 6:25 am

As I see it, the only intelligible motive for the second Iraq war was the plan to put permanent bases in the Gulf area, so that we have more direct leverage on Iran, Saudi Arabia, and the Gulf States. There were a multitude of secondary reasons for choosing Iraq specifically, but altogether they didn’t add up to an adequate motive.

In this analysis the Saudis and the Gulf States would be an ultimate target, which makes a lot of sense; the Saudis and the Gulf States are the primary force behind global Wahhabite nationalism. Our simultaneous alliances with Israel and the Saudis were always a bit dodgy, no?

Occasionally a Bush supporter on the net will agree with my interpretation, supporting Bush’s plan as I describe it. A lot of the confusion and rage in the discussion of the present Iraq war comes from the fact that voters would not support an imperialist war about oil, especially not a strategic one where the first target is not the real target. So the pro-war argument has always been nudge-nudge wink-wink.

7

abb1 02.27.06 at 6:39 am

They already had bases in Saudi Arabia and Gulf States. They wanted to whack Saddam, to make an example of him. And to control the oil, of course. It’s no different than anything you see in the Sopranos, except there’s no FBI.

8

Brendan 02.27.06 at 7:00 am

‘They already had bases in Saudi Arabia and Gulf States. ‘

They had to move the bases out of Saudi, cos thats what Osama wanted. And what Osama Bin Laden wants, generally, the Bush administration gives (including his freedom, apparently).

9

Tim Worstall 02.27.06 at 7:01 am

I’ve always been very confused by this trading oil in euros argument. That confusion coming from why anyone actually believes that it’s important.
Fully agree with John Q on the seignorage and it’s to do with, as he says, the paper money, not the stuff running around computer systems.

Quick numbers. The oil market (80 million barrels a day? at $60 per barrel?) is about $5 billion a day or a couple of $ trillion a year.

The forex markets are $1.5 trillion a day in London alone. Trading all oil globally in euros with the necessary switching in and out of the euro would be a day or two’s trading spread out over a year.

Yes, I know very rough figures and also that things happen at the margins in economics but difficult to see how this would have any great effect.

What would be more worrying is if some in the current Administration buy the argument but anyone think that people like Bernanke actually do?

10

Brett Bellmore 02.27.06 at 7:21 am

But it’s only “an imperialist war about oil,” in the most indirect sense: Buying oil from the middle-east would be no more of an issue than buying it from England, (We’re not going to war over the North sea oil reserves, are we?) if it weren’t for the regrettable fact that the profits from selling that oil are fueling the world-wide expansion of Wahabbism and international terrorism.

So, sure, if they didn’t have the oil, we’d have no reason to go to war, because they couldn’t afford to be a threat, but we’re not going to war FOR the oil. We’re going to war to stop what they’re spending the profits on.

Frankly, we’d do as much to hurt international terrorism by ending the war on drugs, (It also funds terrorism.) at much less cost, but that would actually expand human liberty, so Democrats can’t get behind doing THAT…

11

abb1 02.27.06 at 7:30 am

The Iraqi government wasn’t financing either Wahabbism or international terrorism.

12

dale 02.27.06 at 8:18 am

it’s an interesting discussion (what were the reasons for the iraq invasion) – imo, it’s obviously oil, though not solely. i would imagine reasons for the invasion and destructyion of iraq were multiple, and included the establishment of permament bases (see here for details of massive permanent bases), as well as dramatic – the invasion and subsequent destruction of iraq, as well as all the horror, bullying and beating that has accompanied it, serves as a marvellous show of force in support of the new american doctrine of “applied force when it suits us”.

in service of this latter objective, it should be noted that the revelation of US atrocities and the fact that the US government so plainly doesn’t care about them is also a type of show of force, and a very effective one.

as far as i recall, one line of discussion at the time of the invasion and destruction of iraq included a focus on water – didn’t iraq have a sophisticated regional utilities infrastructure or something? did anyone follow this up?

13

Jack 02.27.06 at 8:18 am

Surely it’s not only seignorage but also the liquidity premium caused by states, corporations and individuals holding reserves of dollars because that is what will buy oil or grain or service debts in an emergency.

14

John F. Opie 02.27.06 at 8:30 am

Hi -

Any shift from the dollar to the Euro for international trading purposes is a nightmare for the ECB.

Why?

Because the ECB has a money fetish: they actually care about the state of M1, M2, M3 and all the attending money volumes.

Having the Euro serve as the international transaction instrument would mean that the M indicators would become distorted beyond all sensibility, like they have in the US. Hence it’s not really in the interests of the EU to allow this to happen: it means that they will lose their ability to adjust the M1, M2 and M3 to fit their monetary policies.

That these are irrelevant doesn’t mean anything to them, it’s their fetish. And I’m using that term in the anthropological sense.

Functionally, there is no difference between a bourse in dollars and one in euros: neither one are the native currency of Iran, so the motives are a tad bizarre and can only be put down to yet another Iranian attempt to embarass the US.

Sort of pathetic, when you get right down to it, sort of on the level of Tom and Jerry, if you know wahat I mean (and take a look at my blog if you don’t…)

15

soru 02.27.06 at 8:35 am

A lot of the confusion and rage in the discussion of the present Iraq war comes from the fact that voters would not support an imperialist war about oil, especially not a strategic one where the first target is not the real target. So the pro-war argument has always been nudge-nudge wink-wink. .

Actually, I think if you track the level of US domestic support for the war, it has little correlation with any particular setback or incident on the ground, and a lot to do with changes in gas prices.

So I suspect a proportion of the war’s supporters were only backing it because of the ‘nudge nudge’ agenda, and were disappointed when they found out that it didn’t come to pass.

16

jet 02.27.06 at 8:54 am

Soru,
That would be a truly disturbing correlation.

Abb1,
Saddam was giving large sums of money to support terrorists who operated internationally, ranging from Syria, Lebanon, Palestine, and Israel (with some attacks in other countries). I believe you refer to them as “freedom fighters”.

17

Carlos 02.27.06 at 9:58 am

Some of the biggest benefits of the seignorage are indirect, however. Being able to borrow money in a currency of which you control the supply, is a pretty big benefit, for example.

18

abb1 02.27.06 at 10:01 am

I haven’t heard of Saddam giving any large sums to any freedom fighters in Syria, Lebanon, Palestine or Israel. If you have evidence – post the link, if not – stop trolling, buddy.

19

notsobright 02.27.06 at 11:10 am

I never get the Euro/Dollar argument either. I’m perfectly willing to believe that it’s because I’m a fool when it comes to econ.

It’s stated as the idea that the U.S. can print more dollars to buy gas — but can’t Poland just print more zloties to buy dollars? The zloty falls, but surely oil is priced with an idea of the relative worth of a dollar?

20

y81 02.27.06 at 11:12 am

Is there any empirical evidence that foreign policy conflicts are weakening the U.S. economy? (E.g., time series date showing a correlation between the global popularity of the United States and its economic performance?) Otherwise, the last paragraph of Quiggin’s post seems like the sort of silly thing one would find in a newspaper column, not something a social scientist (or even a social scientist manque like me) would say or respect.

21

ajay 02.27.06 at 11:29 am

5 – Aha, I understand. Thank you for explaining that. So my next question is: does that mean that there would be no problem with an Iranian oil bourse if it priced oil in dollars?

22

Jack 02.27.06 at 11:59 am

Why do we have to guess why we went to war? Shouldn’t there be an official statement that makes everything clear?

Since we do, I favour the “Murder on the Orient Express” solution — wherever you look there is someone who had it in for Saddam: oil people, military strategists, democracy idealists, WMD paranoids, domestic political expediency, PNAC delusionals, Iraqi adventurers, Iran, Israel, the Kurds, Osama bin Laden, Kuwait, Saudi Arabia, Presidents with family vendettas. The list is endless. THE reason is a red herring or something unsatisfyingly abstract and devoid ov villains like internal US motivations for external foreign policy in an environment of weak policy feedback rather than the hidden identity of an authentic puppetmaster.

y81, for the same reason that Argentina, Indonesia and so on couldn’t print pesos or ruppiah when they had crises. The dollar is currently the most lliquid currency and the US economy provides stabilising ballast for it. At the same time the US benefits by, for example, being able to borrow in its own currency and being able to agree prices in teh same currency.

If you are a small country you may not be able to borrow in your own currency so when you have to print money your courrency collapses but your debts do not.

23

abb1 02.27.06 at 12:32 pm

I’m not sure I agree with “you borrow in your own currency” argument, if I understand it correctly. Anyone can borrow in their own currency, the only problem is they’ll have to pay a helluva lot of interest if their currency is weak and keeps falling relative to other currencies. I don’t think the US is immune from that. It just hasn’t happened yet.

24

omada 02.27.06 at 12:38 pm

Energy banker and blogger Jerome a Paris wrote a Daily Kos diary on the Iranian oil bourse just a couple of days ago.

25

Brendan 02.27.06 at 2:23 pm

‘Actually, I think if you track the level of US domestic support for the war, it has little correlation with any particular setback or incident on the ground, and a lot to do with changes in gas prices.’

Er….I doubt that. Unless you have some evidence to support that theory.

What does predict support for the war with a high degree of accuracy is….casualties. BUT not just casualties. Instead the cross-confound is how well the war is perceived to be fulfilling its aims: or, to put it in less high-falutin’ language, how likely it is perceived to be that the US ‘win’.

The article I’ve been quoting from ends with this hypothesis: ‘Public support for U.S. military operations, then, does not inexorably decrease like sand flowing through an hourglass. Instead, the American public regularly makes judgments about the potential costs and benefits of a military operation. As the likelihood of obtaining any benefits diminishes, the human cost of war becomes less tolerable, and casualties reduce support for the operation. On the other hand, if and when the public is optimistic about a successful outcome, it is far more willing to bear the human cost of war.’

The problem with Iraq is that, far quicker than Vietnam, it has become perceived as being an ‘unwinnable’ war. Also it’s possible that, ‘ in the years since Vietnam, the advance of technology has changed the level of “necessary” casualties that the public believes success requires. In other words, the public will tolerate the evil of casualties provided that they are truly necessary for victory — but the technological prowess of the American military has changed the public’s expectations of how many casualties are in fact needed to achieve victory’.

In any case, what is definitely the case is that in Vietnam, Korea and Iraq, once support has started to fall, it will tend to continue with that trend in general terms over the long run. The only way the situation would be saved is (and this is me talking, not the authors)

a: Extremely clear and concise criteria for what ‘winning’ would look (in Iraq) like were set out (‘things will get better’ or ‘we will establish democracy’ don’t count, as these aims don’t really mean anything, or rather they mean whatever you want them to mean)

b: An extremely clear plan or plans for moving towards the winning scenario were set out

c: The plans were worked out and acted upon and, within a reasonable period of time, were shown to be working (and by working I mean working by reasonably ‘public’ and objective criteria: i.e. casualties starting to fall, US troop withdrawals, something like that).

Since the Bush administration has been in Iraq for three years, and hasn’t even reached point ‘a’ yet, i would guess that the chances of a huge leap of confidence in his foreign policy judgement, and a long term surge of support for the invasion or Iraq, are slim.

http://www.foreignaffairs.org/20060101faresponse85114/christopher-gelpi-john-mueller/the-cost-of-war.html

26

fifi 02.27.06 at 2:41 pm

The political dimension is important. A currency must have people’s confidence, which requires for it to be embedded in a strong and thriving political system. A switch from the US $ has symbolic associations constituting meanings about confidence in the American identity. Already for many Americans there’s a whiff in the air of decline. This won’t help.

27

John Quiggin 02.27.06 at 2:54 pm

“Is there any empirical evidence that foreign policy conflicts are weakening the U.S. economy? (E.g., time series date showing a correlation between the global popularity of the United States and its economic performance?)”

This depends on how you view trade and current account deficits, which are the variables most directly affected. Both have grown dramatically under Bush, and it seems reasonable to suggest that weakness in US exports is due, at least in part to negative sentiment regarding the US.

Of course, as long as debt is denominated in $US, you can regard all this as a sign of strength if you want.

28

Colin Danby 02.27.06 at 5:16 pm

The weakening will be straight through the Balance of Payments, just like with Vietnam.

The currency-Iraq thing is a fringe conspiracy theory that’s been floating around for a while — a student asked me about it a couple of years ago. Here’s one quick discussion: http://www.pkarchive.org/economy/NothingforMoney.html.

29

Harald Korneliussen 02.28.06 at 4:59 am

abb1 wrote: “So, you take your currency to the forex, exchange it for some tugriks and buy all the oil you need – and then the seller immediately converts tugriks to euros or yuans or whatever. Net benefit for Mongolia? Exactly zero. What difference does it make?”

But the seller doesn’t immediately convert the tugriks to euros, does he? Wouldn’t it be prudent of him to keep a reserve of tugriks?

30

ajay 02.28.06 at 5:01 am

The other point is liquidity. Not to put too fine a point on it, who the hell is going to shift from doing business in London or New York to Teheran? First of all, given that even the Japanese are having trouble running a computerised exchange, would you trust the Iranians? Would you trust contracts made under Iranian law? Would you trust an Iranian court with a derivatives issue?
And why would you shift from a highly liquid exchange like London to a new startup which offers no clear advantages?
For that matter, why would you shift to doing business in euros?
Even if Iran sells all its own oil only on the IOB, that’s still only 4% of total world production.

31

abb1 02.28.06 at 7:20 am

Why would it be prudent for the seller to keep a reserve of tugriks? I don’t get it.

32

ajay 02.28.06 at 7:35 am

As far as I understand, here’s why: oil price suddenly doubles, so your oil bill doubles, so you need to pay twice the number of tugriks. Of course, as soon as oil goes up demand for tugriks will also go up, so the tugrik will become dearer; leaving you in a bit of trouble unless you already have a few tugriks in an old sock somewhere, in which case you can buy your oil with them rather than having to buy expensive tugriks in order to buy expensive oil.

33

John F. Opie 02.28.06 at 9:38 am

The whole point of having your domestic currency also be the world’s currency is that you don’t have to maintain foreign reserves worth a darn.

This means that instead of capital being caught up in massive foreign reserves (so that your central bank can handle all the external redemptions of your local currency) like it is in many countries in the world, you maintain very small foreign reserves, more or less because you’ve committed to do so.

34

abb1 02.28.06 at 9:41 am

First of all it’s the buyer – not seller – who may want to keep some oil currency in reserve.

Well, this is all symmetrical – price of oil is equally likely to go up or down at any given moment, and price of the tugrik too. Also, if oil is worth more tugriks, then the oil sellers will have to get rid of more tugriks, it’ll balance out. It just serves as symbolic token in this case.

35

Phil 02.28.06 at 11:02 am

The more significant market is the market for oil futures and options rather than the market for oil itself. Trading oil in dollars as opposed to any other currency means that the buyer has to obtain $X+d to purchase the oil and shortly after the seller has to dispose of $X-d where X is the price of the oil and d is the commission. If both purchases take place at the same time the net effect on the dollar is to slightly increse the volatility of the dollar in the very short term.

The price of oil and the exchange rates both fluctuate. If you are a European buying oil you face the risk of the dollar price of oil changing unfavorably plus the risk of the exchange rate changing unfavorably. Both risks can be hedged using options and/or futures. These effects are spread out over a much longer term as the hedging strategies of the buyers and sellers are not matched.

The result is that currencies that are used by the commodity exchanges tend to be much more volatile than non-commodity currencies. That is one of the main reasons why Major could not keep the pound in the ERM, the volume of sterling traded each day was greater than all the other currencies combined. The volumes traded on the LSE or NYSE are much larger than the amounts traded on the commodity exchanges but the proportion of foreign money washing into and out of the exchange is much greater.

Given that exchange rate stability is considered to be a desirable goal these days there are considerable disadvantages to being a trading currency for a major commodity.

That said Iran could probably realize its goal of trading oil in Euros if it found a way to offer a futures contract that was attractive to traders.

36

y81 02.28.06 at 9:52 pm

Well, john quiggin, I am afraid you would have to show a much longer time series than that for me to take your argument seriously.

37

saurabh 03.01.06 at 1:28 am

Re: ajay, if the price of oil doubling led to greater demand for tugriks, why wouldn’t we have seen the dollar climbing in the past year? Instead while the price of oil skyrocketed, the dollar dropped… That suggests to me the petroleum markets just aren’t that important to the forex markets.

38

Daniel Boone 03.01.06 at 2:48 am

One thing is certain, the euro is gaining a foothold in the world markets ever since its inception and it’s challenging the ubiquity of the US$. The more the world commerce uses the euro, the less we transact in US$ and, hence, the US currency loses importance, which eventually poses serious problems to the overindebted US economy. Furthermore, conceivably the Iran oil bourse could start as a local marketplace for the Iran oil, Iran providing liquidity at first as the sole market maker, that is, just selling the oil through the bourse to whoever wants to buy it at market prices.

39

John Quiggin 03.01.06 at 3:44 am

“Well, john quiggin, I am afraid you would have to show a much longer time series than that for me to take your argument seriously.”

Pleased to see someone taking the long historical view. I’ll be sure to disregard anything you say about the Bush Administration in future, since, as you say, the time series is too short to make any reliable inference.

40

Alan Oldfield 03.01.06 at 2:36 pm

Ron Paul talks to congress 15.02.2006 (see video)
http://www.energybulletin.net/12987.html

“Dollar dominance got a huge boost after World War II. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world’s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.

The 1944 Bretton Woods agreement solidified the dollar as the preeminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world’s reserve currency. The dollar was said to be “as good as gold,” and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.

The U.S. did exactly what many predicted she would do. She printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question– until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each $35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.

See Wikipedia petroeuro:
http://en.wikipedia.org/wiki/Petroeuro
It all ended on August 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it– not even a pretense of gold convertibility, none whatsoever! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.”

41

Alan Oldfield 03.01.06 at 3:15 pm

An article with a similar conclusion was written by Iranian academic Bahman Aghai Diba for the Persian Journal. These pieces insist that Iran lacks the legal and financial infrastructure to host international trading in oil.

These writers are missing a key point. They are assuming that oil will continue to trade freely, albeit perhaps at a much higher price. They assume that liquidity and transparancy will endure in the oil markets. But there may come a time when geologically driven oil shortages dry up liquidity in the oil markets. There may come a time when politically driven resource competition creates shortages in the oil markets. Liquidity will disappear when sellers in New York and London cannot guarantee delivery. It stands to reason that commodity markets function best, with great liquidity, when there is a plentiful supply of goods to trade. If there is a shortage, much less of that commodity will end up on the auction block. This is especially true for strategically critical commodities such as oil.

http://www.energybulletin.net/13225.html

42

Robert McHugh 03.01.06 at 3:41 pm

Fed Vice Chairman Roger Ferguson unexpectedly announced Wednesday he was stepping down to pursue “other professional opportunities” (translation: that usually is the terminology given when either the boss or the employee are not happy with each other). Interesting timing, with M-3 about to be hidden, with the Iran oil bourse about to only accept Euros. Recently, Bernanke replaced Greenbackspan as Fed Chairman, which comes on the heels of the resignation of the Philadelphia Fed Regional Bank President Anthony Santomero, which followed resignations of two of the seven Fed Governor spots (which Bush finally filled this week), and six of the twelve Fed Regional Bank President posts over the preceding two years. Hey, Fed Governors and Regional Bank Presidents are treated like gods. They have enormous power, prestige, and presence. Why quit? Why the wholesale resignations? Could it have to do with what’s coming down the pike?

43

neontetra 03.02.06 at 12:36 pm

“Suppose oil is traded only in Mongolian tugriks. So, you take your currency to the forex, exchange it for some tugriks and buy all the oil you need – and then the seller immediately converts tugriks to euros or yuans or whatever. Net benefit for Mongolia? Exactly zero. What difference does it make? It seems to me that as oil exchange currency the US dollar is no more more significant than a subway token.”
—abb1

This post brings up the very good question: what difference does it make what currency oil trades in, anyway? So, lets follow the admittedly absurd proposition that oil may only be traded in tugriks. A single crude oil contract (one thousand barrels) is worth almost 62 thousand bucks today. That converts to 73.5 million tugriks. Given a week or two, a banker might be able to come up with that sum. Don’t forget that currencies are commodities, subject to supply and demand equations like any other. Some have a vary large, liquid market with small spreads between buy and sell quotes, others, like tugriks, don’t. Maybe a Canadian mining and exploration company would want a lot of tugriks now and then. But overall, it is not a huge market.

How many oil contracts can the tugrik support? Total supply is not that large: M2 in 2004 is 847 billion tugriks (stats here). That will buy only 11 thousand oil contracts. Clearly, if the world traded oil only in tugriks, the Mongolian central bank would have to get busy issuing bonds. Bankers all over the world could buy these bonds and lend out the cash to those who want to buy oil. Mongolia would have to issue a lot of bonds. This amount of cash would completely change Mongolia as a nation, because many of those petro-turgriks would come back to Mongolia. What would the Saudi princes do with their tugriks? They would probably buy beautiful ranches in Mongolia and breed racehorses (they probably already do that). Canadian oil-sand barons, Venezuelan oil rich bureaucrats, Russian KGB tycoons, all would have mountains of tugriks. Eventually that Mongolian cash would come home to roost like loyal hunting falcons on the high steppes of Asia. Because if the oil sellers don’t buy Mongolian property with the tugriks, then they will have to sell them – the principal buyer would be the Mongolian central bank.

Mongolia would be flooded with their own cash. Real estate values would soar, stock market values in Ulan Bator would skyrocket. Domestic industries such as mining, farming and manufacturing, would produce so little money in comparison to the huge currency trade that they would be declared unprofitable and irrelevant. Because he money would come in through international banks instead of broad based domestic industry, it would be an extremely unequal distribution of wealth. This is not unlike what has happened to the United States in recent decades. But the US economy, being the world’s largest, can absorb such huge quantities of money much better than the tiny economy of Mongolia.

The real question in my mind is why does oil have to be traded in a single currency? It was Henry Kissenger who formalized an agreement with OPEC, that in return for military protection, OPEC would agree to trade oil only in dollars. Kissenger foresaw the long term structural benefits to this arrangement. It need not be so. A sensible system would be to peg oil to gold. Oil exporters could ask for bullion, or, for countries that have stable currencies, could accept any national money at the rate gold trades for in that currency. Since every nation needs oil, it makes sense to trade it in a way that is internationally equitable.

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