Iran Switch to Euros? Inconsequential!
Alarms are ringing, warning of disaster for the US economy if the government of Iran switches from the US dollar to using the euro for its sales of oil. These are false alarms.
by Fred E. Foldvary, Senior Editor
Articles are swishing around the Internet that the US government will not allow the Iranian chiefs to start an oil trading center in euros because this would somehow wreck the US economy. There are warnings that the US military will attack Iran, not so much because of its development of missiles and nuclear weapons, but because a switch to the euro would somehow cause a major fall of the US dollar. The claim is that an oil bourse in euros would decrease the need to hold dollars, and so hundreds of billions of dollars would come rushing back into the US, causing high inflation, sky-high interest rates, and a crash of the dollar relative to other currencies. Some say the US invaded Iraq for this reason also.
The international trade in oil does indeed use US dollars. The US dollar has been an international currency since World War II, and many countries use the US dollar as a reserve or backing for their own currencies. The alarming articles say that after Iran switches its oil sales to euros and creates a euro petroleum exchange center, other Muslim countries and than all oil exporters will start selling oil in euros also, and the dollar will fall out of use.
This is all nonsense. First of all, the only major oil exporter that is in an economic position to switch to the euro is Iran. The other major oil producers have huge financial assets in the US and in US-dollar assets such as bonds. If the US dollar collapses, then the chiefs of these countries, as well as those of China and other countries holding US treasury bonds, would suffer huge losses. Indeed, as the US dollar has lost value relative to other currencies during the past few years, the assets of non-US owners have lost value as measured in their domestic currency, while foreign assets owned by US nationals have gained in value as measured in dollars. The USA also benefits from a lower value of the dollar as this makes exports less expensive to foreigners, offsetting the loss from a higher price of oil.
Now suppose that some foreigners do sell their US treasury bonds. There is a global market for US bonds. Dumping bonds would lower the global price, and raise the interest rate on the bonds. But US bonds compete with the bonds of other governments and with corporate bonds. A higher interest rate on US bonds makes it more attractive and other bonds less attractive, and bond holders would sell other bonds and buy US bonds. Iran would sell US bonds while others would buy them. Interest rates in US-dollar assets would rise very little.
How would billions of foreign-held US dollars come home to the US? Only by foreigners buying US goods and assets, or converting dollars to euros or yen. The only other currencies that have sufficient volume to be useful internationally are the Japanese yen and the euro of the European Union. The US dollar swamps these other two by a huge amount. There are not enough euros or yen for these to be widely-held reserves for international trade.
The long-run value of the US dollar depends on how much stuff a dollar buys. As the dollar falls in value relative to the euro, American goods become priced cheaper for foreigners. If the dollar were to collapse, US assets would be cheap for foreigners. They would come and buy up real estate, stocks, bonds, and your silverware collection. So the dollar will only fall until US goods and assets become bargains. The foreign buying of US goods will make the dollar stop falling.
To sum up, if Iran sets up a bourse to trade oil in euros, the effect on the US economy will be insignificant. Other major oil producers will not follow, because they hold US-dollar assets. The fall in the US dollar exchange rate would be minor, because cheaper US goods and assets would attract buying by foreigners. US interest rates would only rise a little, as higher rates would induce foreigners to buy US bonds. Dollars will not come flooding into the US, because there is a global demand for dollars as a relatively stable currency, the safety of US bonds, and the use of dollars as a currency reserve with no good alternatives.
The US dollar and US bonds trade in a global market where any fall in the US dollar hurts foreign owners of US assets and any rise in interest rates makes US bonds more attractive. Dollars cannot come to the US unless foreigners buy US goods, which is good for US business, or assets, which is good for US sellers. So the effect on the US economy for Iran to switch to euros is trivial. The US chiefs know this, and would not go to war to stop a euro oil bourse.
The real threat from Iran is its development of nuclear weapons and missiles, combined with the declaration by the chiefs of Iran that they seek the elimination of Israel, and soon. The support of terrorists by the government of Iran shows they are serious about the destruction of Israel, to be followed or combined with attacks on US facilities and persons. If you want to worry, be fearful of real threats such as from nuclear bombs and terrorist attacks, and not from crank fantasies about the US dollar.
-- Fred Foldvary
Copyright 2006 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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