Iran’s Ahmadinejad and Venezuela’s Chavez have made some headlines by declaring that they’ve had it with pricing oil in dollars. Making headlines is what these two men aim to do, so in that sense their declarations were a big success.
They also got the other members of the Organization of Petroleum Exporting Countries to agree to look into pricing oil with a basket of currencies. But I would bet that it isn’t going to happen anytime soon. And even if it did, it just wouldn’t matter all that much.
The dollar is simply the pricing unit for the oil business. Its strength or weakness has no significant impact on the real price of oil. The dollar’s swings just make oil prices look more volatile than they really are. Replacing the dollar with another currency such as the euro wouldn’t change this reality–as soon as the euro started falling, as one of these years it surely will again, OPEC members would complain (as they’re doing now with the dollar) that the weakness of the currency was making them look bad. Replacing the dollar with a currency basket would smooth the volatility, but it would also mean that oil would henceforth be priced in a unit with which hardly anyone was familiar. As a result, all media coverage of oil prices would involve translating the current basket price into dollars or yen or euros or whatever. Which would be a change from current practice, but not the kind of thing that would dramatically change the world or affect the value of the dollar.
Now there are other things that oil exporters can do that would affect the value of the dollar. They can insist on being paid in euros or other currencies, which Iran already does. They can shift some of their central bank reserves out of dollars and into other currencies, which lots of countries around the world–not just oil exporters–are already beginning to do. And if their home currency is pegged to the dollar, they can think about breaking or at least adjusting that link, as Saudi Arabia and several of its neighbors are contemplating.
All these things are putting downward pressure on the dollar and may continue to do so for a while. They may even result in a big, scary shift in which the euro takes over from the dollar as the world’s reserve currency. I wouldn’t bet on that, though: My money’s on the renminbi (or heck, maybe the rupee) in 20 or 30 years.
In the meantime, Ahmadinejad and Chavez can yap all they want about moving oil prices out of dollars. It just doesn’t matter much.
Update: The WSJ has a front-page piece today about the Gulf states rethinking their dollar pegs. Also, in the comments, Benedict Tan makes the good point that we use price indexes for lots of other things, so why not oil? My main response is that, with a pricing unit already available for which there’s decades of history, it’s going to be hard to get people to shift off it to an unfamiliar index. OPEC could make the shift only to find that futures markets keep trading oil in dollars. Still, he’s right that using a currency basket would be better. It might get markets to focus on the real price of oil and not be distracted by the “dance of the dollar.” Irving Fisher would totally approve. Although That Anonymous Dude’s mention of Himalayan yaks (also in the comments) raises the question of whether they might make a good pricing unit for oil.
As for commenter Matt, who thinks I’m an idjit: The status of the dollar as the world’s reserve currency has all sorts of real effects, mainly in allowing the U.S. to get away with financial behavior that other countries cannot. (This does not work indefinitely, though, so it’s a mixed blessing.) All I’m saying is that pricing oil in dollars has no such effects that I can see. And China’s economy is growing faster than India’s, but I also think it’s at higher risk of a wrenching political/economic blowup that could derail growth for years. Plus, India is expected to pass China in population within 25 years. So while I would agree that it’s a longshot, I don’t think it’s totally crazy to mention the rupee as a possible future reserve currency.