Foreign Correspondence

[Amaunet]

That is a good site. I think what the United States is considering is subsequent foreign investment or the second part of the cycle, the return of the petrodollars in the form of bank CD's, treasury securities or other dollar-denominated assets such as U.S. stocks, real estate and so forth.

This from your reference seems the key: the US Dollar's relative value is not determined by the currency in which oil is priced, but by the desire of foreign investors to hold dollars or investments denominated in dollars.

The U.S. must feel that trading in the euro will inhibit OPEC or other foreign producers from investing in the United States.

This, however, is not written in stone as OPEC while trading in the dollar already invests in Western European countries.

Thus this is a matter of degree and success is contingent upon how smart the banks are in lending their deposits from OPEC countries, petrodollars.

The United States by its past treatment of wayward producing countries seems to fear a break in the petrodollar cycle albeit the lending or the third part of the cycle has soured.



Now that we have viewed many long term fundamentals that affect a currency's strength, let's look at the more recent history of the U.S. dollar and see how these fundamentals have caused it to fall.

The enormous U.S. debt and balance of payment deficits really began about 1973. At that time, the price of a barrel of oil was about $4.00/barrel. A few years later, the price was over $21/barrel as the OPEC nations consolidated and cut back production. The price of oil peaked in 1981 at over $31.00/barrel.

Did this stop the United States from burning oil? Hardly. Consumption did go down temporarily, then rose again sharply. The same was true of most industrialized countries, but the United States, as the major oil consumer, accounted for large percentages of worldwide oil purchases yearly.

The result was what has been called the greatest shift of wealth in the history of the world. Billions and billions of dollars went from the United States to the OPEC countries, mostly in the Middle East. These middle eastern countries essentially had no economy, other than the drilling and production of oil. They couldn't just put their windfall of dollars into their economy because hyperinflation would result. So they sent the dollars back to the United States and other western European countries, depositing them in the form of bank CD's, treasury securities, etc. Hence was born the term "petrodollars."

The large U.S. banks, with a sudden influx of petrodollars (deposits from OPEC countries) needed to loan the money. How else do banks make money? But the U.S. economy was in a recession as a result of the sudden sharp rise in oil prices, and businesses weren't in the market for big loans. Where could the banks go?

The banks lent their petrodollars to third world developing countries, which needed money badly because of the sudden boost in oil prices. The developing countries desperately needed oil -- for industrial expansion and public consumption. They didn't have the money to pay for it, so they borrowed dollars from the large U.S. and western European banks. They were willing to pay high rates for the loans, and for a brief (exceptionally brief) time, everyone was happy. OPEC nations had a safe place to park their influx of cash, large U.S. banks had a place to loan the petrodollars at decent rates, and developing countries had the funds to continue purchasing oil.

But this situation created a problem. The United States was sending billions of dollars yearly out of the country for a product that literally went up in smoke when consumed.

To make matters worse, many developing countries borrowed so much they could not repay their loans. Some couldn't even pay the interest. Thus, dollars were not returning to the United States. These dollars were needed to help reduce the trade deficit.

The banks refinanced at lower interest rates, consolidated loans, issued new loans to help the countries make their interest payments and after a massive default by many emerging nations an entire restructuring of the third world debt took place (The Brady Plan).

But even today, the problem continues. Ten of the twelve largest U.S. banks have more loans to developing countries than they have total shareholders' equity and the lending continues. Loans by U.S. banks to emerging nations has grown dramatically in 1993 and 1994.

This puts the U.S. in a vulnerable position. When just one of the developing countries appeared to be near default again (Mexico was the culprit, as it was also the first nation to default in the 1980s Third World Debt Crash), the U.S. was forced to defend Mexican debtors.

Had Mexico been allowed to default, the major U.S. banks may have fallen below their reserve requirements and would have been forced to stop making commercial and private loans altogether, with disastrous results to the U.S. economy. To prevent this default, the United States had to loan huge amounts to Mexico. Today the U.S. must also continue purchasing goods and giving aid to many of the developing countries, with the equally-disastrous result that the dollar becomes weaker and weaker.

There is no easy way to change this flawed structure. The third world economy is hooked on the dollar, but there are already so many dollars in circulation that they fall in value steadily. Signs of strength in several developing economies will help reverse this scenario. The weakening U.S. dollar makes American-made goods cheaper overseas, giving promise of increased U.S. imports and a potential lessening in balance of payments deficits. Hope is on the horizon. But overall, the value of the dollar is locked into a downward spiral. Without fundamental changes, the dollar will continue to fall.

Now that you know the long term fundamentals that affect the dollar and all currencies you know what to watch for to see if the dollar will reverse its trend in the long term. Next chapter we learn factors that cause currencies to rise and fall in the short term.



All Content Copyright Gary A. Scott 1968-2003 (unless stated otherwise)

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