Source: The Wall Street Journal.
It would be a mistake to think of this story as esoteric or insignificant. Let me explain.
At present, Saudi Arabia accepts only U.S. dollars in trade for oil (this is by agreement between the kingdom and the Nixon administration back in the 1970s). This means that any buyer of Saudi oil must obtain U.S. dollars to pay for it. Buyers can do this in two main ways:
- They can sell products (exports) into the U.S. marketplace, accepting dollars in payment.
- They can buy U.S. federal debt by purchasing Treasury notes.
Either way, the buyer is forced to participate in the U.S. economy, presumably in ways that are, on net, beneficial to the U.S. (whether or not they are beneficial to the buyer).
The purchase of federal debt, however, is problematical. Our federal government has been running deficits for years, which is another way of saying we have been using other countries’ wealth to finance our profligate spending.
HERE IS THE POINT: To the extent that Saudi Arabia begins accepting yuans for oil sales, the U.S. will be forced to reduce deficit spending. That is — for us — deficits will begin to matter.
But Saudi Arabia is not the only country that wishes to abandon the U.S. dollar as the currency standard for trade. India, for example, also would benefit from greater independence from the dollar. And, of course, should China’s yuan become the international currency standard, China will enjoy the benefits the U.S. has exploited for the last 50 years (then lost).
Tidewater News and Opinion Forum 
I’m surprised it took this long.
Perhaps I will get that smaller government after all.
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“They can buy U.S. federal debt by purchasing Treasury notes.”
I guess you will have to explain how buying a Treasury note gives you the cash to buy Saudi Oil. If you have the cash to buy the note, why must you first buy a Treasury note?
Second, you left out a primary source of dollars – currency markets where you can buy dollars with a wide variety of other currencies.
Of course, the dollar being the principle reserve currency works to our advantage. In spite of China’s large economy, it will not supplant us until it establishes a more stable, constitutional form of government and allows its currency exchange rates to be subject to market forces – as our dollar is. Relying on despotic governments is risky. This week, for example, Russia is about to default on a major tranche of bonds it sold in 2013. Anyone holding rubles is screwed.
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RE: “I guess you will have to explain how buying a Treasury note gives you the cash to buy Saudi Oil. If you have the cash to buy the note, why must you first buy a Treasury note?”
As I understand it, Treasuries are used as dollar reserves in the foreign exchange marketplace. The oil buyer needn’t buy treasuries directly, but the currency exchange dealer that holds treasuries is able to convert the buyer’s local currency to dollars to facilitate the buyer’s purchase.
Theoretically, the foreign exchange market doesn’t need a single “reserve currency.” The U.S., however, likes the dollar’s reserve currency status because it means that other nations help sustain the illusion that dollars have material value.
Once that illusion begins to break down, the flow of foreign dollars back to the U.S. will begin to shrink. Russia’s impending bond default is an example of this. The terms of the bond require the interest payment Russia owes to be paid in dollars, but our sanctions have restricted Russia’s access to its own dollar reserves. Because Russia can certainly make its payment in rubles, the effect is like a reverse sanction that may harm us more than them.
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You need to study on this quite a bit more.
The value of the dollar is no more of an “illusion” than the value of any other currency. It is less of an “illusion” than the Yuan because its value is market determined and not by government decree.
No, Treasuries are not used as reserves in currency markets. There are no reserve requirements specific to currency trading that require the purchase of U.S.Treasuries. Central banks do hold reserves of foreign currency. But that is a different subject.
Here is a primer on how currency trading is done. . . https://www.investopedia.com/articles/forex/11/why-trade-forex.asp
Russia can TRY to pay its dollar obligations in rubles, but they will still be in default. A contract is a contract. Bondholders have no obligation to accept anything but the contractual amount of dollars. The ruble has lost more than half of its value in the last three weeks. And still heading south. The Russian economy is on the edge of hyperinflation and total collapse because of Putin’s stupidity. Thirty years of economic progress erased in two weeks.
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RE: “The value of the dollar is no more of an ‘illusion’ than the value of any other currency.”
That’s true, but beside the point. No currency in today’s world has inherent material value.
RE: “No, Treasuries are not used as reserves in currency markets.”
I believe they are, in the manner I described: “The oil buyer needn’t buy treasuries directly, but the currency exchange dealer that holds treasuries is able to convert the buyer’s local currency to dollars to facilitate the buyer’s purchase.”
Perhaps you thought I was referring to the use of treasury notes as a fractional-reserve basis for lending dollars, but I wrote differently.
RE: “Russia can TRY to pay its dollar obligations in rubles, but they will still be in default. A contract is a contract.”
Yes, a contract is a contract, but defaulting on a loan is generally speaking advantageous to the borrower. Russia may suffer some reputational pain, but as long as it has products to sell and buyers willing to buy them, the effect will be temporary.
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“That’s true, but beside the point.”
Uh, it IS kind of the point. If the value of all currency is an “illusion,” why is the dollar at a particular disadvantage or headed for trouble as you seem to wish? The “illusion” for any currency is sustained by having a vibrant economy and a stable government. In spite of Trump’s best efforts, we have both.
Currency market makers MAY park dollars in Treasuries if they are holding more than they can move quickly. But, they don’t have to. The point is that NOBODY HAS to buy Treasuries to buy oil in dollars. The claim following “HERE IS THE POINT:” makes no sense so the suggested connection between the Saudis getting Yuan for oil and American Treasury operations is tenuous at best.
Defaulting on a loan is generally NOT advantageous to a borrower unless they NEVER need to borrow again.
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RE: “If the value of all currency is an ‘illusion,”’why is the dollar at a particular disadvantage or headed for trouble as you seem to wish?”
I wish to avoid de-dollarization of the global economy. If it must happen, I’d at least like to see a system where something better than the dollar serves as the global standard. As I wrote, the problem — for us — with de-dollarization is that the volume of dollars coming back to the U.S. to buy our exports will shrink.
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