Venezuela Switches to Euros -- Ominous News for the American Economy
Recently, Business Week reported that oil producer, Venezuela, "has moved its central bank foreign reserves out of U.S. banks, liquidated its investments in U.S. Treasury securities and placed the funds in Europe."
The importance of this news should not be underestimated.
Generally speaking, international trade has become a process in which the U.S. produces dollars and the rest of the world produces goods and/or services that dollars can buy. Nations trade to capture needed dollars to service dollar-denominated foreign debts and to amass dollar reserves in order to sustain the exchange value of their domestic currencies. As it currently stands, if a country wants to prevent damage to its currency, that nation's central banks must acquire and hold dollar reserves in amounts corresponding to their own currencies in circulation. Fortunately for the U.S., this system (in place since WWII) creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold even more dollar reserves, making the dollar stronger still.
This phenomenon, known as "dollar hegemony," is created by the geopolitically constructed peculiarity that critical commodities, such as oil, are denominated in dollars. And because oil is priced in "dollars" for the most part, everyone accepts dollars as the currency of choice.
The strength of the dollar since 1945 is a result, for the most part, of the dollar being the international reserve currency for global oil transactions (i.e., "petro-dollar"). As a result of the dollar being the standard denomination for oil transactions, the U.S. prints hundreds of billions of these fiat petro-dollars, which are then used by nation states to purchase oil from the oil producing nations. These petro-dollars are subsequently recycled from the oil producing countries back into the U.S. via Treasury Bills or other dollar-denominated assets such as U.S. stocks, real estate, etc.
Because of this system, dollar reserves must be invested in U.S. assets which produces a capital accounts surplus for the U.S. economy. Luckily for the United States, the U.S. capital account surplus finances the U.S. trade deficit to a certain extent. [But if the capital account surplus should diminish (as countries shift to euros rather than dollars) and the U.S. trade deficit continues to grow even wider, the American economy will rupture quickly.]
Since the U.S. prints the petro-dollars, for all intents and purposes, the U.S. controls the flow of oil. When oil is denominated in dollars as the only fiat currency for trading in oil, an argument can be made that the U.S. essentially owns the world's oil for free.
So what happens if the oil producing nations decide to suddenly begin trading oil on the euro standard? Without being dramatic, the United States would go into economic ruin. Oil-consuming nations would be forced to flush dollars out of their central bank reserves and replace them with euros. The dollar would crash in value and the consequences would be similar to the types of currency collapses we have seen in Mexico, Argentina, etc. Foreign investments would pour out of the U.S. securities markets. Similar to the 1930's, the current account deficit would become unserviceable, the budget deficit would go into default, many banks would collapse overnight.
And that's just what would happen in this country. America's economic crash would result in the economic crash of many other nations. Most notably-- Japan.
We all know what happened to the last major oil producing country that shifted from dollars to euros. We also know what might happen to other major oil producing countries if they shift to euros.
As we have discussed at The Bulldog Manifesto (here and here), history is filled with examples where the United States has used military force to protect it's economic interests.
And now that Venezuela is shifting, what will happen to them?