It appears that the Greek crisis is disappearing into the past. Let’s go back to watching the US stock market rise inexorably to 36,000 and beyond. Another domino has been successfully kept from falling, another ‘key man’ from collapsing … right? No, sez Ambrose Evans- Pritchard:
The Frankfurter Allgemeine summed up the deal succinctly: “No member of Europe’s monetary union should be liable for the debts of another state. Bilateral credit from Berlin for Athens is not the same as German acceptance of responsibility for Greek debt.”
This shatters the assumption since Maastricht that monetary union leads inexorably to fiscal union. By drawing the IMF into Euroland’s affairs, Germany has broken the spell and reduced EMU to a fixed-exchange system with knobs on, like the 1930s Gold Standard that it so resembles. No wonder Jean-Claude Trichet at the European Central Bank is cross.
Far from stemming contagion, the deal leaves Club Med exposed. Underlying default risk has risen for Greece, Portugal, Italy and Spain, as well as for Ireland, Slovakia and Malta even if credit markets keep missing the point. The world’s top holder of EU debt does understand. Greece is the “tip of the iceberg”, said the deputy-governor of China’s central bank. “The main concern today, obviously, is Spain and Italy.”
I’ve noticed the same thing here from America, the comparison between the hard gold standard and the hard dollar standard. The assumption that is being challenged is that which states the rising value of crude oil – which is the axle around which so- called ‘modern’ economies turn will be measured against dollars.
What this means is that crude is priced in dollars and as demand increases for crude relative to supply the value of dollars will shrink.
And so it has up until the middle of 2008, when crude oil was valued highly in the oil market relative to dollars.
Any assumption about crude and dollars needs to be examined, carefully. The dollar is an intermediary. It has no real value itself it is only a proxy. The assumptions made about dollar value decline is part of the assumptions made about continuing economic growth and concurrent inflation. We have always had growth, inflation and a dollar that loses value as a consequence. Dollars are proxies for the final value of goods and services made available and sold in our economies. The assumption that dollars will always lose value is a reasonable one but not an iron law.
Keep in mind that any dollar trade is a three way proposition. Crude is traded for dollars and thence for some other good or service which is made available by the crude. A cheapening dollar has it as the proxy for the final value of the good or service.
It is the good or service that is really losing value relative to crude oil. The dollar is simply an intermediary.
The dollar is not required to be a proxy for the final value of the crude derived good but can instead represent the crude itself. This is the observation that can be made by watching the crude market struggle for weeks to punch though the $84 resistance barrier.
A price that increases past that point suggests that the dollar does indeed represent the final value of goods and services that are the end product of oil use. A price that cannot pierce that level suggests that the dollar represents the value of crude oil, instead.
A price that increase much past the $84 per barrel is one that will increase the likelihood of a general economic dysfunction. $90/barrel represents around 4.5% of world GDP. Even if China can afford $90 oil, it’s customers cannot afford China’s products. This is the reason that China is now experiencing a trade deficit. It’s consumption of primary inputs – including an increasing amount of crude does indeed cost more – represents greater value than the goods it exports.
Even if Saudi Arabia cannot hold the price below $80 a barrel by dumping some spare capacity on the Brent market, the upper bound represented by the current price’s effects on economic activity in general will ultimately hold the dollar price at or below this level. The high- dollar cost of crude is holding all the world’s economies hostage!
What matters is not the dollar price of crude but the value of the crude measured against its productivity. If the dollar price of crude holds steady, the rising value of the crude must be measured by the rising value of the dollar.
If dollars represent oil then the dollar is indeed a hard currency like the gold- backed British pound- sterling of 1930. As then, maintaining the exchange value of currencies is the obsession du jour. With hard currencies, there really is no alternative activity that makes longer- term economic sense. The result is – as Ambrose Evans- Pritchard suggests – Greece twisting slowly in the wind.
The greater result is the that crude and the dollar both in tandem will increase in value while the goods and services decline. In both the hard and non- hard currency regimes, the final value of the goods declines. It’s where the dollar is positioned as the proxy the matters. As a hard currency, the dollar keeps inflation in producer countries in check. It also intensifies deflation in consumer countries. This is because hard currencies – which represent real, valuable primary inputs – are hoarded.
Right now there are a lot of dollars in circulation so the dollar/euro relationship is fluid. But … as more dollars are hoarded and removed from circulation, the relationship will change with the dollar becoming more scarce and more desirable. The dollar will increase in value relative to the euro as well as other currencies.