PetroEuros

March 1, 2004

In a recent article, The Economist discusses the notion of currencies being backed by fiat power. Since no major country now backs its currency with gold, the value of currencies is based solely on the good faith of those who use it. Further, currencies are kept roughly in line with each other by Central Banks, which use a variety of tools to keep exchange rates stable in order to promote their country's fiscal policies. The Economist argues that because currencies are valued solely on this good faith, it is possible for a catastrophic collapse in values due to a loss of confidence.

I agree with the author that it is possible we are in store for a massive devaluation of the dollar, but I do not believe it is because of the fiat power of money. First off, the dollar isn't really untied, but is loosely fixed to the price of crude oil. The danger we face isn't that the world loses confidence in the dollar so much as the world opts to value oil in Euros. If the international community determines that the Euro should be the currency which oil is priced in on a global level, the US will be forced to buy Euros, (and thus sell dollars,) in order to obtain necessary energy supplies. This forces the price of oil in dollars to rise, which leads directly to inflation.

What this means is that we, as Americans, have very little control over inflation in our country. If OPEC decides that the Euro is the way to go, there really is very little the US can do about it. As long as we remain dependent on foreign oil, this is a very realistic scenario.