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Niti in Sanskrit means policy/strategy/vision. This blog hosts my political views, along with news and commentary. This blog has moved here.

Thursday, February 24, 2005

Dollars and Oil

Daniel Drezner asks, "How stable is Bretton Woods 2"?
Economists are labelling the current monetary arrangements as Bretton Woods 2. Under this system, the U.S. is running massive current account deficits to be the source of export-led growth for other countries. To fund this deficit, central banks, particularly those on the Pacific Rim, are buying up dollars and dollar-denominated assets.
Why do most of the countries accumlate dollars? If all they wanted to subsidize export-led growth they could have purchased any other currency, say Euro. I think a major reason is because their biggest import is oil from the Middle Eastern countries. To buy oid they need dollars. Why?

Because M.E. countries demand dollars for oil! Oil selling countries need a currency which has low inflation and also make it easy for them to invest in a relatively low-tax property-safe environment. US provides a reasonably low-tax, property-rights based economic and political environment to the Oil selling countries. Plus, US also protects them from invasion by maintaining bases in the M.E. region.

If oil selling countries in M.E. region decide to switch to Euros, they may not be sure if US will protect them with the same enthusiasm. Also, in order to invest in US economy they will have to again convert Euros to US dollars.

Therefore, dollar may reign as an international currency of choice until countries in M.E. region decide to do something different.
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