One or multiple international currencies? Evidence from the history of the oil market

Livia Chiţu, Barry Eichengreen, Arnaud Mehl 17 March 2014

a

A

Notwithstanding a near meltdown of the US financial system, the downgrade of US sovereign debt by one rating agency and the emergence of the renminbi as a potential rival, the global financial crisis underscored – in the view of many – how dominant the dollar remains in the global monetary system (see e.g. Frankel 2013, Prasad 2014).

One of the clearest signs of the dollar’s dominant international role is its status as the all but exclusive currency used in global oil markets. The prices of West Texas Intermediate, Brent, and Dubai crude are expressed in dollars. The dollar is used as the unit of account for virtually all benchmark prices. NYMEX, the world’s largest oil futures market, provides quotes exclusively in dollars. In the global oil market, whether for spot, term, or future contracts and irrespective of country, the dollar reigns supreme.

The dominance of the dollar in oil markets is relevant for several key international economic issues. It is essential to the understanding of the dollar’s international status and of international currency choice. It has implications for the degree of exchange rate pass-through of oil and commodity price shocks, and for forecasting inflation.

The dollar as a unit of account

The dollar’s dominance as unit of account and means of payment in global oil markets is said to rest on two pillars.

  • One, as with all facets of international currency status, is network effects (Krugman 1980).

Oil prices tend to be expressed and transactions settled in dollars because the US was the largest global oil producer for fully a century, before being overtaken in the 1950s by the Middle East (Yergin 2008). By then, however, the practice of expressing oil prices in dollars and settling transactions in that unit was widespread, making it costly for individual buyers and sellers to do otherwise.

  • The second pillar is the homogeneity of the product.

Because oil is a relatively homogenous commodity, there is substantial convenience in quoting prices in just one currency to facilitate comparisons (McKinnon 1979).

Room for multiple currencies

In a recent study (Eichengreen, Chiţu and Mehl 2014), we present evidence that the effects of network increasing returns and product homogeneity on the currency used as means of payment in the global oil market are not as strong as conventionally supposed. In earlier periods, oil transactions were in fact undertaken in a number of different currencies. This suggests that there is room for more than one national currency as means of payment even for a good as homogenous as oil. This conclusion is consistent with what we have called elsewhere the “new view” of international currency markets (Chiţu, Eichengreen and Mehl, forthcoming), according to which network increasing returns are not as strong as commonly supposed, first-mover advantage is not everything, incumbency is no guarantee of success, and several national currencies can play consequential international roles.

Specifically, we show that European oil import payments before, and after World War II, were evenly split between the dollar and non-dollar currencies – mainly sterling. Figure 1 (based on data from Economic Cooperation Administration, 1949) shows the breakdown by currency of denomination of total oil imports of 16 European countries participating in the Marshall Plan for selected years (pre-war, 1947, 1949, 1950 and 1953). While the dollar was clearly an important currency for payments, with an average share of about 40% of total oil imports, it was by no means the only one or, for that matter, overwhelmingly dominant. In fact, almost 60% of European oil imports were paid in non-dollar currencies, mainly sterling.

Figure 1. Currency denomination of European oil imports (Oil imports in quantity terms, %)

Note: The figure shows the breakdown by currency of denomination of the oil imports (crude and refined products) of a sample of 16 European countries as a whole in each fiscal year for which the countries reported data in quantity terms (i.e. oil imports in thousands of metric tonnes) to the OEEC (estimates based on ECA, 1949, Tables 5-6, pp. 35-36). Pre-war data are for 1938 or another ‘representative’ pre-war year (ibid., p. 33). Data for fiscal 1953 were projections by the time participating countries were submitting data to the OEEC.

Limited data suggest that what was true of European oil markets was also true of the global oil market. As shown in Figure 2, the dollar was the main currency of payment of global oil imports after World War II, with an estimated share of 31%. But the estimated share of non-dollar currencies was also large, at 23%. Although there is no information on currency denomination for the residual (46%), it is likely that at least some of these imports were paid in currencies other than the dollar.

Figure 2. Currency denomination of global oil imports after World War II (Oil imports in quantity terms, %)

Note: The figure shows the estimated currency breakdown of global oil imports (crude and refined products) in quantity terms (i.e. imports in thousands of metric tonnes) in 1948-49. ‘Dollar’ = imports paid in dollars by European countries (ECA, 1949, Tables 5, p. 35) + US imports (Federal Trade Commission, 1952, Chapter 1, Tables 6-7) + 30% of sterling area imports (Schenk, 1996). ‘Non-dollar’ = imports paid in sterling by European countries + 70% of sterling area’s imports. ‘Unknown’ = imports for which no information is available. Barrels are converted to metric tonnes using a factor of 0.1364 for crude oil and 0.1228 for refined products when needed.

Concluding remarks

Use of the dollar and other currencies in international petroleum transactions varied across countries. We find that these differences in dollar usage were associated with the extent of trade linkages with the US and the size of the importing country. Countries with more stable currencies used the dollar less; strategic motives (i.e. government influence in the oil sector) made countries less inclined to use the dollar; and countries that were constrained by capital controls in their ability to pay freely with sterling used the dollar more. In contrast, we find little evidence in favour of liquidity effects or international political considerations in explaining currency choice.

These findings suggest that there is room for more than one international currency as means of payment even for a good as homogenous as oil. They suggest that network increasing returns are not as strong as sometimes supposed, that first-mover advantage is not everything, and that incumbency is no guarantee of continued dominance. They, therefore, suggest that a shift from the current dollar-based system to a multipolar system is not impossible.

Disclaimer: The views expressed in this column should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

References

Chiţu, L, B Eichengreen and A Mehl, “When Did the US Dollar Overtake Sterling as the Leading International Currency? Evidence from the Bond Markets”, Journal of Development Economics, forthcoming.

Economic Cooperation Administration (1949), Petroleum and Petroleum Equipment Commodity Study, European Recovery Program, March 1949, Washington DC.

Eichengreen, B, L Chiţu and A Mehl (2014), “Network Effects, Homogeneous Goods and International Currency Choice: New Evidence on Oil markets from an Older Era”, ECB Working Paper, No. 1651, March 2014.

Federal Trade Commission (1952), The International Petroleum Cartel, Sub-committee on Monopoly of Select Committee on Small Business, US Senate, 83rd Congress, 2nd session, Washington DC.

Frankel, J (2013), “The Latest on the Dollar’s International Currency Status”, VoxEU.org, 6 December.

Krugman, P (1980), “Vehicle Currencies and the Structure of International Exchange”, Journal of Money, Credit and Banking, 12, pp. 513-526.

McKinnon, R (1979), Money in International Exchange: The Convertible Currency System, Oxford University Press, Oxford.

Prasad, E (2014), The Dollar Trap – How the US dollar Tightened its Grip on Global Finance, Princeton University Press, Princeton: New Jersey.

Schenk, C R (1996), “Exchange Controls and Multinational Enterprise: The Sterling-Dollar Oil Controversy in the 1950s”, Business History, 38 (4), pp. 21-40.

Yergin, D (2008), The Prize – The Epic Quest for Oil, Money and Power, Simon & Schuster, London.

a

A

Topics:  Energy International finance

Tags:  international currency, oil market

Economist in the Directorate General International, European Central Bank

Professor of Economics and Political Science at the University of California, Berkeley; and formerly Senior Policy Advisor at the International Monetary Fund. CEPR Research Fellow

Principal economist in the Directorate General International, European Central Bank