David Woo Defends the Oil Price Denomination Fallacy

David Woo, global head of foreign exchange strategy at Barclays, knows a hell of a lot more about the FX market than I do. And it turns out that Woo doesn't dismiss the oil-price denomination fallacy out of hand. In fact, he thinks there's something to it. Here he is in a Q&A with FT readers:

What would be the effect if commodities including oil were priced in a currency other than the dollar? William McMurray
David Woo: The impact on the US dollar would be negative. The fact that the dollar is the main transactional currency for global trade means that the world has to maintain minimum dollar balances to facilitate international payments. If these dollar balances are no longer required, it will be clearly harmful for the dollar. That said, we think the risk that the pricing of Opec oil will soon move to a system based on a basket of currencies is low.

I'm not convinced.

FX movements are the result of FX flows, not FX stocks. If Fred has a trillion dollars under his mattress, that doesn't affect the value of the dollar at all. If he sells that trillion dollars for euros, however, then the dollar will fall. Yes, there are trading accounts with large dollar balances in them, although "large" is relative – I doubt they have more than a couple of billion dollars in them at any given time. If all those balances were converted into euros in one day, that might (or might not) have a small one-off, one-day effect on the dollar-euro exchange rate. If the move was into a basket of currencies, which would include the dollar, then any effect would be even smaller. But such effects would in any event be minuscule in the context of the trillions of dollars of FX flows which get traded every day.

Now Woo is right that "the dollar is the main transactional currency for global trade" – and, I might add, for the FX markets as well. There really isn't any such thing, for instance, as a euro-yen exchange rate: there's a euro-dollar exchange rate and a dollar-yen exchange rate, and the euro-yen "cross rate" is computed from those two component rates. If global trade and the global FX market moved out of dollars as the basic global reference currency, that really would reduce demand for dollar liquidity, and could hit the value of the dollar. But if the chances of oil being denominated in anything other than dollars are slim, then the chances of the dollar losing its reference-currency status in world trade more generally are infinitesimal.

(Thanks to Jesse Eisinger for the heads-up.)