Oil Should be Denominated in Bitcoin
As Henry Harianto rode his ubiquitous scooter up to one of the many makeshift gas stations in Bali to fill it up with petrol from a re-purposed Absolut Vodka bottle, he grumbled about how the price of gasoline has been steadily increasing over the past year and that it’s been eating into his living expenses. Harianto is not alone. In the archipelago of 168 million people, the fall in the Indonesian rupiah (the local currency) has been progressively making oil — the feed stock gasoline and other petroleum products much more expensive. With the rupiah having taken a battering over the past year. in late October, Indonesia, in an effort to stem the tide of foreign exchange outflows asked suppliers of diesel and crude to stop charging in dollars and offered them a variety of other options such as the rupiah, Chinese yuan, euro, Japanese yen or the Saudi riyal. And while Jakarta is hopeful that as many suppliers as possible will opt for the rupiah to relieve downward pressure on its embattled currency, such hopes are wishful at best.
With the rupiah having fallen to 20-year lows against the U.S. dollar, traders and suppliers of imported goods to Indonesia will not be betting and risking foreign exchange losses on their exports to the islands. But even if suppliers don’t opt for the rupiah, even the euro or the yuan could help because those currencies have been slammed by the dollar over the past year. Brent crude, which is denominated in dollars has jumped 17% year-to-date, but in rupiah terms, the benchmark oil price has soared by over 31% — purely because of the rupiah’s slide against the dollar. No stranger to foreign exchange crises, Indonesia suffered both economic and political turmoil in 1997 thanks to foreign exchange devaluations in the Southeast Asia region which led to the eventual overthrow of the Suharto political dynasty. The turmoil that ensued will no doubt be one that Indonesia will be wont to avoid a repeat of.
But Indonesia is not unique in its foreign exchange woes. In nearby India, Prime Minister Narendra Modi recently lobbied hard with Middle Eastern oil producers to consider accepting Indian rupees for their crude exports to India. India’s fiscal deficit has been weighed down by the rupee’s precipitous slide against the dollar and steadily rising oil prices. China, the world’s largest importer of the black stuff saw its yuan slide to 10-year lows last month as traders fretted over its tepid economic growth prospects. From Pakistan to the Philippines, governments are struggling with the double whammy of rising oil prices and currencies sliding against the greenback.
And while oil prices have taken a step back in recent weeks from their ascent, the dollar shows no sign of weakness as the Fed looks set to continue hiking interest rates. With rising geo-political tension and looming trade wars, the dollar has resumed its status as a flight to safety amidst uncertain times.
The desire to shed the dollar as the benchmark currency for oil is not new. Countries, especially importers, have been ruminating about ending dollar dependency for years, but with little political consensus on its replacement. Beyond bilateral agreements, such as when Russia and China signed two major 30-year natural gas supply agreements in 2014, which involved payment in yuan and Russian rubles, a globally-viable dollar replacement that would also be economically and politically palatable to all parties has been elusive at best. Further compounding dollar dominance is the United States and Saudi Arabia are the two largest producers of oil in the world and Saudi Arabia has a strong incentive to continue using the dollar. Under a 1973 agreement with the U.S., Saudi Arabia promised to price all its oil in greenbacks in exchange for American arms and protection. But Saudi Arabia isn’t the only country in the region to go with the dollar flow — the United Arab Emirates, Kuwait, Qatar and Oman — all oil-rich countries — have pegged their currencies to the greenback as well.
But the dollar-denominated oil market means that the world is essentially subsidizing American expenditure. To quote the Scottish economist (and convicted murderer) John Law,
“I maintain, that an absolute prince who knows how to govern can extend his credit further and find needed funds at a lower interest rate than a prince who is limited in his authority.”
“In credit as in military and legislative authorities, supreme power must reside in only one person.”
In the case of oil, because of its denomination in dollars, supreme power resides in only one country — the United States. And as the Trump administration turns its back on the fate of the rest of the world and America looks inwards, that hitherto dominance must now be called into question. Denominating commodities necessary for life, liberty and the pursuit of happiness across the globe in dollars was the price the world paid for American engagement, preservation of the rule of law and its support of global institutions. But with an increasingly belligerent narrative emanating from 1600 Pennsylvania Avenue, the world should begin to question whether it’s getting what it’s paying for. Already, the Trump administration has undermined countless international norms (there is no such thing as international law), verbally undermining its support for the United Nations, drawing into question its support for NATO and withdrawing from the Paris Climate Accord as well as the Trans-Pacific Partnership — all of which have limited global efficacy without American participation. But swapping from the dollar to another currency will bring with it its own set of problems — because the world lacks a truly global currency. Oil is a global commodity and is best traded in a fully-convertible currency, free from the machinations of national governments and ideally immune from the vagaries of four-year presidential terms. And while the pricing of oil itself in dollars is not without challengers, the oil market ecosystem is inexorably dollar-based, with benchmark crude futures contracts on exchanges in Dubai, London and New York traded and settled in dollars. Splitting price discovery and payment currencies would mean forcing buyers and sellers to assume foreign exchange risk.
Which is where Bitcoin comes in. “But what about the transaction times?” I hear you say. Indeed, the number and speed of transactions for the Bitcoin network as it currently stands is horrendously slow. But remember, we’re not trading Bitcoin, we’re denominating oil in Bitcoin and evolving the oil market ecosystem to accept and exchange Bitcoin. Because trading can continue to use existing infrastructure, as long as Bitcoin prices remain stable (they currently are not), all that will be required is to do a daily reconciliation of all trades when the oil markets close. It’s a bit like settling transactions off-chain so as not to burden the Bitcoin blockchain with the constant changes, as the vast majority of transactions will cancel each other out. Furthermore, the Bitcoin blockchain itself has the added benefit of providing a platform for the immutable ledger of physical trades if necessary, allowing buyers and sellers of physical oil to log their trades and to leverage the Bitcoin blockchain to develop smart contracts (not a full feature yet on Bitcoin blockchain but available on the Ethereum blockchain) to conduct trades and transactions. And it may not just be Bitcoin, but as the world’s leading cryptocurrency, it stands to reason that acceptance will be somewhat easier. Because the status quo seems somewhat unsatisfactory to say the least. For instance, because the rupee and the rupiah are not fully convertible, oil suppliers accepting it would essentially be signing up for a barter system, using the buyer’s currency to buy goods from that country. And while Iran, which is under U.S. sanctions may agree to do so, its neighbors are not under any pressure to accept such terms. At the very least, Bitcoin could be converted out to dollars or any other major currency if so desired.
Because it’s hard to envision, doesn’t mean that it should not be attempted. In the worlds of President John F. Kennedy,
“We set sail on this new sea because there is new knowledge to be gained, and new rights to be won, and they must be won and used for the progress of all people.”
“We choose to go to the Moon! We choose to go to the Moon in this decade and do the other things, not because they are easy, but because they are hard. Because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one we intend to win, and the others, too.”
The pressure for change will not go away, especially from states with rising oil import needs and bursting fiscal deficits and those with difficult relations with Washington. Right now, it is understandably difficult to envision a new world order where the resources of the planet are denominated in anything other than the dollar. But in the absence of alternatives to the dollar which will not favor any specific nation or group of nations, cryptocurrencies such as Bitcoin may not be such a far-fetched alternative. The dollar’s dominance is nowhere near collapse, but we should at least start to question its hitherto unassailable status.