The Oil Exchange Rate Paradox

Today it’s time for another paradox.

I will cal this one: the Oil Exchange Rate Paradox.

Everyone knows that the price of oil is priced in US dollars.

Another thing everybody (?) knows is that there is a negative correlation between the US dollar and the price of oil (although the usual explanation isn’t quiet right in my point of view, but that’s not for today).

Another fact is that the the majority of oil producers/exporters peg their exchange rate to the US dollar, like Saudi Arabia, Venezuela, Angola, Nigeria (not anymore) and many others…

So….my question is: When the price of oil falls  and the USD appreciates, every currency pegged to the USD will appreciate too (against other currencies).

However the drop in oil prices will reduce exports and therefore it decreases the oil exporter trade balance, leading to an increasing pressure for currency depreciation.

In conclusion, this oil producing country has an appreciating currency with imbalances that may lead do a depreciation. This is the Oil Exchange Rate Paradox.

Usually a country faced with this paradox will devalue its currency against the USD, will use its Foreign Reserves or will just control the withdrawl of capital.

I guess a simpler solution would be to just peg the currency to another one (a commodity currency, which depreciates when the price of oil falls, like the CAD, the AUD or the NOK) or simply just let it float.

This is a strange Paradox, because I’ve never heard of this before, so maybe I’m just plain wrong…

Well…maybe I’m not, who knows?


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