What is the connection between the USD and oil?
If OPEC decides to increase the cost of oil does it increase demand for US dollars?
The USA dollar is the unit of account for oil contracts. If an oil supplier sells product to a buyer then the payment for the product is made in US Dollars. This is from history after WW2 when the dollar was convertable to gold for international exchange. Now dollars are used by convention. (There are people who believe that the dollar is used because of threats from the USA. I am somewhat sympathetic to this argument. If the USA invades Iran then I will become convinced as they and Iraq have been interested in writing contracts for oil payments in other currencies.)
As for oil cost, cost is a subjective term relating to how much wealth measured in some currency is needed to get oil to a buyer. So to say OPEC decides to increase cost is accurate in a manner of speaking. A better statement would be if OPEC decides to increase the price of oil in dollar terms.
If the folks at OPEC demand more dollars per unit of oil, demand for dollars remains the same, it is the supply of dollars available for other purchases that decreases. So I would say No, an increase in the price of any good does not DIRECTLY increase the demand for dollars. It may cause panics or some other behaviors where people decided that they want to hold larger balances of dollars instead of oil and other stuff, but that is an indirect effect.
Who benefits from having oil traded in USD? Are the dollars exchanged on FOREX? Does it increase its exchange rate?
The US.
Yes.
Yes.
Basically, the fact that the dollar is the currency used throughout the world to facilitate commodities exchanges on the global market (aka the “reserve currency”), means that it is in higher demand than it otherwise would be…or in other words, the dollar is more valuable because more people want it. As it states at the link: This status allows the US “to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity. It also permits the [US] government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.”
This has proven to be a detriment in disguise, as the US has used this advantage to dig itself into an inflationary debt hole…printing vast amounts of dollars and being able to get away with it without serious inflationary effects by essentially exporting the inflation across the globe. But as we are currently seeing, this unsustainable setup is beginning to unwind.
One thing that needs to be made clear is that the 700% inflation of the price of oil between 2000 and 2008 was not caused by the weak dollar.
That is a prime example of how some people ramble on inductively without even bothering to examine the most basic facts.
The dollar, at its worst, was trading on the foreign exchange markets for a bit more than half of what it had been in 2000. At most, this would have doubled the price of oil.
What’s more, when the price of oil vacillated widely, there was never a corresponding change in the price of the dollar at all.
In fact, the price of oil is driven largely by speculators. This is because it’s not a free market condition, but a state-mandated set of commodity auction entities, forcing oil to be treated in a way that distorts its price and production.
Therefore, when Bush comes into office, the price of oil plunges because he’s from an oil family, and especially naïve people assumed that meant more oil would be produced. When the truth became obvious – that the Bush/Saud oil families wanted LESS oil available, in order to drive up prices, and were willing to go to war to cause this – oil speculators began to bid up crazily, with each foreign policy insanity Bush produced. Attacking Afghanistan nearly doubled the price of oil. Attacking Iraq drove it up another twenty bucks. Threats against Iran and belligerance against Chile had similar effects.
Here is a chart of oil prices, with oil-threatening foreign policy blunders added in:
http://butnowyouknow.files.wordpress.com/2008/11/oil-prices1.jpg
Who ever said it was?