Dollar Down, Euro Up and Bush's legacy

Aref Assaf, 11-22-2007

Synopsis:

The issues around which discussions of the Iraq war revolve to be nothing but a screen that hides other causes fueling the present conflict -- causes that require some knowledge of economics to grasp. According to this view, a leading motive of the U.S. in the Iraq war -- perhaps the fundamental underlying motive, even more than the control of the oil itself -- is an attempt to preserve the U.S. dollar as the leading oil trading currency, on the view that the institution of petrodollars, as these have developed since the early 1970s, is fundamental to well-being of the U.S. economy.
Clearly, the real underlying antagonism in the conflict is not a military or geopolitical or national-security issue between the U.S. and Iraq, but rather an economic struggle between the U.S. and Europe.

____________________________

The War Against the Euro - has it failed?

"The dollar is falling" was the cry of Iran's President at a recent OPEC meeting. Many OPEC members are now publically expressing their grave concerns about the dramatic decline of the value of the  U.S. dollar. In fact, some members are publically calling for  depegging from the dollar, the use of other currencies in which to sell their oil. For OPEC, the issue is the substantial decrease in the value of their huge financial reserves which are denominated in U.S. currency. There is also the recognition that huge investments in foreign companies in the U.S. do not create local wealth; and with the weakening of the American dollar, the value of such investments is rapidly eroding.

While free market economists have their theories about the fall of the dollar, I would argue that the unprecedented rise in the Euro's value to the U.S. dollar is another facet of the Bush administration’s failed Iraq Policy. Bush’s unilateral and antagonistic policies may have perhaps irrecoverably debased the dollar as the world’s currency. If OPEC were to decide to accept the Euro for its oil, then American economic hegemony would be irreversibly challenged. “If one day the world’s largest oil producers demanded euros (sic) for their barrels, it would be the financial equivalent of a nuclear strike”. Bill O’ Grady, A.G. Edwards

  Iraq, which has the second largest oil reserve in the world after Saudi Arabia, has been a major US concern since the start of the Bush administration, and indeed earlier. Iraq’s total reserves could be 200 billion barrels or even more, and all of it can be easily and cheaply extracted. Because the US is the world's largest consumer of oil and its appetite is growing because of its standards of consumption, it needs control over the oilfields of the Middle East.

The U.S.'s policy, however, is not premised on controlling oil for its domestic consumption. More importantly, it wants to also deny this control to the other world economic powers - the European Union, China, Japan. Driven by both strategic imperatives and reasons related to energy security, the US wants to ensure that Europe's access to oil will be routed through American-controlled pipelines.

Indeed, broadly speaking, the war in Iraq was directed as much against major powers in Europe as Iraq, a fact to which the "old Europe" of Chirac and Schroeder were quite alert. As in the case of Caspian oil, the US wants to deny Iraq’s oil to China as well, which has a quickly increasing need for imported crude. Since America perceives China as its potential rival in establishing a secure and dynamic global system under its own control, this is quite a significant reason for the Bush administration’s persistence to keep China out of the oil regions of Eurasia.

There were many motives related to the Iraqi oil justifying the Bush administration's military intervention in Iraq. But the biggest one seems to be about the currency used to trade oil: the role of preserving the dollar as the world’s reserve currency.

The United States' status as the unrivaled global superpower has rested on two unchallengeable pillars. First, the overwhelming US military superiority over all other rivals; second, the control of global economic markets with the dominant role of the US dollar as reserve currency. Reserve currencies are held by governments and institutions outside the country of issue and are used to finance international economic transactions, including trade and the payment of debts. Reserve currency status is not just an international status symbol. It brings international seignior age, benefits for ‘home’ financial institutions, relaxation of the ‘external constraint’ on macroeconomic policy, a greater role for the issuer in international institutions, and the wider geopolitical consequences of exercising currency hegemony.

However, this all changed in 1971 when president Richard Nixon took the dollar off the gold standard that has been agreed to at the Bretton Woods Conference in 1944. Thus, the dollar has been an irredeemable currency, no longer defined or measured in terms of gold. This removed the restraints on printing new dollars. The dollar has become the world’s dominant currency and the core reserve asset of central banks all over the world. It has replaced gold as an international currency. Central banks around the world have built up large reserves of dollars. Those dollars flow back into the US banking system in the form of investments in US dollar-denominated assets.

The dollar hegemony is key to the future of American global dominance, in many respects as significant if not more so, than the overwhelming military strength. And the petrodollar has been at the heart of the dollar hegemony since the early 1970s. Almost two-thirds of the world's currency reserves are kept in dollars, because oil importers pay in dollars and oil exporters keep their reserves in the currency they are paid in. The entire global oil trade is conducted in dollars. This means that everyone needs to keep dollars. This effectively provides the American economy with an interest-free loan, as these dollars can be invested back into the U.S.A. with zero currency risk. This money is not inactive; it is invested in dollar securities like US Treasury notes, stocks, mutual funds, and bonds. The US dollar's current strength is supported by OPEC’s requirement that all OPEC oil sales be denominated in dollars. This was secured by an agreement between the US administration and Saudi Arabia, the largest OPEC oil producer. This had been determined in June 1974 by Secretary of State Henry Kissinger, establishing the US-Saudi Arabian Joint Commission on Economic Cooperation. In 1975 OPEC officially agreed to sell its oil only in dollars.

America today practically borrows from the entire world without keeping reserves of any other currency. Because the dollar is the de facto global reserve currency, the US currency accounts for approximately two-thirds of all official exchange reserves. America does not have to compete with other currencies in interest rates; even at low interest rates, capital flies to the dollar. The more dollars there are circulating outside the US, the more the rest of the world has had to provide the US with goods and services in exchange for these dollars. The fact that the world uses the currency in this way means that the US is importing vast quantities of goods and services virtually for free. The US has a luxury of having its debts denominated in its own currency. This is the position the US has enjoyed for 30 years. It means that the US has been afforded a huge subsidy from everyone else in the world. The United States economy is,  therefore, intimately tied to the dollar's role as reserve currency. The dominant position of the US dollar in world markets is not only a matter of pure economics, but also “deeply rooted in the geopolitical role of the United States.”

Until the advent of the Euro in late 1999 there was no potential challenge to this dollar hegemony in world trade. The coming of the Euro has threatened the dominant role of the US dollar as reserve currency. Some European leaders have even said that the Euro's main aim is to put Europe on an equal monetary footing with the United States - ending the dollar's ''hegemony,'' in the word of former President Jacques Chirac of France.

In just a few years, the Euro has emerged as a real alternative to challenge the dollar. It has established itself as the second-most important currency in the world’s financial markets. Just before the introduction of the Euro, the outstanding amount of bonds and notes denominated in the legacy currencies of the Euro accounted for barely 28% of world issues, compared to 45 % for dollar-denominated bonds and notes. By mid-2007, the gap became much smaller: the share of issues in dollars had fallen to 32 %, while the Euro’s share had increased to 51 %. And even more spectacular development took place on the money market. At the end of 1998, money market instruments denominated in the Euro’s predecessor currencies accounted for just over 17% of world issues, compared to 58 % for dollar denominated instruments. By mid-2007, the share of issues in dollars had fallen to 19%, while the share of Euro issues had climbed to almost 61%. The Euro today accounts for over one quarter of the global market.

Iraq was the first OPEC country, in November 2000, to convert its reserves from dollars to Euros. This was the first time an OPEC country dared violate the dollar price rule. Iraq also converted $10 billion of its currency reserves to Euros. Since then the value of the Euro has increased, and the dollar has begun to decline. Libya has been urging for some time that oil be priced in Euros rather than dollars. Iran, Venezuela, and other countries have begun to denominate their petroleum trade in Euros. In 2002 the majority of reserve funds in Iran's central bank had been shifted to Euros. Some in Saudi Arabia have called for switching to the Euro as “a more effective punishment [than an oil embargo] for the United States, Israel’s principal source of financial and political support”. Russian President Vladimir Putin has threatened to price its oil in Euros as well. Since the oil trade is a central factor underpinning the dollar's hegemony, all these are potentially very significant threats to the strength of US economy in particular, and the US global hegemony in general.

With a significant part of the petroleum trade using the Euro instead of dollars; many countries would have to keep a part of their reserves in Euros. The dollar would then have to compete with the Euro for global capital. Not only would Europe not need dollars anymore, but Japan (which imports more than 80% of its oil from the Middle East) would have to convert most of its dollar assets to Euros. The US, too, being the world’s largest oil importer would have to get hold of Euro reserves. This would be disastrous for the American attempts at monetary management. Not only they would lose a large part of their annual subsidy of effectively free goods and services, but the switch to Euro reserves from dollar reserves would bring down the value of the US currency. Even a modest shift out of dollars, or a change in the flow, would create significant changes. If the Euro becomes a bigger reserve currency [i.e. if the US were to share its reserve currency status with the Euro] it is also likely to mean that either the US buys more Euros or the Europeans reduce their dollar holdings and buy Euros.

That is why there is a clear and definite oil (and petrodollar) connection in the recent military conflict in Iraq. This financial dimension is a power game of the highest geopolitical significance. The future of the dollar/ Euro competition to be the global reserve currency is far from a minor issue of interest only to banks or currency traders. A hidden war between the dollar and the new Euro currency for global hegemony corresponds to two different perceptions of the global order: Pax Americana, or the American Century model of global hegemony on one hand; and to balance the overwhelming dominance of the U.S. in world affairs on the other.

Consequently, the war in Iraq is a war whose purpose is bigger than Halliburton or Exxon: it's a long term and a strategic objective being fought to maintain America's position on top of the world.

Related:

• Strategic Energy Policy Challenges for the 21st Century

• Petrodollar Warfare, Oil, Iraq and the Future of the Dollar, William R. Clark

• Read a compelling statement by Cong. Ron Paul delivered in  2006.

• The Dollar Hegemony: Dollar, Dollarization, and Progress by Jean Gabriel