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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.
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