War in Iraq, 'petro-dollar' and the challenge by euro

From: Rakesh Bhandari (rakeshb@STANFORD.EDU)
Date: Wed Jul 28 2004 - 20:26:52 EDT

This is the kind of analysis already offered by Hans Ehrbar and
implicitly David E. Spiro but blasted by Krugman and Cyrus. I hope
that it prompts careful analysis from those specializing in money
matters here.
Yours, Rakesh


I think publication date is April 2004.

        War in Iraq, 'petro-dollar' and the challenge by euro

War in Iraq, 'petro-dollar' and the challenge by euro

Dr. Bulent Gokay
Senior Lecturer in International Relations and Director of European
Studies Programme
SPIRE, Keele University, Staffs ST5 5BG, England, UK

Oil has been a major US concern about Iraq since the start of the
Bush administration, and indeed earlier. Iraq-s proven oil reserves
are 113 billion barrels, the second largest in the world after Saudi
Arabia, and eleven percent of the world-s total. The total reserves
could be 200 billion barrels or even more, all of it quite easy and
relatively cheap to extract. Because the US is the world's largest
user of petroleum, and its appetite is growing because of its
standards of consumption, it needs control over the oilfields of the
Middle East.

The US policy, however, does not only want to control oil for its own
consumption, but also to deny this control to other important
industrial powers - European Union, China, Japan. For geopolitical
reasons and reasons related to energy security it wants to determine
that Europe's access to oil will be routed through it. Indeed, for
this reason and another, 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 the Caspian
oil, the US wants to deny Iraq-s oil to China as well, which has a
quickly increasing requirement of 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 factors related to the Iraqi oil, driving Bush
administration to intervene in Iraq militarily. 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. This appears
to be the major driving factor contributing US policy over Iraq. In
other words, the need to dominate oil from Iraq is deeply intertwined
with the defence of the dollar.

Since the emergence of the United States as the dominant global
superpower after 1945, the hegemony of the US has rested on two
unchallengeable pillars. First, the overwhelming US military
superiority over all other rivals; and 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 seigniorage, 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.

In the aftermath of the Second World War this was understandable
because the US dollar was backed up by gold. In 1971, US president
Richard Nixon took the dollar off the gold standard that has been
agreed to at the Bretton Woods Conference in 1944. Since 1971 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 dollar. 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 for dollars.

America practically borrows today from the entire world without
keeping reserves of any other currency. Because the dollar is de
facto the 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 receiving 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 President
Jacques Chirac of France.


In just a few years the Euro has emerged as a real alternative to
challenge the dollar hegemony in world trade. It has established
itself as the second most important currency on 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-2003, the gap became much
smaller: the share of issues in dollars had fallen to 43 %, while the
euro-s share had increased to 41 %. 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-2003, the share of issues in
dollars had fallen to 30 %, while the share of euro issues had
climbed to almost 46 %. The Euro today accounts for 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 indicated that they
would denominate their petroleum trade in euros. During 2002 the
majority of reserve funds in Iran's central bank have 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¬. In October 2003, Russian President Vladimir Putin announced
that Russia might 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 uses 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
have to convert most of its dollar assets to euro. 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 that
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
either the US buys more euro 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 correspond to two different perceptions
of the global order: Pax Americana, or the American Century model of
global dominance on one hand; and to balance the overwhelming
dominance of the U.S. in world affairs on the other. In this
connection, the war in Iraq is a war whose purpose is bigger than
Halliburton or Exxon: it's a war being fought to maintain America's
position in the world.

It is really surprising how little the topic of reserve currencies
has been discussed. As of 30 December, 2003, the euro was worth 25%
more than the dollar. With an additional ten member states (from May
2004) the EU represents an oil consumer 33% larger than the US. The
fact that following this enlargement 60% of OPEC oil will be imported
by the EU, from a purely economic perspective it would make sense for
Iraq (and all other OPEC countries) to require payment for oil in
euros, not dollars. If OPEC were to decide to accept euros for its
oil, then American economic dominance would be practically over.

The US, in alliance with the British, has intervened in Iraq
militarily in March 2003, installed its own authority to run the
country. Soon after the invasion it was announced that payment for
Iraqi oil would be in dollars only. But the story does not end there.
Paradoxically, despite all these recent military and political
advances and the fast increasing grip of the US military power in
Eurasia, for a variety of economic and political reasons, it appears
that a growing number of oil producers in the Middle East, South
America, and Russia are talking openly trading their commodity for
euros instead of dollars, or perhaps denominate oil in a "basket of

Dr. Bulent Gokay
Senior Lecturer in International Relations and
Director of European Studies Programme
SPIRE, Keele University, Staffs ST5 5BG, England, UK

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