Euromedia

What if Petrodollars become PetroEuros?

This is an argument that has received some attention outside of the mainstream media, but has been derided by many critics as essentially flawed.

Being a little shaky on global economics, its hard for me to really weigh in here, but it does seem interesting.

Basically, the argument is that in 2000 when Iraq switched its currency for oil transactions to euros from dollars (in its oil for food transacations), that was a key reason why the US became obsessed with taking over the country. Because Iran and Venezuela had also voiced similar sentiments, and due to unsurity about the political situation in Saudi Arabia, its key OPEC ally, the US wanted to stave off a move to the euro by these 3 OPEC countries and perhaps others following suit.

So, to protect the hegemony of the dollar as the international reserve currency b/c of the huge volume of oil transactions, it was in the US interest to try to preserve all these petrodollars around the world.

Anyway, like I said, I dont really understand what the impact of turning all those dollars into euros would be, and how that would affect the overall value of the dollar, etc., but I wonder how oil politics play into the respecitve attitudes of the US and European countries towards Iraq. Heres some perspectives on the issue. If you like long conspiracy theories, check out the last link.

The Globalist - Iraq, the Dollar and the Euro

NY Times - Whos Afraid of the Euro?

Revisited - The Real Reasons for the War with Iraq

Iraq, the Dollar and the Euro

By Hazel Henderson | Monday, June 02, 2003

The euro is finally taking its place alongside the U.S. dollar as a new global reserve currency. This has been further enhanced by the euro's recent gains against the dollar. But what would happen to the U.S. economy if OPEC decided to use euros, instead of dollars, to price oil? Hazel Henderson explores the consequences.

uturists like me specialize in “what if” scenarios, outside the box thinking and trying to anticipate surprises. In even the best-laid human plans, events rarely unfold as predicted — even by experts.

Blind spots

Mostly, these surprises are the result of “blind spots”, or because experts use different models or specialized approaches and languages — making communication difficult.

As countries diversify into euros, the currency has taken its place alongside the dollar as the world’s other global reserve currency.

One such surprise scenario is rooted in the close relationship between oil, dollars, gold and Europe’s euro currency. Remember back in 1973, OPEC countries quadrupled the price of their oil and tied it to the U.S. dollar.

Over the years, this flooded the world with “petro-dollars”, which were recycled through banks as loans. The U.S. dollar reigned supreme as the world’s de facto reserve currency.

A history of dollars

Everyone wanted to own dollars, which were considered as good as gold (even though, since 1971, dollars cannot be redeemed for gold, after President Nixon shut the gold window).

Gold no longer backs the dollar — or any other currency. All currencies since 1973 are called “fiat” currencies — backed only by the faith markets have in a country’s government and its economic fundamentals.

Volatile markets

Central banks that used to keep gold bars in their vaults have sold much of their precious metal. Now, they try to “manage” their currencies by raising or lowering interest rates, buying and selling them in the open market and other techniques.

A strong euro makes for a more stable world — and takes the burden of the sole reserve currency status off the U.S. dollar.

Gold is still popular for jewelry and as a safe haven. It trades actively on the world’s commodity and futures exchanges, along with platinum, oil, hogs, coffee, sugar — and fiat currencies themselves.

These currency markets, oil and gold markets are very volatile — dependent on the expectations about the future of millions of their investors and speculators.

What drives the markets?

These markets reflect a collective speculation on the future of such items as Iraq, U.S. foreign policy, the Middle East, oil supplies, alternative energy sources and technologies, the rise of China, the expansion of the EU — and the weather.

They all drive today’s global financial markets, including the $1.5 trillion of daily currency trading.

Losing ground

In the past 12 months, the U.S. dollar has lost some 30% of its value against the European euro. The Bush Administration has played up the bright side. The cheaper dollar makes it easier for U.S. exporters to sell abroad.

Many believe that deeper reasons for the U.S. attack on Iraq were its decision in 1999 to require payments for its oil for food program in euros.

The United States needs to increase its exports because it has a whopping trade deficit (currently reading 5.2% of our GDP). Former Treasury Secretary Paul O’Neill dismissed this as “a meaningless concept.”

But global investors and currency speculators take it seriously — along with the bursting of the U.S. stock market bubble, accounting scandals and heavily indebted corporations and consumers.

No surprise

The list goes on, and includes the U.S. savings rate at almost 0%, the increasing budget deficits due to President Bush’s tax cuts and his build-up of military spending, the Iraq war and the new Bush doctrine of preemptive attacks on any country that might threaten our future national security.

In light of all that, global investors started unloading dollars and U.S. assets. No surprises here.

A new global reserve currency

But as countries that formerly held mostly U.S. dollars in their currency reserves begin to diversify into euros, the currency has taken its place alongside the dollar, as the world’s other global reserve currency.

Back in 1973, OPEC countries quadrupled the price of their oil and tied it to the U.S. dollar. The dollar reigned supreme as the world’s de facto reserve currency.

While current data are hard to come by, the euro now accounts for as much as 35% of global trade and reserve holdings. This new reality makes for a more stable world — and takes the unsustainable burden of the sole reserve currency status off the U.S. dollar.

Clearly, with its enormous, open-ended commitments in the global war on terrorism, the U.S. economy cannot at the same time, continue to absorb most of the world’s exports — and remain the locomotive of the world’s economic growth.

An oblivious administration?

This new situation seems a surprise to the Bush Administration. It is still keen on expanding its overseas commitments, re-building Iraq — and offering aid packages to Turkey, Pakistan and other countries whose support is sought. In the meantime, it has passed a $350 billion tax cut package in late May, 2003.

While Mr. Bush tells Americans to continue shopping, traveling and enjoying the American way of life, federal deficits grow, domestic programs are cut — and half of all U.S. states are engulfed in budget crises.

Dropping the other shoe

What happens if global investors continue pulling out of the United States — and the dollar keeps falling? Many market players expect it to fall another 20%. Other countries that have lost money in the dollar’s fall may continue buying more euros.

In the past 12 months, the U.S. dollar has lost some 30% of its value against the European euro.

The other shoe may drop, too. OPEC may decide to officially re-denominate their oil in euros (since most of the organization’s customers are in Europe anyway).

OPEC economists have been considering this “no-brainer” scenario for sound financial reasons — even though they feared U.S. wrath and retaliation.

War speculation

Indeed, many believe that a deeper reason for the U.S. attack on Iraq was its decision in 1999 to require payments for its oil for food program in euros.

The United States — heavily dependent on imported oil — benefits price-wise and in influencing markets through OPEC’s U.S. dollar pricing. Iraq’s dinar will also be replaced by dollars — if the United States has its way.

A major adjustment

Thwarting President Bush’s global dollar diplomacy and its designs on breaking OPEC’s oil pricing power provide additional reasons for OPEC to switch to payments in euros. This would mean that the United States would have to buy euros with dollars before it could buy OPEC oil.

The Bush Administration has played up the bright side. The cheaper dollar makes it easier for U.S. exporters to sell abroad.

The dollar would fall further — and the euro would rise. The U.S. economy would eventually have to adjust to $5-a-gallon gasoline (the average world price).

The bad news would be a deeper U.S. recession, SUV owners would suffer while Toyota and Honda would grab more market-share with their 50-60 mpg hybrid cars.

Good news?

The good news would be that U.S. exports would flourish and that Detroit would accelerate its own fuel-efficient car production. The solar and renewable energy technologies would be fully capitalized as a new sustainability sector of the U.S. economy, providing millions of new jobs.

And the Bush Administration would have to pull back from its over-commitment to the global war on “evil” — and shift its priorities to funding education, homeland security and federal grants to help states fund their new mandates.

Who's Afraid Of The Euro ?

Paul Krugman

I once attended a conference at which a senior Japanese official made an impassioned speech about the need to establish the yen as an international reserve currency. When my turn came, I explained that this was silly; even if the yen did become a reserve currency, it would make virtually no difference to Japan or to anyone else. At the end of the session, the moderator thanked me for my contribution--which, he said, emphasized once again the crucial importance of the yen's role as a reserve currency. I never figured out whether this was a case of the translator having trouble with my accent, or whether it was a polite way of telling me I had said something unacceptable. But I do know that people almost always attach far more importance to the issue of reserve currencies--the role of the dollar and its rivals in international trade and finance- -than the subject deserves.

And so it was inevitable that the coming of the euro --the common European currency that seems set to be introduced next year, and that may eventually challenge the dollar's dominance--would inspire irrational fear. Sure enough, a few weeks ago the intellectual fashion victims at one of those other business magazines ran an editorial entitled "The euro makes trade a new game." "Thanks to the dollar's role as reserve currency in world financial markets," they opined, "the U.S. has been able to do what no other country can-- consistently import more goods than it exports.... The U.S. owes some $5 trillion to dollar holders abroad, thanks to three decades of trade deficits." Gosh, what happens if those people switch to euros?

Well, not to worry. It just isn't true that America's ability to import more than it exports is unique. Since 1980 the U.S. current- account deficit (which includes services and investment income as well as goods) has averaged 1.5% of GDP. That's about the same as Britain's average, less than Canada's 2.2%, and nothing like Australia's 4.2%. These countries paid for their excess imports the same way we did: by selling foreigners stocks, bonds, real estate, and so on. The only difference is that because their deficits were bigger, their debts are also bigger as a share of GDP. Ours, it turns out, aren't that large--at least on a net basis. While it's true we owe foreigners about $5 trillion, they owe us more than $4 trillion; the difference is about $800 billion, or 10% of GDP.

But doesn't the dollar's special role give us some advantage? Most of the international role of the dollar comes from its use as a "unit of account"--the measuring stick for international business. When a Japanese refiner buys Kuwaiti oil, say, the contracts are in dollars. This is a testament to U.S. economic influence, but flattery aside, it's hard to see what we get out of it.

What about our ability to borrow in dollars, to sell dollar- denominated bonds to foreigners? Hey, other countries do that too. But our debts are in our own currency! So? We still pay interest on them. True, we could inflate away our foreign debt. But we won't--and if investors thought we would, they would demand higher interest rates.

Well, then, you may say, surely the international role of the dollar forces people out there to hold dollars for transaction purposes. Yes, but not so you'd notice. When Daewoo repays a dollar loan from Sanwa, it writes a check on its account with some international bank. True, that bank itself surely maintains an account in New York, backed in part by non-interest-bearing reserves held at the Fed. So the U.S. does in effect get a zero-interest loan out of the dollar's international role--but it probably amounts to only a few billion dollars, small change for an $8 trillion economy.

Where the U.S. does get a significant free ride is from the willingness of foreigners to accept our currency--actual bills. Foreigners hold more than $200 billion of American money. Guess what kind of business requires payments of large sums in cash, by people unconstrained by official restrictions on possession of foreign exchange? That's right: the dollar is the world's premier medium of illicit exchange. Every year the U.S. ships foreigners $15 billion in cash (about 0.2% of GDP), and gets real goods and services in return. Better not ask what kind.

So the threat to the U.S. from the rise of the euro is this: five years from now, when wise guys in Vladivostok make offers you can't refuse, the payoffs may be in 100- euro notes instead of $100 bills. The loss of such business might cost the U.S. economy as much as 0.1% of GDP. Somehow, I think we can live with that.

Posted by Ira Spitzer at April 4, 2004 08:54 PM