U.S. economy, oil contracts & war

By C. Rammanohar Reddy

It was in the U.S.' interest to end the first experiment of a switch to the euro in oil contracts. Its invasion of Iraq has accomplished that.

WE ALL knew the invasion of Iraq was about oil. Here was the country with the second largest proven reserves of crude and the easiest to extract. The invader-country, on the other hand, was the world's largest consumer of oil and it now imports more fuel than it produces. The U.S. is also home to most of the largest petroleum extracting and producing companies.

Now that Iraq has been occupied and is to be administered, Roman Empire style, by serving and retired U.S. army consuls, Iraq's oil resources are there for the picking.

All the links between Iraq's resources and U.S. needs must have been recognised by the members of the inner circles of decision-making in Washington, given their past connections with the petroleum industry. But was there a link between the U.S. invasion and the currency in which global trade in oil is conducted? The theory has been advanced that the war was all about aborting a bid, experimented with by Iraq, to end the central role of the U.S. dollar in oil trade. The stakes were too high here. A change from the dollar to the euro would have shaken the very foundations of the economy of the imperial power, so the threat had to be cut off at its very roots. The theory seems almost conspiratorial and therefore implausible.

But the developments in the global oil market in recent years have been there to take note of. And on the other side, there are the real conditions which have made the U.S. economy dependent on the dollar retaining its pre-eminence in the global economy. These connections too would not have escaped the notice of the inner circles of power in Washington and therefore must have played a definite role in persuading the U.S. that it was in its economic interests to invade Iraq.

The U.S. dollar is the preferred currency of global trade. More than two-thirds of national foreign exchange reserves are denominated in the U.S. dollar. About 40 per cent of the dollars issued by the U.S. are held outside the country by non-U.S. nationals and entities.

All this makes the U.S. currency the most powerful one in the world; the de facto international currency. This power is in part a reflection of U.S. economic supremacy during 1950-75. The global power of the dollar has continued for other reasons, a reflection, especially since 1990, of U.S. political and military supremacy. When a particular currency is sought after by the rest of the world, the issuing economy has much to profit. The U.S. has done precisely that over the past four decades. When the dollar was linked to the value of gold (until the early 1970s), the U.S. used the status of its currency to finance its Vietnam War. It kept the currency presses running knowing that the rest of the world was willing to hold whatever it printed. Even the delinking of the dollar from the value of gold made no difference.

With members of the Organisation of Petroleum Exporting Countries (OPEC) denominating oil sales in dollars and building up stocks of "petrodollars", the U.S. more than ever began to use the dollar's status to do things that no other country could afford to. It consistently ran up huge current account deficits in its balance of payments — because there always have been Japanese surpluses, petrodollars and the funds of the corrupt which have been invested in U.S. securities and other local financial assets. The rest of the world has been, in effect, financing domestic U.S. savings.

The U.S. trade deficit now stands at $460 billion and its current account deficit at over $500 billion (5 per cent of the GDP). This means, as one U.S. economist, David Dapice, recently put it, the U.S. depends on a daily capital inflow from the rest of the world of $1.5 billion to prop up domestic consumption. The value of the dollar is therefore held up by large capital inflows.

What if the dollar ceases to be the currency of choice in the global economy or even if the euro becomes a serious contender? What if all the funds parked in the U.S. money are pulled out? What if this flow of capital dries up?

The effect on the U.S. economy would be cataclysmic since the amounts involved are huge. Robert Brenner, another U.S. economist, estimated that in end 2000, foreign ownership of the U.S.' gross assets were equivalent to as much as 67 per cent of GDP and argued that "any serious attempt to flee these assets would put enormous pressure on the dollar". More recent data from the U.S. Federal Reserve show that the situation has not changed since then. At the end of 2002, the market value of foreign ownership of just U.S. financial assets (corporate equity and bonds, U.S. Treasury securities and bank deposits) added up to $3,350 billion or more than one-third of the U.S.' GDP.

The U.S. is clearly financially dependent on the rest of the world. If this is a lever foreigners do not use, then it is because there is — as yet — no threat to the dollar as a global currency.

Where do oil and Iraq fit into all this? Global oil contracts are denominated in the U.S. dollar. This means that the U.S. consumers of oil are unaffected by the movement of their currency, while the rest of the world ends up paying more for oil whenever the dollar's value goes up. So, any shift away from the dollar will affect consumers. The annual value of the global oil trade is now more than $600 billion. This accounts for 10 per cent of world trade. A movement away from the dollar denomination of oil contracts would naturally reduce the global importance of the currency and fundamentally weaken the U.S. economy. Whether out of design or not, Iraq had already demonstrated that an oil economy outside the world of the U.S. dollar was possible. In 2000, Iraq asked for and was granted the right by the United Nations to have its oil exports under the U.N. oil-for-food programme conducted in euros.

What seemed a foolish decision then (because the euro had plunged in value) turned out to be very profitable for Iraq. The appreciation of the euro by 20 per cent since late 2000 meant that Iraq got more for its exports. More than two years ago, the U.S.-based energy analyst, Arjun Makhijani, drew attention to the implications for the U.S. of a larger shift to the euro in global oil trade. Iraq's experiment has not prompted other oil exporters to follow the same path.

But OPEC has taken notice. In as carefully worded a speech as was possible, Javad Yarjani, a senior OPEC official, spoke in 2002 of the possibilities and benefits of the world moving away from dollar oil contracts and shifting to euros. Since nearly half of OPEC's imports are from the European Union and OPEC is the main supplier of oil to the E.U., such a shift makes sense, to begin with, for the European economies. Russia is reported to be considering oil futures in euros and Iran switching a major part of its foreign exchange reserves to the same currency. A larger shift to the euro will spell larger trouble for the dollar.

This then was the setting for the U.S. invasion of Iraq. An economy that is powered by debt-laden consumption growth, that has low or negative savings, that keeps running up huge current account deficits and can afford to do all this solely because of foreigners' preference for its currency has everything to lose from even the smallest of threats to the present order of things.

It was in the U.S.' interest to end the first experiment of a switch to the euro in oil contracts. Its invasion of Iraq has accomplished that.

Copyright 2000 - 2002 The Hindu

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