Gulf War II: Saving the US$ against Euro Madhukar Shukla April 17th, 2003 The reasons for any war are always complex and numerous. Correspondingly, to attibute one single motive to the Gulf War II - whether righteous move to end a dictatorship, threat of terrorism, oil interest, geo-political strategic ambitions, or weapons of mass destruction, etc. - would always be a simplistic exercise. However, there is one critical reason behind this war, that has been discussed neither in media, nor in politics - viz, this war was fought to "save the dollar" from collapse... but, before you raise the eyebrows, please read on... What Makes the US$ a Strong Currency It would be stating the obvious to say that US is a super power and dollar is the strongest currency in the world. The US dollar derives its strength, because it has been de facto the only international currency. What is often less clearly understood are the reasons for this supremacy of US$ over other currencies. In fact, the hegemony of US$ defies common economic logic; common sense dictates that the value of any currency should reflect the fundamental strength (or weakness) of the economy it represents. On the other hand, if one looks at the US economy, clearly US$ is over-valued. Consider, these facts: US$ is not pegged to gold since 1971 (US made the dollar a float currency in 1971 - backing out on its Bretton Wood commitment. In 1971, it was left with just $11bn in gold to pay for a debt of $70bn). US - "the consumer of the last resort" - imports more than it exports; in 2002 itself, the US imports were 48% more than its exports. consequently, the current account deficit of USA in 2002 was $550bn (more than the GDP of India), which was slightly more than 5% of the US GDP USA has been maintaining this level of current account deficit for more than last quarter of a century!!! as a result, the accumulated debt of USA is $6-7trillion, which is about two-third of the US GDP Out of this, around $2.7trillion is foreign debt, making it the largest debtor nation in the world Since September 2002, the US debt is increasing at the rate of $1.25bn per day. etc. So how come, sitting on an economic fault-line, US$ remains so strong? The primary reasons for the strength of US$ is its demand as a currency of transaction, around the world: about 80% foreign exchange transactions are conducted in US$. approximately half the world exports are done using US$. more importantly, by agreement with OPEC, all oil trade is done in US$, and oil is needed by all economies. to conduct international trade, countries and banks keep US$ in their reserves. Currently, US$ accounts for 68% of all global exchange reserves. all IMF loans are given in US$, and the debt servicing can be done only in US$ (which incidentally is not surprising, since US Treasury holds 51% stakes in IMF) etc. This international status of US$ gives US a unique advantage, which no other nations can compete against. In order to meet their international trade obligations, countries and banks must maintain foreign exchange reserves - i.e., buy dollars from currency market, keep a check on their trade deficit (so that their currency does not get over-valued), etc. But for USA, it is as simple as printing dollars!!! It can import the goods and services it needs/consumes from anywhere in the world virtually free. In effect, US produces US$, and other countries produce goods and services that can be bought by US$!!!...In the present state-of-affairs, the huge foreign US debt is a non-issue as far as day-to-day transaction with US is concerned. [to be fair, at least, in the recent past, the US has not printed US$ just to keep take care of its trade deficit - too many dollars floating in the global market will reduce the value of the currency. In recent times, such an idea has been voiced more than once. In a speech given on November 21, 2002, Ben S. Bernanke, a Federal Reserve Board governor, did mention a device called a "printing press" which he explained can take care of the sliding state of US economy. The government, he noted, can "produce as many U.S. dollars as it wishes at essentially no cost." This is a possibility - though, not an improbability - but still a remote one; only once earlier the US had printed dollars to pay for its trade deficit was in 1945-51 era.] A more practical way to keep the US$ afloat, however, has been to keep it in circulation. The more dollars are exchanged around the world for trade among countries, or invested back by foreign owners in US, the more world must continue to provide goods and services to US in exchange for the dollar. With around $3 trillions in circulation around the world, this is what has kept the US$ the strongest currency in the world. Emergence of Euro as a Threat to US$ Hegemony So what can be a threat to the monopoly of US$? If the "industry standard" for global trade (specially oil trade) shifted to some other currency, US$ - and therefore, US economy - would be in deep trouble. If countries switch away from dollar standard, it would result in catastrophic consequences for the US economy, e.g.,: the US will be forced to pay its debt by supplying its creditor countries in real goods and services in return - and not just in US$ the imports to US will cost substantially more (in real terms) than what they do presently, and as more dollars get off-loaded in the currency market, the value of US$ will further go down, etc. In fact, one of the worst-case scenario for US has been if the oil-producing countries shift away from US$ as the global currency of transaction. Not only would it grind the US economy to a halt (the US is world's largest importer of oil, and imports more than 50% of its requirements of more than 20mn barrels/day [2000 figures], for which it would now have to pay), this would also snowball into countries selling off their dollar-based forex reserves to buy the alternative currency... in the process, the global trade would also gradually shift away from US$, reducing its value. And this is precisely what started happenning during last 4-5 years. In 1999, the European Union introduced the common European currency, Euro, which replaced the individual currencies of the 12 members nations. Starting as weak currency (when it slid to 85cents against the dollar), over last couple of years, the Euro has continued to strengthen against US$, and has emerged as a strong competitor to US$ as a standard currency for international trade and transactions. In fact, since 2001, US$ has lost around 25% of its value against the Euro. There are other trends as well, which have started threatening the monopoly of US$: In January, 2002, China announced its intention to diversify its portfolio of reserve currencies to increase the proportion of Euros in the kitty. This was a significant development, since China is not only one of the largest single market and exporter, but also holds $208bn - the second largest after Japan - in forex reserves in US$. While the forex currency portfoilio is a state secret in China, according to BNP Paribas, the Central Bank for Euro, this could have led to the share of US$ in China's forex portfolio from around 80% in 1998 to less than 50%. Between, 2001 and 2003, Canada increased the Euro proportion in its forex reserves from 23% to 42%, while reducing the US$ from 75% to 55%. In January, 2003, Russian Central Bank announced that it had increased its Euro holdings in forex from 5% to 10%, while reducing the dollar's share from 90% to 75%. It made sense also, since 42% of Russia's imports come from Europe. by mid-2002, many central banks in Taiwan, HongKong, and East European countries, had also started increasing their Euro holdings, while going slow on buying US$. Following the trend, in March 2003, Bank Indonesia was also considering shifting its forex from US$ to Euro. The other country in the "Axis of Evil" - North Korea - also stopped dealing in US$ from December, 2002. etc. These shifts were natural, since dealing in Euro for international trade offer these countries many advantages, viz.: Euro is, at least theoretically, more stable currency, since it is pegged 15% to gold in comparison to the US, the European Union does not carry huge trade deficits or foreign debt the European Union has a larger share of world trade as compared to the US, and has emerged as a major trade partner with the middle-east, Russia, and China. It is also expanding by bringing in new members in the Euro-zone (starting with 12 members, it has grown to a 15-nation body, and another 10 countries have signed to join the EU by May 1, 2004). using Euro for trade with the EU countries would save on transaction costs, as well as reduce the foreign exchange risks in the Euro-zone, etc. one can buy anything with Euro, which one could buy with US$... except oil!!! World Oil Trade Shifting Away From US$? ...except oil!!! This has been the safety net for US$. As long as the stronghold of US$ remained on the oil trade, the petro-dollars would continue to circulate and be recycled, central banks would continue to save their forex reserves in US$, global trade would continue to be transacted in US$, and the US$ would continue to reign. By an agreement between US and Saudi Arab (the largest producer of oil - and chairman of OPEC), the oil supplies are denominated in US$ only by all OPEC countries. well... all, except one! The first salvo against the petro-dollar monopoly was fired by - yes, you guessed it - Iraq. In November, 2000, Iraq - with world's 2nd largest oil reserves - switched from US$ to Euro in its oil trade. Under the UN's food-for-oil programme, two-third of Iraqi oil as bought by the US companies - now, it had to be paid for in Euro. Soon afterwards, Jordan entered into a bilateral arrangement with Iraq for oil, which was done entirely in Euro. Later, Iraq also converted its $10bn reserve funds in UN to Euros. Other trends started emerging subsequently, which taken together, portended setbacks to the US petro-dollar supremacy, e.g.: In August 2002, Iran converted more than half of its forex reserves from US$ to Euro. Switching to oil payment in Euro would be just the next step. With 12,000 million tonnes of oil reserves, Iran has the 5th largest oil reserves in the world. In 2002, Russia (world's 2nd largest exporter of oil) enterned into negotiation with Germany to establish an exchange for selling euro-denominated oil futures. The 4th largest oil producer, Venezuela, finalised a barter deal with 13 developing countries who will provide it goods and services in exchange for oil. "The Caspian Oil Bonanza" turned out to a non-starter. The region was supposed to have oil reserves, which would dwarf the reserves of Saudi Arab. The US Oil industry had staked major claims in the region (and it is not difficult to believe that the reasons for war on Afganistan was to make conditions smooth to lay the pipeline through the region - which the Taliban had refused). the But in 2002, it became clear that the region had, at the most, 4% of world's oil reserves - and that too of poor quality. In April, 2002, in a speech, Javad Yarjani (Head of OPEC's Petroleum Market Analysis Dept) made the point: "...it is worthwhile to note that in the long run the euro is not at such a disadvantage versus the dollar when one compares the relative sizes of the economies involved, especially given the EU enlargement plans. Moreover, the Euro-zone has a bigger share of global trade than the US... I believe that OPEC will not discount entirely the possibility of adopting euro pricing and payments in the future... It is quite possible that as the bilateral trade increases between the Middle East and the European Union, it could be feasible to price oil in euros..." Yarjani's comments are significant, if one considers that: Even in 2000, the crude oil imports by EU accounted for 27% of total world oil trade as compared to 25% by the US. In May, 2004, when 10 new countries join the EU, it will have a population of 450mn (30% more than the US), and a aggregate GPD of $9.6trillions (roughly matching the US) It would also result in more that 50% OPEC crude being sold to EU countries, and transacted in Euro. Enlargement of EU will put further pressure on the potential EU entrants - Sweden, Denmark, and Norway - to join. Norway is also world's 6th largest producer and 3rd largest exporter of oil. If it joins EU, it will naturally shift to Euro standards... etc. In all probability, if events continued to move in the direction in which they were moving, by 2005, the oil trade, and therefore, the global trade, was likely to shift to Euro standards - thus, hurting/collapsing US economy. The Opportunity from Iraqi Oil So how does "liberating Iraq" help saving US$ from collapse? Securing the Iraqi oil fields offers the US many oportunities for reversing the trend described above. In fact, the US is likely to leverage this situation, and try to create barriers, so as to minimise/eliminate even a future possibility of any movement away from US$ in oil trade. Some of likely outcomes of US occupation of Iraq will be: US will not share the "Iraq reconstruction" work with any other euro-biased country. The "vital role" it has promised to UN in the reconstruction will remain confined to humanitarian assistance. The US will maintain control by awarding all oil contracts to US companies. This is already taking place, and any "interim Iraqi government" will get these contractors fait accompli. This will help US in ensuring that Iraq's oil trade reverts back to US$ standards. The power of OPEC has emerged as a contraint for US in influencing the nature and denomination of global oil trade (specially, now that there are chances that OPEC may decide to denominate oil in Euro). US will use its position in Iraq to undermine/dismantle the power of OPEC. The steps are likely to be as following: OPEC maintains an oil price-control mechanism, which relies on mutually agreeing on each member country's production quota. This has helped in keeping the oil prices stable around the world, and in avoiding a mutually detrimental price-war among the OPEC member countries. Consequenty, most OPEC members accept a limit on their oil production, which is well-below their capacity. Iraq, at present, produces around a limit of 2million barrels/ day, though it has the capacity of producing far more (upto 7million barrels/day, according to some estimates) than this limit. US will use "Iraqi Oil for Iraqi People" line to start violating the quota set by OPEC. Once this happens, other OPEC members are likely to compete with Iraqi oil by producing beyond their quota. The ensuing price war will result in: (1) world-wide reduction in oil prices, which will benefit nations (e.g., US), which are highly dependent on oil imports, and (2) break-down the authority of OPEC, and OPEC itself, leaving US free to form bilateral ties with these countries (in which it can insist that oil remains denominated in US$) Needless to say that political and economic intentions do not work exactly the way they are planned. The real world is far more complex. The other equally-likely scenarios as well. For instance, the OPEC may nevertheless decide to redenominate oil in Euro. Or there can be the rise of ethic tensions and anti-US sentiments in Iraq, making implementation of these intentions impossible... The Iraqi Liberation can become a replay of Vietnam for US, as well. ***** Sources Quoted in this article: [1]: Put URL Here [2]: Put URL Here [3]: Put URL Here [4]: Put URL Here [5]: Put URL Here [6]: Put URL Here [7]: Put URL Here [8]: Put URL Here [9]: Put URL Here [10]: Put URL Here Archives [Your Feedback] [View Guest Book] To Subscribe, pl send a blank mail to [email protected]