A small but persistent group of writers believes that the threat to dollar-denominated oil purchases was a key factor in the war on Iraq, and is now behind the Iranian crisis; two more pieces making this connection appeared last week.[1,2]  --  For more examples, see here and here.  --  Few economists credit this theory, however.  --  Richard Heinberg briefly embraced the theory, then distanced himself from it.  --  In the week before the invasion of Iraq, economist Paul Krugman posted a refutation of the notion on his website.[3] ...


Speaking freely

By Toni Straka

Asia Times Online
August 26, 2005


Could the proposed Iranian oil bourse (IOB) become the catalyst for a significant blow to the influential position the U.S. dollar enjoys? Manifold supply fears have driven the price of crude oil to its recent high of US$67.10 -- only a notch below its highest price in inflation-adjusted dollar terms. With the world facing a daily bill of roughly $5.5 billion for crude oil at current price levels, it becomes apparent that sellers and purchasers of the black gold are looking into all ways that could lead to a financial improvement on their respective sides.

Non-U.S.-dollar holders so far have been the victim of additional transaction costs in the oil trade. The necessary conversion of local currencies into oil-buying greenbacks can be considered a hidden tax, charged and enjoyed by the international banking sector. The IOB, by eliminating this transaction cost, will become a factor that could unsettle the dollar's dominant position. While the worldwide bottleneck of inadequate refining facilities and partly dramatic declines in production -- for example in the North Sea -- are two factors that cannot be eliminated in the short term, there is one area left which could result in smiling faces of oil producers as well as most buyers.

Oil consumers are entangled in a web of supply fears that span the globe. In Venezuela, President Hugo Chavez threatens to divert oil supplies from the U.S. to China, which faces severe gasoline and diesel shortages these days. Attacks on Iraqi oil installations have slowed exports there. Ecuador's oil industry is still recovering from a strike, while Nigerian oil companies are in the middle of efforts to avoid a strike there.

Until now, oil has been solely priced, traded, and paid for in the greenback on markets in both London and New York. But monthly worldwide oil revenues of over $110 billion (on a 20-trading-day basis) -- a third of which ends up with OPEC (Organization of the Petroleum Exporting Countries) members -- raise the question of what happens to these cash mountains. According to the most recent data from the US Treasury Department, OPEC members have parked only a skimpy $120 billion in direct dollar holdings, which are almost equally split between equities and American debt paper. This is a clear indication that oil producers are investing their windfalls elsewhere. The yield spread between U.S. and EU debt papers in favor of the EU is another hint where the petrodollars might be heading.

Especially in the case of Iran, it does not make sense to accept dollars only for its much-desired commodity. Given that Iran is seen as a hostile country by the current U.S. administration for its intention to build its own nuclear reactors, one wonders whether the new IOB will not try to attract buyers other than Americans. Iran has recently announced that the new oil exchange will start up its computers in March 2006.

The proposal to set up a petroleum bourse was first voiced in Iran's development plan for 2000-2005. Last July, Heydar Mostakhdemin-Hosseini, who heads the board of directors of the Iranian Stock Exchange council, said authorities had agreed in principle to the establishment of the IOB, where petrochemicals, crude oil and oil and gas products will be traded. The oil exchange would strive to make Iran the main hub for oil deals in the region and most deals will be conducted via the Internet. Experts from London's International Petroleum Exchange (IPE) and the New York Mercantile Exchange (NYMEX) have reportedly confirmed the feasibility of the project.

The IOB can count on two sharp arrows in its holster. It can -- and probably will -- lure European buyers with oil prices quoted in euros, saving them dollar transaction costs. And it can strike barter deals with oil-hungry giants like China and India who have a lot of products and commodities to offer. One doubts whether American hamburgers and legal services will be considered adequate collateral for the world's most after-sought resource.


Weaned off the almighty commodity, the U.S. dollar can have a deeper impact on the U.S. economy than a direct nuclear attack by Iran. The permanent demand for dollar-denominated paper stems substantially from the fact that until now almost all resources of the world are quoted in it. While this led to the eurodollar (U.S. dollar-denominated deposits at foreign banks or foreign branches of American banks) market in the 1970s, the new terms of trade could ring in the demise of the dollar as the premier reserve currency.

With the world economy depending so much on oil, the black gold itself can be seen as a reserve currency that will be handed out against only the best collateral in the future. Last month, the Federal Reserve Bank of San Francisco published a paper about the progress of the diversification of central banks' reserves around the world. It concluded that the dollar's position is on the decline in many countries. China, the new industrial giant, has officially declared that it will diversify a part of its forex holdings into oil by building a strategic petroleum reserve. Construction of storage tanks has begun this year and will take several years until completion. China has not yet said how many barrels of oil it wants to store. The implications for the oil market can only be guessed as China wants to use its future reserves to smooth out spikes in oil price.

Iran holds a strong hand as the No 2 producer of crude behind Saudi Arabia, pumping 5% of the world's oil demand. Politicians there will also keep in mind that dollar deposits might become a burden in the future, if the U.S. steps up its current war of words to the level of economic sanctions in the attempt to halt construction of Iran's nuclear power plants. Money in the bank does not help when you have no access to it. Substituting Iran's domestic oil demand partly with nuclear power will place the country in a win-win situation. Cheaper nuclear energy and increases in oil exports from the current level of roughly 2.5 million barrels a day will result in a profitable equation for Iran.

Only one major actor stands to lose from a change in the current status quo: the U.S., which with less than 5% of the global population, consumes roughly one third of global oil production. Oil in euros would benefit millions more in the EU and its trading partners, though. And it would loosen the grip the U.S. has on OPEC members. Thinking of the rapid growth of hostilities between the U.S. and Arab nations in recent years, a renunciation of the dollar appears to be more than just an Arab daydream.

As this development poses a very real danger to the superior status of the greenback and the interests of the U.S., the "president of war" can be expected to take a strong line against the winds blowing from the Middle East. One may be reminded that Saddam Hussein had entered into discreet talks with the EU, proposing to sell his oil for euros. That was in the year before the first oil war of this century.

The IOB could help the euro to become the interim primary reserve currency before China and India rise to the first two slots in the global economic ranking in the next few decades. A decline of the dollar's position in oil trading might also open the floodgates in other commodity markets where the dollar is the medium of exchange but where the U.S. has only a minority market share. A global economy driven by tough efficiency demands in the light of thin profit margins almost everywhere is a good primer for accounting changes in other commodity markets as well. This process could begin in resources like steel and energy and spread to all other resources that are marketed globally. The world outside the U.S. has a lot to gain from it.

--Toni Straka is a Vienna, Austria-based independent financial analyst and portfolio manager, who worked as a financial journalist for over 15 years and now evaluates global market trends. He runs a blog, The Prudent Investor, where this piece first appeared.



Special Report


** Iran's danger to America is not its nuclear program but its plan to introduce a euro-based energy exchange. **

Raise the Hammer
August 22, 2005


Starting in 2006, Iran will start up an "oil bourse", or a stock exchange for trading energy, that will be based on the euro, not the US dollar. While this may seem innocuous, it will be a grave risk to continued American global hegemony.


Today, most oil trading takes place on the New York Mercantile Exchange (NYMEX) and the London-based International Petroleum Exchange (IPE). Since the 1970s, the OPEC countries have all agreed to sell oil for U.S. dollars only. This means every country that wants to buy oil must first acquire enough U.S. dollars to buy what it needs.

Year after year, America imports much more than it exports. It must pay out that difference (its current accounts deficit) in dollars. Last year, the U.S. ran a current accounts deficit of over $600 billion USD; this year, it's expected to increase to $700 billion.

If there were no good reason for other countries to buy all those American dollars, then the dollar would decline in value until the U.S. economy could no longer afford to import goods from abroad. This is what happens when other countries run large current accounts deficits over long periods.

However, the deal with OPEC means other countries have no choice but to buy all those excess American dollars, which props up the value of the dollar and allows the American "import economy" to go on year after year. Effectively, America's main export is U.S. dollars, and it is absolutely imperative to preserve a captive market for those dollars among oil-consuming countries.

The continued viability of the U.S. economy depends on it. Americans can still afford to consume because their economy is suffused with cheap imports; a falling dollar will raise the prices of imported goods. At the same time, Americans enjoy some of the lowest oil prices in the world, largely due to the petrodollar arrangement. This has skewed the American vehicle market toward gas-guzzling but profitable SUVs and light trucks.


One of the major unstated reasons the United States invaded Iraq was to stop Saddam Hussein from trading oil for euros, which he had begun in 2000. Hussein actually made more money selling oil for euros, as the euro appreciated 17 percent against the dollar between 2000 and 2003. Other countries in the region, particulary Iran and Syria, began public musing about switching from dollars to euros around the same time.

All three countries were subject to a barrage of threats from the United States government, but only Iraq went through with the switch, and it was summarily invaded. One of the U.S. government's first acts in Iraq was to switch oil sales back to dollars.

Now, Iran plans not just to sell oil for euros, but to create an exchange market for parties to trade oil for euros. The oil bourse will provide a euro-based price standard, the way West Texas Intermediate crude (WTI) and North Sea Brent crude do today. To the extent that the balance of reserve holdings starts to shift from dollars to euros, that's very bad news for America's system of dollar hegemony.

Iran is taking a calculated risk that enough countries have an interest in a petro-euro market to contain American aggression. Many central banks are already quietly shedding their dollar reserves, nervous that America's economic fundamentals ($500 billion federal deficit, $700 billion current accounts deficit, $4.5 billion federal debt, record business and personal debts, zero savings) cannot be sustained for long, and hoping to insulate themselves from what they see as an inevitable recession. The US dollar has declined by a third against the euro since 2000, despite the petrodollar arrangement.

At the same time, Europe is eager to enjoy more of the "virtuous circle" that comes from supplying a major reserve currency: a ready market for its currency and guaranteed reinvestment as euro-holders plant their money in European markets. Vladimir Putin, Russia's president, has also expressed interest in switching from dollars to euros. Russia would benefit from getting paid in a stronger currency, and it would represent a political victory over America after fifteen years of watching its clients and assets in the oil-rich Caspian region co-opted by American expansion.


Iran may, indeed, be attempting to acquire nuclear weapons. However, it also has a "legitimate" interest in developing nuclear power, since its own oil reserves are already post-peak and it aims to continue in its role as an energy exporter. Iran is a signatory in good standing to the Nuclear Non-Proliferation Treaty (NPT) and has openly informed the International Atomic Energy Agency of its intentions as required by the Treaty.

However, Iran's presumed attempt to acquire nuclear weapons is only the politically acceptable excuse for America's threats. The real danger is that Iran will lay down the foundation for a post-hegemonic international energy industry in which America is merely one of many players. If Iran is, in fact, developing nuclear weapons, it is doing so to acquire a deterrent against exactly this kind of American encroachment.

Indeed, recent world events have only enforced the notion that a nation's successful efforts to acquire nuclear weapons confer respect and status, not the opprobrium it deserves. India, a growing economic power that possesses a nuclear arsenal and refuses to sign either the NPT or the Comprehensive Test Ban Treaty (CTBT), has just been rewarded for its efforts by U.S. President Bush, who has agreed to "work to achieve full civil nuclear energy cooperation with India." This is a straightforward violation of the NPT, which forbids signatories from exchanging nuclear materials or support with non-signatories.

If Iran really is trying to acquire nuclear weapons, is it any wonder why? Look at the advantages that having nuclear arsenals have given to U.S. allies India, Pakistan, and Israel, all of which have benefitted immensely from a playing field tilted in their favour by their ability to project devastating power. As official hysteria about Iran's intentions escalates in volume and intensity, remember the real force undermining the moral authority of the NPT: the big nuclear 'have' countries that still refuse either to apply the ban consistently or to take any meaningful steps of their own toward "general and complete disarmament" -- ostensibly the NPT's ultimate goal.

Ironically, America originally invaded Iraq -- a poor, defenseless country -- partly to send a message to other oil producing countries not to rock the petrodollar system, but the real message for small countries is that they need to present a credible deterrent threat or risk being ignored and/or invaded.

FURTHER READING (see original for links)

"From Petrodollars to Petroeuros: Are the Dollar's Days as an International Reserve Currency Drawing to an End?" Strategic Insights, Volume II, Issue 11 (November 2003)
"Iraq, the Dollar and the Euro," Hazel Henderson, The Globalise, June 02, 2003
"The Real Reasons for the Upcoming War With Iraq: A Macroeconomic and Geostrategic Analysis of the Unspoken Truth," William Clark, January 2003 (Revised March 2003, with Post-war Commentary January 2004)
"US Dollar Hegemony Has to Go," Henry Liu, Asian Times, April 11, 2002

--Ryan lives in Hamilton with his family and works as an analyst, web application developer, writer and journal editor. He is the editor of Raise the Hammer. Ryan also helps to edit Perspectives on Evil and Human Wickedness, writes occasionally for CanadianContent.Net, and maintains a personal website.


By Paul Krugman

March 14, 2003

http://www.pkarchive.org/ ('The Unofficial Paul Krugman Archive')

I've been getting a number of emails from people suggesting to me that this impending war is all about money -- specifically, to ensure that the dollar, and not the euro, remains the world's #1 currency. The idea is that the U.S. economy will be in danger if OPEC members start demanding payment in euros rather than dollars.

With respect to my correspondents, this isn't a plausible argument. It's politically implausible -- who, exactly, in this administration is supposed to be thinking about the role of the dollar as a key currency? The same people who invited the author of The Bible Code to brief the Pentagon? And anyway, the economics are wrong.

Remember the three roles of money: medium of exchange, unit of account, store of value. The dollar plays all three roles to some extent on world markets. It's a medium of exchange: people converting Brazilian reais to Malaysian ringgits (or rather banks making trades in the FX market) normally do so through two transactions against the dollar. It's a unit of account: although most world prices are set in other currencies, the share of prices in both financial and goods markets specified in dollars is larger than you would expect from the raw economic weight of the United States. And the dollar is a store of value: the Fed estimates that about 60 percent of US currency -- that is, actual pieces of green paper -- is held outside the US.

But why does all this matter? Does it give the U.S. a special advantage in the world? Well, yes -- but not nearly as big an advantage as people imagine. And a change in how OPEC gets paid would make very little difference.

The U.S. advantage comes to the extent -- and only to the extent -- that the international role of the dollar lets us borrow money more cheaply than we otherwise could. One component of that is clear: because foreigners hold a lot of dollar bills, which pay no interest, we in effect get a free loan of that much money.

Dollar-denominated bank accounts also provide a bit of an interest-free loan, because they are ultimately backed by deposits at the Federal Reserve. But most of the accounts held by foreigners have very fractional backing -- they're typically eurodollar accounts, which are only partly backed by accounts in the U.S., which are in turn only partly backed by deposits.

It's also possible that even our interest-bearing debt commands a better price -- i.e., a lower interest rate -- because of the dollar's special role. But there doesn't seem to be any evidence of that, and it's not likely to be more than marginal. (Also, the U.S. isn't the only country that can issue dollar-denominated bonds.)

So the main thing is cash overseas -- $300-350 billion of bills, mostly in large denominations, hidden under beds, being transferred among criminals, etc. At an interest rate of 4 percent -- say that's a normal rate -- this is a subsidy to the US of $12-14 billion per year. Small change, for a $10 trillion economy. It's not even a significant part of our current account deficit.

Moreover, would a change in OPEC settlements really affect this?

There's probably some link between the dollar's role as unit of account/medium of exchange and its role as store of value. But when we say that Saudi Arabia is paid in dollars, what we mean is that oil is paid for with a wire transfer from a London bank, with the sum denominated in dollars. It doesn't mean that green pieces of paper change hands, or even that there is a stash of green paper somewhere being held to back the transaction. What really matters for the cash held overseas is which currency people who don't trust their native currencies think is a good bet. Rumor has it that the Russian mafiya is switching to euros, since Europe is where ill-gotten Russian gains get banked or spent; if so, that's a much bigger deal for seignorage than pricing of Persian Gulf oil.

So this particular conspiracy theory is wrong. Sorry.

Of course, you may well ask, why then are these people so determined to have their war? The answer is because. Just because.