Black and gold: oil and the US dollar

A dozen national leaders will sit in a room in Libya sometime in 2012 and essentially decide whether the U.S. continues as a country.


The men are the leaders of the oil producing nations, and the meeting the next Opec conference. More radical members are pushing to have the cartel move away from trading in the U.S. dollar. It would devastate the U.S., while rewarding the oil states.

Forget for moment peak oil, party politics, the credit crisis, terrorism or even nuclear rogue states – these are all secondary to the new Cold War. This time around it’s economic warfare, played out on the business pages.

According to the petrodollar warfare hypothesis, Continental Europe and the United States have been embroiled in a bitter fight since the 1995 introduction of the euro – which can explain the Iraq invasion and demonization of Iran; the underlying themes can be traced back to successive U.S. administrations’ refusal to acknowledge peak oil, climate change or renewable energy sources. Complicating things for the future is the involvement of Russia and China.

Guns and butter

To tell the story I must first step back to 1971, when President Nixon, needing to control inflation caused by rampant “guns and butter” spending on the Vietnam war and social programs, brought the U.S. off the gold standard. That year also saw Opec countries agreeing to trade oil exclusively in US dollars – ironically, the year U.S. production hit peak.

The 1944 Bretton Woods agreement – of the WWII Allies – had established the US dollar as the world’s reserve currency.  All other currencies had their rates of exchange fixed  to the dollar, which in turn was redeemable for gold at $35 per ounce. But the US was soon expanding the supply of Federal Reserve notes – essentially creating money which was not backed by gold. When Nixon came off the gold standard it sent a shockwave across the world’s markets.

The US dollar remains as a reserve currency. four-fifths of all foreign exchange transactions and half of all world exports are denominated in dollars, and IMF loans are counted out in greenbacks. But then, the world desperately needs dollars to buy oil. Third World countries sell raw materials for dollars just to stay afloat.

Having the dollar buoyed by oil rather than gold made the U.S. rich. This also suited the oil producing nations, as a strong dollar is more profitable than payment in a weak currency.

The last ever American trade surplus was recorded in 1975. Every year since has seen a deficit, yet the economy has grown. The U.S. is essentially exporting dollars in return for goods and services. It is addicted to oil.

U.S. economy depends on massive global oil consumption

Ronald Reagan was the first politician to focus on the relationship between the dollar and oil. His first action as president in 1981 was to remove the solar panels Jimmy Carter had installed on the White House roof (and axe the tax credit for those wanting to fool around with renewable energy). He saw the future of the US depending on the massive international consumption of oil, and encouraged the Saudis to flood the market.

This brought the price of oil down to a particular low around 1985-86, boosting global consumption; a complete reversal of the 1973 oil embargo. This was win-win: increasing oil use boosted international demand for the dollar and the AImagemerican economy soared, while the low price of oil brought the Soviet economy to its knees, as their inefficient extraction meant they could not sell at a profit. The Soviet Union finally collapsed in 1991.

But in 1995, European nations gambled everything on creating a currency to capture oil revenue. The euro was launched specifically to become the “new” US dollar, a reserve currency used in the oil trade (it is currently used daily by 327 million Europeans and has more banknotes in circulation than the US dollar).

If the world had adopted the euro as reserve currency the U.S. economy would have been wiped out. And it looked like this was beginning to happen in 2000, when Iraqi dictator Saddam Hussein began to trade Oil for euros. Depending on who you listen to, this was either revenge for sanctions or a level-headed economic decision, as the euro was stronger than the dollar and had more purchasing power (a barrel of oil traded for euros bought more on the world market than one traded for dollars).

Afghanistan and Iraq invasions

The next major player is George W Bush. Elected 2001, he launched the Afghanistan invasion shortly after the 9/11 attacks, and the following year named Iraq as part of an “axis of evil,” along with Iran and North Korea.

The U.S. stance on Iraq, supposedly over weapons of mass destruction, was backed by Britain and Australia – both with sovereign currencies tied to the dollar – and most bitterly opposed by France and Germany, which had invested all in the euro. On one side, countries with an interest in Iraq reverting to the dollar, and on the other, nations with a financial interest in continuing euro oil sales.

The Iraq war began March 2003; Bagdad fell in April; by June, the London Financial Times announced Iraq was now selling oil in dollars.

Iran’s ‘nuclear bomb’

The next international leader to talk up the euro bandwagon was Mahmoud Ahmadinejad, who became president of Iran mid-2005. (Iran had actually been quietly accepting euros for oil since 2003 but never made an issue of it.) Iran was subsequently announced to be “10 years away from developing a nuclear bomb.”

Looked at this way, economic warfare is Iran’s nuclear bomb.

Venezuelan President Hugo Chavez was next to the game, announcing his intention to move foreign-exchange holdings out of the dollar and into the euro in October 2005. (Bizarrely, this immediately followed American media support for religious broadcaster Pat Robertson’s call for Chavez’s assassination.)

Ahmadinejad and Chavez got their chance to attack the U.S. at the November 2007 Opec summit. “They get our oil and give us a worthless piece of paper,” Ahmadinejad told an impromptu press conference, “We all know that the U.S. dollar has no economic value.” He pushed Opec members to dump the dollar, while Chavez argued for a more Socialist agenda for the group. US ally Saudi Arabia rallied against both calls.

Prophecy for 2012?

The next Opec summit is held in Libya in 2012. Ahmadinejad has already said he will be urging oil exporting countries to cease accepting the US dollar.

At the time of writing (March 2010) the euro is in freefall over the collapse of the Greek economy, and beginning to look like an experiment that failed. The euro might not exist in 2012, or it might be so worthless that no sane Opec leader would contemplate the switch. But what’s to stop Ahmadinejad pushing to trade in a basket of other currencies, including the Chinese yuan? Iran has a special trading relationship with China, in pretty much the way that Saudi Arabia does with the US.

The bell tolls

According to an October 2009 report in the British Daily Telegraph newspaper, China’s recent actions suggest it is preparing to go head-to-head with the U.S. over reserve currency. It’s worth quoting at length:

You can date the end of dollar hegemony from China’s decision last month to sell its first batch of sovereign bonds in Chinese yuan to foreigners.

Beijing does not need to raise money abroad since it has $2 trillion (£1.26 trillion) in reserves. The sole purpose is to prepare the way for the emergence of the yuan as a full-fledged global currency.

It’s the tolling of the bell,’ said Michael Power from Investec Asset Management. ‘We are only beginning to grasp the enormity and historical significance of what has happened.’

(Daily Telegraph, China Calls Time on Dollar Hegemony, October 2009)

Beijing previously kept the yuan pegged to the dollar, deliberately low to boost exports that keep factories running full tilt, but this is no long term strategy as it risks inflation due to rising domestic demand.

The next Great Depression

Opec nations account for two-thirds of the world’s oil reserves and one-third of production. If they turn against the dollar en masse in 2012, or if enough oil producing nations individually switch to other currencies, the US economy is over. The last Great Depression was bad enough, but back then the U.S. had vast reserves of oil. The only way out of the next one will be for the nation to export more than it imports.

Being realistic, the average Opec leader is deeply conservative and decidedly pro-Western – educated in the West and arguably reliant on Western expatriates to keep their economies running. But they are under immense pressure to ramp up domestic spending; if nothing else, to fend off Islamic revolution. If the dollar slumps, other currencies would give them more purchasing power on the world market – their oil is simply worth more sold this way. The question is, how long would they remain loyal to a plummeting dollar?

Meanwhile, Russia – strong again thanks to rising oil prices – is emerging as a wildcard, ramping up oil and natural gas sales to Europe. Currently trading in euros, Vladimir Putin has let it known he would prefer payment by ruble. It is perhaps no coincidence that the U.S. has a “missile defence plan” in Eastern Europe. Ostensibly to shield against launches from Iran or North Korea, the Kremlin feels they are squarely aimed against Russia.

Committed to Iraq and Afghan presence

This economic argument suggests why, despite a new U.S. president coming to power with a mandate of change, the nation remains committed to a military presence in Iraq and Afghanistan. Barak Obama, like Nixon, has a guns and butter spending problem: how can he invest in the home economy while maintaining a $3 trillion overseas war?

Put simplistically, the best way to ensure Iraq exports oil for greenbacks is to keep the troops there to oversee things. The U.S. also needs control of Afghanistan to exert influence over Central Asian reserves. (It is estimated that the Caspian Sea basin has $12 trillion reserves of oil and natural gas.) Even if this involves a pipeline through Afghanistan, the U.S. does not intend to steal anyone’s oil – but the nation remains utterly dependent on oil trade continuing in the dollar.

There’s a Catch-22 situation here: Obama can’t afford to call the troops home if it means losing a grip on the oil producing regions; he can’t afford to keep them in place if it causes the dollar to weaken. Either way, oil producing nations could turn their backs on U.S. currency.

Forty year free ride

The world buying oil with dollars has given the U.S. economy a 40-year free ride. Being tied to oil is a great strength, but also a colossal weakness: the day the world stops buying vast amounts of oil is the day the US collapses.

Accepting this argument goes some way to explaining why successive U.S. governments:
• can afford to run massive deficits year in, year out
• won’t acknowledge peak oil, alternate energy or global warming (in favour of promoting oil consumption)
• invaded Afghanistan, and maintain a presence in the country
• invaded Iraq, and maintain a presence there
• came head-to-head with France and Germany over Iraq
• threatened Iran
• promote a missile defence plan in Eastern Europe
• look on the rise of China with alarm

It has the benefit of being simple (perhaps overly simplistic) but does not rely on illogical rhetoric like having to believe particular presidents are evil or stupid.

Disclaimer: the small print

I am not attempting to be anti-U.S, nor “rehabilitate” Iraq or Iran, both of which are longtime rogue states. I am not trying to come up with some sort of universal theory of the world; just look at disparate different events from a unified viewpoint. I’m also aware that placing information in a chronological framework could look like blame or finger-pointing.

mideast2%5B1%5D Black and gold: oil and the US dollar

By far the greatest danger, however, in arguing too strongly for the petrodollar warfare hypothesis I can give the impression that there are no other benefits to the US of its involvement in the Mid East. As a recent column by the excellent writer Charles Hugh Smith observes, the „US has neatly carved out a sphere of influence in the fulcrum of the Mideast.“ He has drawn a map of US influence that can either be interpreted as surrounding Iran, or else as neatly bisecting the region in a line from the Mediterranean to China. (It probably is both – it’s about being close to all oil resources and the major players; no one can embark on colonial ambitions without having to cross US forces). As Smith tells it:

It is a strategic power play of breathtaking consequence. Ultimately, the U.S. doesn’t have to „win“ or even control territory; it simply has to deny control to others, introduce a permanent uncertainty and unease in their plans, and establish forward bases for power projection.

Clearly, there is room for both positions – petrodollar warfare and a more traditional view of empire. Soldiers on the ground are a way of keeping the peace, both in military and economic terms.

If nothing else – if you reject this argument – oil being traded in the US dollar has given Americans a particular advantage: the price of oil does not fluctuate with their currency. For example, oil becomes a lot more expensive in the UK when the pound sterling slumps in value (against the dollar, that is). British citizens are paying the same dollar price per barrel of oil, but each dollar costs more pounds, so to them, oil has become more expensive..

peakgraph%5B1%5D Black and gold: oil and the US dollar

This essay of mine is an attempt to look at oil from a currency viewpoint, which suggests that the U.S. has more to fear than just peak oil. Hydro-carbon resource collapse is coming; it’s just that bigger threats to the American economy are closer at hand.

Personally, I believe that a world be shaped by American ideals is a better place than one shaped a Chinese dictatorship that starved 30 million of their own people. For obvious reasons I do not want the U.S. economy to collapse.

Oil will hit peak, and the U.S. economy will fall. The tragedy is that by attempting to stave off more immediate economic threats, the nation is not readying itself to better deal with the more long-term issue life post oil.

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