The threat to a fistful of petrodollars
By Liam Halligan
-- -- From Russia, you might say, with
love. This weekend, Alexei Kudrin, Russia's finance minister,
dropped a bombshell in Washington.
Attending the annual meetings of the World Bank and
International Monetary Fund, Kudrin caused his American hosts
discomfort by openly questioning the dollar's pre-eminence as
the world's "absolute" reserve currency.
The greenback's recent volatility and the yawning US trade
deficit, "are definitely causing concern with regard to its
reserve currency status," he said. "The international community
can hardly be satisfied with this instability."
Kudrin's intervention coincided with another meeting, also in
Washington, of finance ministers and central bankers from the
Group of Seven - which doesn't include Russia.
Top of the agenda: the effect of ever-rising oil prices on
inflation and interest rates.
G7 countries are worried the spiraling price of crude - which
closed at $72.79 a barrel on Friday and which has now trebled in
three years - could inflict real economic damage. The US Federal
Reserve, in particular, has been forced to take drastic action -
raising interest rates 15 times since June 2004 to keep
inflation in check.
Given that fragility, it is significant that Kudrin is now
wondering aloud if the long-standing dollar hegemony can last.
For him to do so is to highlight that America is vulnerable
should that status be lost. That's because Russia, with its
awesome oil and gas reserves, could kick-start a challenge to
the dollar's supremacy.
Most nations stockpile their foreign exchange holdings in
dollars. The US currency accounts for more than two thirds of
all central bank reserves worldwide.
This reserve status means that the dollar is constantly in
demand, whatever the underlying strength of the US economy.
And now, with massive trade and budget deficits to finance,
America is increasingly reliant on that status. The
unprecedented weight of US liabilities means a threat to the
dollar's dominance could result in a currency collapse, plunging
the world's largest economy into recession.
That won't happen immediately. The dollar has sat astride the
globe for some time now - in fact, for most of the last century.
But this statement from Russia - a country of growing financial
and strategic significance - still caused the dollar to slide.
It also fuelled speculation that central banks could
increasingly diversify their holdings away from dollars.
Kudrin's statement followed news that Sweden has cut its dollar
holdings, from 37 per cent of central bank reserves to 20 per
cent, with the euro's share rising to 50 per cent. Central banks
in some Gulf states have also lately mooted a shift into the
euro. Such sentiments helped push the dollar to a seven-month
low against the single currency last week.
But Russia's intervention will have raised eyebrows in
Washington because the backbone of the dollar's reserve currency
status - the main guarantee that status continues -is the fact
that oil is traded in dollars. And that is something the likes
of Kudrin can directly affect.
For historic reasons, the dollar remains the world's
"petrocurrency" - the only currency for the settlement of oil
contracts on world markets. That makes the EU and Russia
dependent on it. But with central banks switching to euros, the
logical next step would be for fuel-exporting countries to start
quoting oil prices in euros too.
The EU is Russia's main trading partner. More than two thirds of
Russia's oil and gas is exported to the EU. That makes Russia a
strong candidate to become the first major oil exporter to start
trading in euros. Such a scenario, in recent years, has become
theoretically possible. But now, with these latest comments,
Kudrin has thrust that possibility into the open.
The G7 meeting was dominated, of course, by concern over Iran's
nuclear programme. The threat of military action against Iran,
itself a major crude exporter, is one reason oil prices are now
testing record highs.
It is worth noting that Tehran has ongoing plans to set up an
oil trading exchange to compete with New York's NYMEX and with
London's International Petroleum Exchange. In the light of
Kudrin's comments, it is significant that the Iranians want to
run their oil bourse in euros, not dollars.
Were the Iranians to establish a Middle-East based euro-only oil
exchange, the dollar's unique petrocurrency status could
unravel. That, in turn, would threaten its broader dominance -
which, given America's groaning twin deficit, could seriously
hurt the US economy.
Some cite this as the real reason the US wants to attack Iran:
to protect the dollar's unique position. I wouldn't go that far,
but the prospect of a non-dollar oil exchange in Tehran is
certainly an aggravating factor.
The opening of Iran's new oil exchange has recently been
delayed. But, having spoken with numerous officials in Tehran,
and western consultants who've been working with the Iranians
for several years, I think it will go ahead. The exchange entity
has already been legally incorporated in Iran and a site
purchased to house administrative and regulatory staff.
The reality is that as long as most of Opec's oil - read Saudi
Arabia - is priced in dollars, the US currency will retain its
hegemony. But the opening of an oil bourse in Tehran, which now
looks likely, will signal at least tacit Saudi consent for euro-based
oil trading. The US knows this, which is why it is nervous about
the dollar's status being questioned.
From the G7's fringe, Kudrin has now touched this raw nerve.
This weekend's meetings have been dominated by questions of
global financial imbalance - in particular, America's huge
Kudrin's missive comes as central bankers, and currency dealers,
start to conclude the only way to resolve the massive US
external deficit is a somewhat weaker US currency. As the IMF
itself warned yesterday, a "substantial" dollar decline may be
One way to bring that about would be for the euro to enter the
global oil trading system. This is unlikely to happen soon. It
might not happen at all. But the idea is now not only realistic
but firmly on the table in Washington. Perhaps not with love,
but it was placed there by the Russians.
Liam Halligan is Economics Correspondent at Channel 4 News
Copyright of Telegraph Group Limited
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