The beginning of the end of the dollar era?

For years, OPEC members have been putting the blame on a weakening US dollar for the rise in oil prices. Some members have also been calling for changing the basis for oil pricing to the Euro, or special drawing rights (SDR) of the International Monetary Fund, or to a basket of currencies. Till now, the idea failed to acquire any traction and the dollar continued to reign supreme as the world’s reserve currency. But a recent report in the Independent noted that the “Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil”1 and move to a basket of currencies, which could include the Japanese yen, the Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Cooperation Council. If true, fructification of this move would mean the demise of the dollar actually taking place. However, the ramifications of an end to dollar-based oil trade would extend far beyond the oil market and would herald the beginning of a new international political order.

Until now, two main factors have helped sustain the privileged position of the dollar in the world. Firstly, the capital flows towards the United States as a result of re-investment of the commercial surpluses obtained by nations and investors through their trade with the US. Secondly, the global pricing of all oil transactions in US dollars. Both factors guaranteed the perpetuation of the dollar as the leading and indispensable international reserve currency. In fact, many countries peg their currency to the dollar. As a result, when the dollar weakens, so do the proceeds of these countries which accrue from exports. Moreover, these countries hold large deposits of US Treasury bonds, and hence their economies are largely dependent on consistency of the dollar’s value. However, it was the oil transactions conducted in dollars that allowed it to be paramount.

Though the accuracy of the Independent report was immediately denied by the Gulf countries as well as by Japan and Russia – which many analysts say was expected — it led to a sharp slide in the dollar. No doubt, reports of this kind are not new, and popular perception is that the US dollar will continue to hold its current position since countries that are dependent on US trade as well as those that have invested heavily in US T-bills will find it difficult to pull out their investment without causing a collapse of the US economy, which in turn will impact their own. Moreover, there are several other, and equally strong, arguments for retaining the dollar, particularly for the oil trade. First, unless the three benchmark crude markers — the West Texas Intermediate crude (WTI), Norway Brent crude, and the UAE Dubai crude – find takers for an alternative currency, oil will continue to be denominated in dollars. Even the Oman crude oil futures contract launched two years ago in Dubai is traded in dollar terms. Second, despite the rise of China and India and other Asian developing countries as important oil consumers, the most liquid market for oil continues to be the New York Mercantile Exchange, followed by the London-based Brent contract. Therefore, unless the various oil producing nations are prepared to allow their oil exports to become benchmarks for the rest of the world, it will be difficult for them to influence the basic currency for global oil. Third, the strong political and defence relations between some of these countries and the US would deter many of them from taking a step that would be perceived as inimical to US interests. Fourth, though the value of the dollar has been depreciating each year along with the value of their investments, they cannot dump the dollar to cut their losses since the dollar will slide even further. And finally, the Chinese yuan and many Gulf currencies are not fully convertible and is therefore not in a position to replace the dollar in global commodity pricing.

Nevertheless, the trend to move away from dollar-based contracts in the oil market has already begun, driven by the fact that the value of the dollar is falling and it is only the global demand for petrodollars that is propping up the currency rather than because of any real backing from US manufacturing activity or economic output. In fact, several creditor countries, and China in particular, are worried about America’s ability to repay its debts to them. In 2002, Iran announced that it would shift a large part of its international currency reserves from dollars to euros and that it would launch an oil bourse on the island of Kish which would price the sale of Iranian oil in euros and currencies other than the dollar. After several delays, the bourse was finally inaugurated in February 2008. Prior to this, in 2000, President Saddam Hussein began to sell Iraqi oil in euros rather than dollars since the majority of Iraq’s oil trade was with the EU, India and China. Russia too has, in the past, publicly stated that it was contemplating shifting its oil trade away from the dollar due to the dollar’s weakness and volatility. More recently, prior to the G8 summit in July 2009, President Dmitry Medvedev called for creating a mix of regional reserve currencies as a way to address the global financial crisis, and questioned the dollar’s future as a global reserve currency. China, too, has called for replacing the dollar as the globe’s top reserve currency in the long term. Moreover, apart from the impact on their investments and their economies, countries also realize that once the dollar loses its reserve currency status, America’s status as an economic and military power will diminish, allowing them more leverage in interantional affairs.

However, most analysts believe that the time for replacing the dollar with another currency(ies) is premature. Even the Independent report states that the objective of the “meetings” is to replace the dollar over the next nine years, i.e. by 2018. The important issue, however, is that, denials notwithstanding, there is a serious and concerted move by several countries to eventually diversify away from the dollar, which in turn implies that America’s supremacy as the world’s primary economic power is being challenged. And when the dollar is replaced by another currency as the world’s reserve currency, it would mean the end of the United States as the economic superpower. No longer would it be able to impose financial terms on the rest of the world. More importantly, it would mean the end of the “petrodollar” system, since the Arab oil-producing countries will no longer be under pressure to sell their oil only in dollars, which in turn would free other oil consuming countries from buying dollars to pay for their oil, thereby removing a crucial prop for the dollar.

Indian economic advisors too are worried by the dollar’s performance, and have been advising the government to diversify its foreign exchange reserves, the major part of which is in dollars, to other currencies. It has also gone along with other BRIC member countries in proposing a “supranational” currency and use of SDR as a reserve currency.

Doubts notwithstanding, there is general consensus that the dollar’s future as a reserve currency could be ending despite the resistance it is bound to face from the US or countries dependent on the US security umbrella. A beginning has been made with Iran selling its oil in euros, and Russia having announced in 2008 that it would be selling some petroleum products in rubles as a prelude to switching from dollar-based oil sales. When that happens, the implications for the US and indeed the global power balance will be immense.

• 1. Robert Fisk, “The Demise of the Dollar”, The Independent, October 6, 2009, www.independent.co.uk/news/business/news/the-demise-of-the-dollar-1798175.html