31 January, 2006
With speculation mounting over the possibility of a US- or
Israeli-led military attack of Iran sometime later this year, it has
been suggested that real motivation for US antipathy towards the
Iranian government has little to do with concerns that Tehran is
developing nuclear weapons. Some commentators have instead suggested
that Iran’s real Iranian threat to the US and its economy is that, in
defiance of the US administration, it is attempting to establish an oil
'bourse’ (exchange) in March of this year which would enable oil to be
traded in euros. This would move oil sales away from their usual
denomination in dollars and would, it is argued, undermine the American
currency with grave consequences for the US economy. (1,2) This
internet-based debate is reminiscent of what occurred before the
invasion of Iraq when several observers, myself included, hypothesised
that Saddam Hussein’s decision to sell Iraqi oil in euros was perhaps
one of the reasons the US wanted 'regime change’. (3,4) The US decision
after the invasion to return Iraqi oil sales to dollar denomination and
to convert back into dollars all Iraqi foreign currency reserves, which
had been in euros prior to the war, was certainly entirely consistent
with this theory. (5)
However, others have claimed that the idea that the currency in which
oil is sold matters at all is based on a poor understanding of
economics. If oil sales were switched away from the dollar, they claim,
it would make no difference to the US economy, and therefore this
cannot have anything to do with the reasons the US went to war in Iraq
and is now adopting a threatening stance towards Iran. I will try and
address their main argument, as I feel the economic reasons why the
denomination of oil sales are is an important issue have not always
been clearly explained, including by myself.
Those arguing that the denomination of sales is crucial to dollar
strength have tended to say that countries are forced to save dollars
so that they have dollars to buy oil. Their critics, however, reply
that you do not have to save in dollars to buy oil since you can save
in whichever currency you want and then buy dollars on the foreign
exchange market whenever you want to buy oil. What matters, say the
critics, is in which currency people ultimately save rather than in
which currency they trade. (6,7) It is people saving in dollars, or in
US financial assets, which results in high levels of investment in the
US and ultimately permits the US to run a huge trade deficit.
The latter argument is largely correct, but it leaves out the crucial
fact that the reason countries choose to save in dollars, to a far
greater extent than in any other currency, is nonetheless related to
the fact that oil is sold in dollars. Yes, what is important is in
which currency countries save, but this is to a significant extent
determined by which currency they trade in.
In order to understand why, we need to ask ourselves, why do central
banks keep foreign exchange reserves at all? Also, what considerations
determine which currency they choose to keep as reserves? The answer to
the first part of this question is that the main reason central banks
keep foreign currency reserves is so that, if necessary, they can
intervene in the markets to support the exchange rates of their own
currency. If, say, their currency is being attacked by speculators who
are selling it on the foreign exchange markets, the central bank can
use its foreign currency to buy up its own currency, thus supporting
its value. You cannot, of course, buy up your own currency unless you
have previously accumulated savings of foreign currency. So when
central banks keep foreign currency reserves, their prime concern is
not so much to invest this money in order to secure the maximum
possible return, but instead to protect their own currency so that it
is a stable currency. The more reserve currency a country has, the less
likely that speculators are going to attack that currency. Nobody would
dream of launching a speculative attack against the yen or the yuan
because their reserves are so massive, but the currencies of many poor
countries are far more likely to suddenly devalue since their central
banks have only small foreign currency reserves and can do little to
protect their currency if the markets decide to sell it. In this
context, it is worth also remembering how George Soros became famous by
launching a speculative attack against the pound. The Bank of England
ultimately was unable to defend the currency as its foreign exchange
reserves were being run down, a clear illustration of how the strength
of a currency is related to the ability of the central bank to defend
it. (8)
So protecting your own currency is the main reason for keeping foreign
exchange reserves, but in which currency should you keep them? Well the
answer to this question depends nearly entirely on the answer to the
question 'against which currency would a sudden and unwanted
devaluation of your own currency be most damaging?' If the answer to
the second question is 'by far the most damaging unwanted currency
devaluation would be a fall of my currency versus the dollar', then it
makes sense to keep the vast majority of your currency reserves in
dollars: doing so will enable you to buy your own currency with
dollars, thus supporting its dollar exchange rate. If you are most
worried about your currency devaluing against the dollar, it makes no
economic sense to keep most of your reserves in euros or yen.
For all of the rich countries in the world, a sudden devaluation
against the dollar has the potential to be far more damaging than a
sudden devaluation against the euro, the yen, the yuan, the rubble,
etc. This is because most of the goods and services traded
internationally are priced and paid for in dollars and, virtually all
commodity trade, including the trade of oil which is by far the most
important good traded internationally, is denominated in dollars. If
your currency falls suddenly against the dollar, then the price of oil
will suddenly increase for you, whereas if your currency falls against
the yen, but not against the dollar, the price of some Japanese imports
will go up, and these imports are probably not essential to the running
of your economy anyway. Furthermore, many Japanese imports are also
priced and paid for in dollars, so even these are more likely to go up
in price for you if your currency devalues against the dollar rather
than the yen. Since virtually all of the really important imports are
priced and paid for in dollars, it makes complete economic sense for
rich central banks to keep most of their reserves in dollars. If the
denomination of these important imports, in particular oil, were to
move away from the dollar, then rich countries would move their
reserves into other currencies and consequently the dollar would lose a
lot of its importance.
For poor countries, there is another reason for wishing to trade and
save in dollars. They often have international debts, and these debts
are usually denominated in dollars (in the case of IMF debts this is
always the case). This means that if their currency devalues against
the dollar, their debts go up. As a result, poor countries often
denominate their exports in dollars, so that they can acquire dollars,
without exchange risk. These are used to repay debts, conduct trade
(including, in particular, buying oil which most of them do not have),
and protect their own currencies. Since the exports of poor countries
are often essential to the running of the world economy (they often
export commodities), their decision to export in dollars has knock-on
effects on rich countries who then have a further reason for saving in
dollars.
So can we conclude that an Iranian oil bourse trading oil in euros is
the real reason for the current crisis? Perhaps this is prematurely
jumping to conclusions. The claim that the Iranian bourse will
definitely trade in euros appears to me to be based primarily on
speculation at this stage. I have yet to see a clear statement on this
from the Iranian government. There are certainly good reasons for
suspecting that it might be in euros, since Iranian government sources
have previously spoken favourably about trading for oil in euros (9,10)
and according to a statement attributed to the Vice-Governor of the
Iranian central bank, Iran began selling oil in euros to Europe in
2003. (11)
However, in January of 2004, Bijan Namdar Zangeneh, who was then Oil
Minister, played down the possibility of Iran switching to euro
payments, (12) and as recently as last September, the head of Iran’s
stock exchange dismissed claims that the new oil bourse would be using
the euro as the transaction currency. (13) We also know that Iran has
previously been involved in discussions with other primarily Muslim
countries, like Malaysia, which aimed at introducing an entirely new
currency, the 'Islamic Gold Dinar’, which would be used in
international trade, and in particular the oil trade. (14) In the
euro’s favour, on the other hand, is the fact that little has been
heard of the Islamic Gold Dinar in the past year, and just last month
the Chairman of the Majilis Energy Commission (the Majilis is the
Iranian parliament) was quoted as saying that 'preparatory measures
have been taken to sell oil in euros instead of dollar’ and that
initially Iran should 'sell its oil in both dollar and euro, and then
gradually move toward euro’. (15) However, until we hear from official
Iranian sources that the trading will be in euros, it is probably
unwise to draw too many firm conclusions.
The possibility that the Iranian oil bourse might not use euros would
not necessarily diminish its significance and there could still be good
reason for believing that US/UK governments and financial interests
would still be strongly opposed to it as it would challenge their
control of oil trading, but that is another question.
REFERENCES
1. William Clark, 'The Real Reasons Why Iran is the Next Target: The
Emerging Euro-denominated International Oil Marker’, October 2004, www.energybulletin.net/2913.html
2. Krassimir Petrov, 'The Proposed Iranian Oil Bourse’, January 2006, www.energybulletin.net/12125.html
3. William Clark, 'The Real Reasons for the Upcoming War With Iraq: A
Macroeconomic and Geostrategic Analysis of the Unspoken Truth', January
2003, www.ratical.org/ratville/CAH/RRiraqWar.html
4. Cóilín Nunan, 'Oil, currency and the war on Iraq', January 2003, www.feasta.org/documents/papers/oil1.htm
5. Cóilín Nunan, 'Petrodollar or petroeuro? A new source of global conflict’, November 2004, www.feasta.org/documents/review2/nunan.htm
6. James D. Hamilton , 'Strange ideas about the Iranian oil bourse’, January 2006, www.econbrowser.com/archives/2006/01/strange_ideas_a.html
7. Chris Cook, 'What the Iran 'nuclear issue' is really about’, January 2006, www.atimes.com/atimes/Middle_East/HA21Ak01.html
8. William Keegan, 'Black Wednesday gets a whitewash’, February 2005, The Observer, politics.guardian.co.uk/conservatives/comment/0,9236,1411995,00.html
9. C. Shivkumar, 'Iran offers oil to Asian union on easier terms', June 16 2003, www.blonnet.com/2003/06/17/stories/2003061702380500.htm
10. Anon., 'Iran may switch to euro for crude sale payments', Alexander Oil and Gas, (September 5, 2002), www.gasandoil.com/goc/news/ntm23638.htm
11. Juan Caros Escaron, 'El 'petroeuro’ rompe el cascarón’, November 2000, El Mundo
12. Hashem Kalantari, 'Iran Oil Min: No Plan To Switch Oil Pricing From Dollar’, IranExpert, www.iranexpert.com/2004/oilmin11january.htm
13. Anon., 'Oil bourse not to use euros in Iran: TSM chief’, Iranmania,
www.iranmania.com/News/ArticleView/Default.asp?NewsCode=35269&NewsKind=Current%20Affairs
14. Faisal Islam, 'Return to an old standard?’, February 2003, The Observer, observer.guardian.co.uk/business/story/0,,891682,00.html
15. Anon., 'Preparatory measures taken to sell oil in euros’, December 2005, Mehrnews.com, www.mehrnews.com/en/NewsDetail.aspx?NewsID=260851
~~~~~~~~~~~~~~~ Editorial Notes ~~~~~~~~~~~~~~~~~~~
Cóilín
Nunan studied mathematics at the universities of Brussels, Cambridge
and Oxford. He now lives in Scotland and works for the Soil Association,
the UK organic farming charity. His work focuses on the use and abuse
of antibiotics in intensive farming and he has co-authored several
reports examining the many ways in which this can impact upon human
health. He is a Trustee of Feasta (The Foundation for the Economics of Sustainability) and editor of its website.
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