Oil Wars

This was a very interesting article I ran accross today. It may be written by a right wing crank for a right wing rag but I must say its economic analysis is very astute and, as the Brits would say, spot on:

Iran and Venezuela have joined forces in an effort to undermine the U.S. dollar. In October 2005, Venezuelan President Hugo Chavez announced that Venezuela was ready to move the country's foreign-exchange holdings out of the dollar and into the euro. He also called for the creation of a South American central bank designed to hold in euros all the foreign-exchange holdings of the participating countries.

Beginning in 2003, Iran began demanding oil payment in euros, not dollars, although the oil itself was still priced in dollars. Iran has announced the intention of opening an Iranian Oil Bourse in March to challenge NYMEX (the New York Mercantile Exchange) and IPE (London's International Petroleum Exchange).


Saddam Hussein may well have signed his death warrant in 2000 when he began the process of convincing the United Nations that Iraq could sell Iraqi oil for euros, not dollars. Saddam ultimately received U.N. permission to convert Iraq's $10 billion oil-for-food foreign reserves from dollars to euros.

The risk to the United States does not involve how oil is priced – oil could conceivably be priced in any liquid currency, since pricing is a largely technical issue needed to establish transaction values. The real issue is foreign-currency reserves.

The United States relies on approximately 70 percent of all foreign-exchange currency to be held in dollars because we sell Treasury debt into that foreign-exchange market. Should Venezuela and Iran succeed in creating a worldwide flight of foreign-exchange reserves away from the dollar and into the euro, the move could depress the value of the dollar.

Dwindling foreign exchange dollar holdings could end up pushing the Treasury to sell debt into a smaller international supply of dollars, with the dollar not being as strong as it is today. Increasing the cost of our "twin deficits" – the budget deficit and the trade deficit – would have detrimental effects on the U.S. economy and on a Bush administration which seems to have lost traditional Republican budgetary discipline.

As the world's foreign-exchange currency market expands, we should probably expect some reduction in the dollar holdings of central banks. A move to hold more euros may simply represent a decision by a central bank to diversify their foreign-currency holdings, thereby hedging their risk from fluctuations in the dollar. Venezuela and Iran have in mind a politically motivated decision to move out of foreign-exchange currency holdings in the dollar as a conscious decision to wage economic war against America.

In 2004, the Switzerland-based Bank for International Settlement reported that the U.S. dollar-denominated deposits of OPEC countries fell from 75 percent of their total deposits in the third quarter of 2001 to 61.5 percent by the end of 2003. In the same period, the share of euro-denominated deposits of OPEC countries rose from 12 percent to 20 percent. OPEC member euro-denominated deposits reached 44 billion in June 2004, nearly double the 23.4 billion euros these countries held in the third quarter of 2001. In the same period of time, the dollar holdings of the OPEC member countries decreased from $145.3 billion to $132.1 billion.

In 2005, China negotiated major oil and natural-gas rights from Iran. Now under pressure of being referred to the Security Council over their nuclear program, Iran is counting on China to veto any strong move by the United States to have Iran sanctioned.


After Japan, China has the world's second-largest cache of foreign-exchange currency – some $800 billion today – an amount that is expected to grow to $1 trillion this year. In January 2006, China announced an intention to reduce 75 percent of its foreign-exchange reserves currently held in the dollar. Economists widely expect China's move will put downward pressure on the dollar, depending on how much diversification China decides to make into other world currencies. As Iran struggles to fight off world pressure over the defiant path it has chosen to take in pursuing nuclear technologies, Iran might well seek to convince China to hold significantly fewer dollars in their foreign-exchange reserves.

Venezuela and Iran have much in common – both countries are radically anti-America, both have extensive oil reserves, both are resolved to use oil as an economic weapon against the United States. The three countries voting against the IAEA resolution on Feb. 4 were Cuba, Syria and Venezuela. Iranian President Mahmoud Ahmadinejad has just accepted an invitation from Fidel Castro to visit Havana to attend the Sept. 11-16 Non-Aligned Summit and most likely to address the Cuban National Assembly.

A Tehran-Caracas Axis clearly extends also to Havana and Damascus. Whether we realize it or not, we are already involved in an economic war that could easily turn into a shooting war, starting with Iran.

As followers of Venezuelan affairs will recall, Venezuela moved all its foreign reserves out of US treasury bonds and into Euro backed bonds. At the time the opposition went into a hissy fit claiming this was bad for Venezuela. Of course, the Euro has appreciated against the dollar since then earning Venezuela a nice return and proving the opposition, as usual, wrong.

However, as this article points out Venezuela is not alone in doing this and this change is of no small consequence for the U.S. Sooner or later the dollar will take a tumble and Americans will be poorer for it (Ipods will get alot more expensive, for one). So the author is right to be concerned about countries switching the currencies their reserves are held in - the switching is hastening the dollars weakening.

However, he is most definitely wrong to say this is economic warfare. It is not. It is called looking out for your own interests. The dollar clearly is overvalued as the US keeps running huge trade deficits. So a strong dollar is a dead currency walking. When it will decline we don't know, that it will eventually decline sharply we know for certain. And so does Chavez. Hence, he did what was best for Venezuela which is to get out of dollar holding before they lose value. If Venezuela had $30 billion in dollar bonds sitting around and the dollar tanked you can be sure the opposition pundits would be the first to blame him for the debacle.

So what Chavez (and Iran, and China) did wasn't economic warfare. Its simply doing what he was elected to do. But it is no surprise that some in the US (including the Bush administration) would percieve it as economic warfare. They don't look favourably upon anyone who doens't bow to the empire but rather acts in their own self-interest. Such is the "you are eitehr with us, or against us" mentality that prevails in Washington. What we have here is but one more piece in the puzzle of why the U.S. is so intent on brining down the Chavez government.
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