Oleh : J. Soedradjad Djiwandono
Gurubesar tetap Ilmu Ekonomi, Universitas Indonesia


The US attack on Iraq has raised different speculations on what have actually been the real reasons behind it. There is an economic argument that may be a bit far fetched for some, yet I find relevant for explaining the decision by the US and UK to invade Iraq, i.e. to defense the US dollar (USD) against the use of Euro in oil exports and payments by OPEC member countries.

This paper addresses issues concerning the economic rationale for the change of oil trading from USD to Euro as well as its possible economic argument for the US attack on Iraq. In addition an attempt is also made to assess the problems and prospects of a USD base world monetary and economic system that becomes less sustainable in the context of present and future global economy and finance. 

Defending dollar hegemony against Euro encroachment? 

W. Clark wrote in Independent Media Center (26/01/02) that the real reason behind the US plan of attacking Iraq and replacing President Saddam Hussein is to discourage the use of Euro for payment of oil sales by OPEC countries or to defense against Euro encroachment against the USD hegemony in the world economic system.

The argument is based on Iraq successful bit in asking for payment of its oil sales since end of 2000 in Euro instead of the conventional US dollar (USD). According to this argument this step was followed by Iraq decision to convert USD 10 billion worth of its reserves into Euro. In the meantime it is reported that Iran is currently conducting a study to follow what Iraq did. And even though economically less meaningful North Korea also comes into decision for asking payments in Euro for its exports. 

Could we make sense out of this argument? In terms of oil statistics, out of the present world oil production of 75 million barrels a day (bpd) OPEC members produce one third. And Iraq produces 2.5 million bpd or 10 per cent of OPEC’s production.  Iraq is reported to own 11 per cent of proven world reserves of oil; it is second largest after Arab Saudi.

Despite its own huge production the US imports oil to the amount of more than 10 bpd. With the backdrop of adverse economic impacts from the oil crises that the US experienced in the aftermath of oil crises in 1973/74, 1979/80 and 1990/91, one does not have to believe in a conspiracy theory to see the US interest in Iraq oil. At least it must be to the interest of the US government to make efforts to avoid the use of Iraq oil as a means to weaken the US economy. 

Of course, those who subscribe to a conspiracy theory would underline the fact that some members of President George W. Bush administration were former executives of oil companies. These would include the senior and junior President Bush (Arabusto and Harken), Vice President Dick Cheney (Haliburton), and even the National Security Adviser Condoleeza Rice (Chevron).

However, the close relation with the Saddam Hussein government would also include big companies from France, UK and Germany. Russia is for sure interested in getting back its huge loans to the Iraq government. And in spite of the UN economic embargo to Iraq it has been reported that corporations from Japan and China have also been actively establishing their businesses in Iraq. In short the economic and finance interests in Iraq are shared by all big economic powers.

The question remains as to why President Bush is so determined in waging war against Iraq, even after disagreements from its allies and public protest all over the world against it?  This is when an economic rationale of controlling Iraq oil seems to make more sense, and the above argument becomes relevant.  

But, how relevant is the argument claiming that the real reason behind the attack on Iraq is to defense against the encroachment of Euro to the hegemony of USD in the world economic system?  One thing for sure has been the weakening of USD against the Euro. In 2002 USD was depreciated by 15 per cent against the Euro, and the same tendency seems to be continuing. This happens despite the tendency for the EU economy, except some member of the so - called ‘new Europe’, to experience slump as well.

Whether the weakening of USD against the Euro has anything to do with Iraq decision to shift the sale of oil in Euro and the steps taken by Iran and North Korea is difficult to prove. However, a complete shift from USD to Euro on the pricing and the payments of oil trading by OPEC countries would definitely weaken USD further. And an effort by the US government to defense against this policy would only make sense.

In terms of concept Mr Javad Yarjani, a high ranking OPEC official in a speech delivered in Spain last year had argued that conducting oil trading in Euro would benefit more both exporting OPEC countries and importing EU countries due to lower price risk and exchange risk as well.  Both the UK and Norway are oil producers and when they join the EU it may even make more sense for the pricing and trading in oil by OPEC and EU to be conducted in Euro.

The USD hegemony

To pursue the defense of the USD against the encroachment of Euro that may arise from a concerted effort by Saddam Hussein and OPEC countries I would like to go back briefly to the development of the role of USD in the world economic system. 

At the outset we should underline the fact that for practical purposes the USD has been used as reserve currency, intervention currency, means of payments for most trading, including the pricing and payments of oil trading as well as a means for investment in the world.

As reserve holding and intervention currency the USD has been established since the times of the Breton Woods system, which was borne with the establishment of the International Monetary System (IMF) and the World Bank (WB) towards the end of WW II.

The Breton Woods system was based on the premise that all currencies were pegged in a fixed value to the USD with plus and minus one percent flexibility. The system was supported with an adjustment mechanism for correction against shocks that caused imbalances, which used USD as an intervention currency. In this system the USD was pegged to gold in a fixed value of USD 35 to an ounce. Because it was a pegged system with a mechanism for adjustment to provide some flexibility the system was also called a pegged and adjustable system.

After WW II the US economy was the only super power economy that was not destroyed by the war. The US also held huge amount of gold reserves that was unparalleled by any economies at that time. With this position the USD was naturally became an undisputed reserve and intervention currency in the world finance.

The system was functioning extremely well in terms of supporting high growth of the world economy and trade in more than two decades after WW II.  However, the system became unsustainable due to the US extended commitments to provide security the world over and foreign aids, which also included a very expensive Vietnam War. 

As a consequence the Breton Woods system was becoming ineffective and ultimately it was thrown out. It started with a unilateral decision by the US for abandoning its promise to exchange USD circulating in the world with its gold reserves in 1971. It was announced by President Nixon administration during the IMF-WB meetings, which was later known as the Smithsonian agreement. This was followed by a devaluation of the USD in 1973 that was done through changing the valuation of USD to become USD 45 per ounce of gold. In addition the peg system was also changed by raising the ban from plus and minus one per cent to two per cent and a quarter.

The period from 1973 – 1976 was an uncertain period in the world monetary system. In the world of finance it was sometime called a period without a system. Finally, in 1976 the world adopted a floating system during the annual meeting of the IMF and WB in Jamaica (Jamaica Agreement). The floating system was adopted all through out these years until the Asian financial crisis erupted in 1997. After the crisis, the world has been basically accepting a bipolar system comprising of a free- floating system and a hard pegged system. The second one is basically a system with currencies pegged to strong currency (USD or SDR) supported by currency boards. I would include in the second one a pegged to strong currency supported by administrative control on foreign exchange as adopted by Malaysia.

The USD continuously plays the role of reserve currency as well as intervention currency in the tradition of the Breton Woods system. Of course the USD role as intervention currency must be in different nature in the case of a floating system as compared to a peg system.  Theoretically market intervention is not called for in a free - floating system. But, countries do exercise in market intervention to defense its currency in an economy officially adopting free-floating system. Likewise, theoretically countries practicing floating system do not need to hold foreign reserves. But, they do. Statistics even showed that most economies held even larger foreign reserves despite their adherence to floating system. 

If there is a change in the USD role it is in the direction of widening the use of it. In fact the world economy and finance have been operating with USD hegemony. The USD has been used in most payments for trading goods and services, including trade in oil; it has been used for payments in investment activities. In trade relation among nations the continuously increasing deficits in the US current account and the budget have been financed through capital inflows to the US. In the meantime this process has been creating a huge debt of the US economy to the world.

Is USD hegemony unsustainable?

The world exchange system has been undergoing changes, to a certain degree due to the tendency that the system could no longer function well in a new environment with different pattern of trade and economic relations amongst nations resulting from decades of economic growth in production, trade and investment that has changed balance of economic and financial powers.

In the emerging balance of economic powers the US economy is still the world largest and strongest, whereby other economies both directly and indirectly depend on it. However, unlike after WW II in the present and future globalize economy and finance the US economy is no longer playing the sole super power to support USD hegemony.  For sure, with the recent entry of China into a trillion dollar economy and may be India in not too distance future, the US economy would only be the largest and the strongest among super powers. With the new additional members of last year EU becomes an economy with 450 million people and USD 9.6 trillion GDP, comparable to the US 280 million people and USD 10.5 trillion GDP. In spite of its huge problems in the last many years Japanese economy is still a super power.

The US economy in the world system despite its position as the largest and the most powerful is not like its position in political and weapon system since the collapse of the Soviet Union. The economic balance of power amongst countries has been experiencing changes after decades of economic and trade growth. The world economic and finance has also been changing towards borderless and globalize one. 

One important implication here is that a USD hegemony does not seem to go well in the system as described above.  Within an economy the role of national currency as means of payments as well as other functions is based on legal stipulation (fiat) – usually in its central bank act -, which its citizens accept and entrust.

The world accepts and trusts USD to function like a currency within a national economy through some means similar to the way the world looks at the US economy as safe haven. There is some substance in it, but it is mostly based on perception. And the perception must have been undergoing changes, especially with some signals of vulnerability that the US economy seems harboring through what happened in 911, the Enron-WorldCom and other scandals, the near collapse of stock index, and may be the war on Iraq.          

With USD hegemony that seems unsustainable in the present global economy and finance a sustainable world monetary system should be built with a view to a balance of multi-power economy. A multipolar world international finance based on relevant currencies instead of single currency hegemony may be in order. 

@ Guru Besar Tetap Ilmu Ekonomi, UI dan Senior Visiting Fellow, IDSS, Nanyang Technical University.