Dollars by the Barrel
Washington, not Riyadh, threatens the dollar's stability.


Kevin D. Williamson

The specter of “petrodollar warfare” is back in the news after an apparently exaggerated — possibly false — report by Robert Fisk, of London’s Independent, alleging that various Gulf oil emirates, the Chinese, the British, the Japanese, the French, and the Russians are conspiring to end the use of the dollar as the pricing unit in the world’s petroleum markets. Mr. Fisk, the Independent’s Mideast correspondent, is reflexively anti-American; he is also an occasionally sloppy reporter (and a buffoon). But he has, accidentally, performed a public service by inviting a closer look at the story he wishes to tell.

There is no way to know with certainty whether Mr. Fisk’s story is false (the Saudis and the Russians, the world’s two largest oil exporters, say it is), and these “dumping the dollar” stories turn up about once a year. One of the more amusing examples was Tehran’s dramatic September announcement, also referenced by Mr. Fisk, that it would no longer hold U.S. dollars in its foreign-currency reserves. But Iran does not have a particularly large reserve stockpile of U.S. dollars, and the country has relatively little practical use for greenbacks, being the subject of an embargo that rather hinders its trading relationship with the United States. (Iran also routinely depletes its “reserves,” spending large chunks of them on gasoline, which the oil-rich nation cannot quite manage to produce.)

But let’s undertake a thought experiment and assume that Mr. Fisk’s journalism is reliable: Imagine that our dear friends, doughty allies, and generous well-wishers in Riyadh have rented out Dr. Evil’s subterranean lair and convened a S.P.E.C.T.R.E.-type meeting with the Gulf Arabs, the Kremlin, the ChiComs, the fickle French, perfidious Albion, and the scheming Japanese, the purpose of which is to enact a technical pricing change in the world’s oil markets, such that the price of a barrel of crude would be expressed not in dollars but in euros, yen, a “basket of currencies,” or the proposed unified currency to be adopted by the Gulf Cooperation Council. This would be a remarkably trivial agenda to put before such an august gathering, because the net effect of such a change would be something indistinguishable from nothing.

The petrodollar narrative holds that demand for U.S. currency in the world oil markets sustains the value of the dollar, and that a change in those markets would have devastating effects on the American economy. The petrodollar thesis is tied into various conspiracy theories that flourish with Cambrian vitality on the Internet: Saddam Hussein’s decision to trade oil in euros was the “real reason” the U.S. invaded Iraq; it’s the “real reason” we’re at odds with Iran; it’s the “real reason” behind our various beefs with Hugo Chávez. This is fanciful, but it is a story that some people want to believe, for ideological reasons, so they believe it: Iran’s decision to open up a euro-denominated oil exchange in 2006 was described by one economist as “the ultimate ‘nuclear’ weapon that can swiftly destroy the financial system underpinning the American Empire.” It turned out to be something less than that. The language — “American Empire” and all that — is indicative of the cast of mind at play here.

What all these petrodollar-warfare stories neglect to account for adequately is that the oil market is not the only global market. There also exists a very large and robust trade in currencies. There is no rule or treaty that requires that the dollar be the go-to currency for the world’s petroleum markets. The dollar is used in those markets because the Saudis and the Russians don’t want to get paid in Kenyan shillings or Indian rupees or Chinese yuan (because they are not fools) or even in a relatively solid currency such as the Japanese yen. If the oil exporters decide they want to hold euros instead of dollars, there is nothing in the world stopping them from doing that right now: It takes one-thousandth of a second to turn dollars into euros in the FX market, and the cost of doing so is negligible. (Smart guys turn a profit on it.) OPEC already has a de facto euro trade in oil, and if dollars or euros aren’t your thing there exist all manner of contracts that allow you to trade crude in the currency of your choice: Just bebop on down to the Tokyo Commodities Exchange and grab yourself some yen-denominated crude contracts.

The dollar is like any other commodity in that its price reflects the interaction of supply and demand. If you have a price tag on a barrel of oil that reads $70, and you replace that price tag with one reading €50 or ₤45, that does not really have much effect on the supply and demand for dollars. If oil is priced in dollars, Japanese buyers go to the FX market at the beginning of the day and trade yen for the dollars they need, and then trade whatever dollars they’re left holding back into yen, or euros, or Icelandic króna, Mexican pesos — whatever they want. If oil is priced in yen or euros, dollar-holders go into the FX markets and get whatever they need. (And they don’t even necessarily have to buy dollars at all: If a Frenchman wants to buy some Norwegian oil, he can trade euros for kroner, even if the price is advertised in dollars.)