This is one of the research Papers submitted for my Global Energy Course. Though a bit judgmental, these represent solely my views and no one else.
Who controls the food supply controls the people; who controls the energy can control whole continents; that controls money can control the world.
— Henry A. Kissinger
The price of crude oil over the last 10 years has risen by over 350% in USD, over 250% in Euros but the price of oil vis-à-vis the price of gold has remained constant. This points us to a very interesting reasoning of inflation of the USD and the subsequent diminishing value of USD. Experts believe that the only way to curb the sky rocketing prices of crude oil, is to curb the reckless printing of USD bills.
On August 15th 1971, President Nixon took the US dollar off the gold standard. The inside sources say that OPEC did consider moving away from dollar oil pricing, as dollars no longer had the guaranteed value they once did. The US lobbied with Saudi Arabia in the 1970s to ensure that the world’s most important oil exporter stuck with the dollar. Considering the monopoly of oil production in the Middle East, the OPEC followed anything that received consent from Saudis. International oil trades at New York’s NYMEX and London’s IPE were (and still are) strictly denominated in dollars, hence the name ‘petrodollar’. Most of oil traded in the world is through the USD.
The goods and services imported by United States are paid in USD to the producing nation. As a part of the cycle, the producing nations pay their oil bills in dollars to the Middle East producers. These dollars received by the oil producers flow back into the Federal Reserve in New York. This concept is commonly known in international political circles as Petrodollar recycling or Petrodollar cycle. And in response to this cycle, all United States needs to do is print the bills. Essentially this has two effects on the economy of United States of America, it keeps the value of USD artificially inflated with respect to other currencies and given USA precarious flow of credit. The Petrodollar cycle has contributed significantly to the $15 Trillion debt.
The US military and the USD are the two pillars that have helped United States establish hegemony over the years. Any shift in the scales with the valuation of USD would definitely harm the military and vice versa. A sound understanding of the petrodollar concept is essential to comprehend the current political turn of events in the Middle East.
The military might of United States protecting the other pillar, the US Dollar, was at display during the war with Iraq in 2003. Saddam Hussein, after decade-long economic sanctions, was ready to export oil to the Euro nations and the world. In November 2000, Saddam Hussein decided to trade the oil in Euro denominated currency. The reason for this was a mix of economic and political elements. He decided to forgo dealing with the “currency of the enemy” also for the reason that the Euro seemed to be 17% more valuable vis-à-vis the dollar. Almost all of Iraq’s oil exports under the United Nations oil-for-food program were paid in Euros since 2001. Around 26 billion Euros (£17.4bn) was paid for 3.3 billion barrels.
The trading of oil in Euros was considered blasphemous and was one of the reasons for the attack by US army on the pretext of weapons of mass destruction, which the military was unable to find eventually. Once the Saddam was put to death, USA ensured that the trading of oil in Iraq happens through dollar denominated currency. The global economists have always held Petrodollar as one of the top reasons for the invasion of Iraq in 2003.
Iraq is often claimed by experts to have shot at its own foot, and its neighbor, Iran, was in similar waters. Though Iran and Iraq share a very bitter history, they have irked United States and its stock currency, the dollar, in a very similar style. In 2005, Mohammad Javed Asemipour stressed the vision of initiating the trade of petrochemicals and light sulfur crude (and eventually regular crude) in its own oil exchange on Kish Island in the Persian Gulf, southern Iran. Iran proclaimed that the trade could be carried on in the Euro denominated currency. As the Kish Bourse gains momentum, Iran has offered to trade in a basket of currencies that is preferred to the seller and the buyer. This could pose some serious threat to the hegemony of US dollar as the paramount currency. United States and the European Union have unanimously imposed sanctions that have made international financial transactions for the government and Iran’s business community more costly. Iran has increased its offense on the United States to continue trading in either dollar or trading with the home currencies such as Rupee and Yuan. Coincidentally, on March 20th 2007, Levey told the Senate Committee on Banking, Housing and Urban Affairs that unilateral US financial sanctions “warn people and businesses not to deal with the designated target.“ The sanctions are now targeting foreign banks that handle transactions for Iran’s national oil and tanker companies, and companies or individuals involved in dealing with Iran. The sanctions are perceived in international political circles, as an attempt to cripple Iran trade and thus cash strap it. Iran, though, cannot be considered morally supreme with its impending nuclear program, and the Petrodollar is one of the many reasons why United States cannot ignore Iran or its imminent threat to the US.