Download Petrodollar recycling as a predictive means of conflict assessment

ECONOMICS
AARMS
Vol. 8, No. 3 (2009) 463–468
Petrodollar recycling as a predictive means of conflict
assessment
GÁBOR SCHULZ
University of Szeged, Faculty of Economics and Business Administration,
Department of Economics and Economic Development, Szeged, Hungary
It is a quite well-known fact that money and oil have huge influence on politics,
especially on geopolitics. However, the mechanisms of this influence can be very wideranging and diffuse. How could somebody interested in evaluating these factors find a
way through this complex matter? During my research I came across the term
petrodollar recycling, which appears to be a useful and understandable model with
good predictive value. In this paper I am trying to share my thoughts and give an
introduction to the economic background of this system.
Introduction
There seems to be a very strong interrelation between energy and global security. Just
think of local and regional conflicts (like the two conflicts in Iraq) erupting due to a
shift in control over oil resources. The world is starving for more energy and the most
common answer to its plea seems to be: more oil. It is a well known economic fact that
there has to be a balance between demand and supply and this balance is determined
through the price of a given commodity. However, if a certain side is shifted from the
dynamic equilibrium to a sort of misbalance then a cascade of changes is likely to be
inbound. In this paper I'm investigating into the history of the current global
petrofinancial system and try to examine the way the United States is maintaining its
global supremacy through it's most valuable resource, its currency.
Methods
During the course of my investigation I examine the historic events leading to the
establishment of the current petrofinancial era and I try to reach my conclusions by
reviewing the most significant international and domestic literature related to the
current situation in the interrelation of energy (and particularly oil) and global security.
During the course of my investigation I also interviewed a supervisor of the Hungarian
Received: December 3, 2009
Address for correspondence:
GÁBOR SCHULZ
E-mail: [email protected]
G. SCHULZ: Petrodollar recycling
Oil and Gas Company (Mol Nyrt.) in order to get a deeper understanding of the oil
industry itself.
Results
First of all, in order to understand the way how the so-called petrodollar recycling
system works, it’s important to review the most significant financial events of the 20th
century’s second half.
Based on COHEN (2002), current events can be led back to a very important event of
the year 1944 when the International Monetary Fund and World Bank were established
as the result of a conference held in Bretton Woods, New Hampshire (United States).
The main principle of the newly established international monetary system was
convertibility, i.e. the possibility to exchange one currency for another by ensuring that
every currency could be exchanged for U.S. Dollars. Each currency was bound to the
US Dollar, and only the US Dollar was bound to gold and the Federal Reserve was
obliged to convert any foreign currency into gold upon request. The fixed-rate exchange
system was considered to be highly beneficial for international trade as it gave decision
makers the opportunity to eliminate the threat of volatile exchange rates. This was also
very important in regards of international stability and security since volatile exchange
rates and devaluation of currencies made a huge contribution to the rise of fascism in
Europe and the eruption of World War II with all its disastrous events and outrageous
casualties. It also propelled the United States into a very special position, because it’s
currency was the principal currency governing foreign trade (every country planning
and starting to participate in foreign trade was bound to make its payments in this
currency), thus it gave the US a very special power but also an enormous responsibility
since the loss of financial stability could have stalled the entire global economy. That’s
exactly what happened in 1973 when members of the OAPEC1 decided to stop oil
exports to the United States in response to American decision of providing support to
the Israeli armed forces during the Yom Kippur war. This was the first major attack
against the established financial system because rocketing oil prices converted sustained
stability into a very pleasant and strongly missed part of the past. These events and the
outrageous expenses of the Vietnam war forced the United States (presided by Richard
Nixon) to suspend convertibility to gold due to soaring devaluation (at the bottom each
US Dollar was backed by 22 cents worth of gold). The US got into a rat race as it was
forced to print even more dollars to cover its expenses. It is likely that a more deeper
1 Organization of Arab Petroleum Exporting Countries – it is a segment of the OPEC consisting only of Arab
states plus Syria and Egypt.
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shock would have occurred and could have caused a much deeper and longer recession
if there had not been a group of people come up with the principle of the petrodollar2
and its system of recycling.
As per SPIRO (1999) pertodollar recycling was the process in which oil exporting
countries used their excessive trade balance surpluses (resulting from sky high oil
prices) to finance the current deficits of other, mostly industrialized nations. This was of
financing sentenced many nations into a bilateral dependence: on one side, Western
nations have always been dependent on oil imports from the Middle East. On the other
side they had even become dependent on Arab nations to finance their state household.
Every nation? Not really. There was still the United States. The US, the only country
that could legally print as many dollars as it wanted became the most important factor in
this cycle. Since oil trade was and still is noted, as well as traded in US Dollars, every
nation has to purchase huge amounts of this currency for its national reserves in order to
maintain its ability to purchase the required energy.3 These reserves are required to be
huge, since energy consumption is covered mostly by fossil energy sources (e.g. Europe
has 36 percent of its energy generated from oil and 24 percent from natural gas) (DEÁK,
SZTERNÁK, 2009).The US can always afford to spend more than it earns because other
nations are eager to get access to dollars in order to maintain their foreign trade, thus
making the US the only country that can afford to sell less than it purchases. But as long
as the US is the sole exporting country of the commodity used in foreign trade, it is in a
very comfortable position, as it can continue subsidized consumption without having to
turn every dime twice.
Nsouli (2006) differentiates two channels of petrodollar recycling:
The absoprtion channel is through domestic consumption of imported goods in the
oil producing states. In this case the process looks like this:
Oil export revenue
Distribution of assets to the domestic population
Domestic consumption of exports
Assets flowing abroad
This channel has the huge benefit that the flow is irreversible and permanent, but selfsustaining due to the demand for luxury goods in the oil exporting countries, which can
only be satisfied by massive imports from the Western world right now.
The capital investment channel works by investing accumulated financial assets in
foreign assets, like bonds of governments or international organizations, like the IMF.
Rising oil prices raise the income and thus the available assets of countries that have oil to
2
3
The term was first used by Ibrahim Oweiss of the Georgetown University.
About two thirds of current financial reserves are maintained in US Dollar globally (NOUNAN, 2004).
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export. But they have to apply their surpluses so their demand for US Dollar denominated
investment vehicles is increased, which in exchange reduces interest rates and therefore
giving eligible and interested countries a cheap source of financing. To see what amounts
are moved: Current account balances of oil exporters were 571 billion dollars (2006) and
263 billion US Dollars in Eastern Asia, almost making up the entire deficit of the US (–
869 billion USD) (HIGGINS et al., 2006). These amounts are respectively 2.95 times, 1.36
times and 4.50 times the Hungarian Gross Domestic Product in 2006 (CIA, 2009) which
shows that the amounts at stake are really significant.
Discussion
The major question is: For how long can this relatively fragile system be maintained?
This is where international stability and security come into the picture. A shift towards
another currency in international trade (thinking of the Euro or possibly the yen or
Renminbi in the Far East) could have an effect on the US that can only be compared to
several major disasters happening each at one time.
The US could slide into a deep recession if cheap and readily available financing
from abroad started to run dry. It would be extremely difficult to maintain consumption
and governmental spending without these revolving monies which on the other side
would result in other parts of the world, especially developing countries dependent on
American consumption slide into the deepest recession of all times.
Therefore it might be considered an elemental interest of the United States to
maintain the system which also includes intense diplomatic and limited military
operations in order to preserve its abundant financing for as long as possible.
Evidentially there must be a day when oil reserves are depleted and there is no further
possibility to maintain this recycling system but there should still be plenty of time to
go (SZTERNÁK, DEÁK, 2006).
It may also be one of the reasons why France and Germany showed limited
enthusiasm when the War on Terror arrived at the frontiers of Iraq. Since these two
countries are the best fortified strongholds of the Euro, they were to see their dreams
collapse as the US invaded Iraq, a country which was willing to sell oil for Euros. As
the conclusion of geopolitical interests, Iraq was soon navigated back into the
petrodollar corner.
Since the interest in maintaining this system is so intense, it is reaching out into
every part of the US economy. It is small surprise that the biggest taxpayers are willing
to spend some more dollars on strengthening the US military when the American Way
Of Life becomes threatened by increasing credit shortage.
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Conclusion
After all, there seems to be a strong interdependence among nations. The US is
dependent on cheap financing from abroad and is even willing to apply some military
power to protect these interests. On the other side there are countries trying to establish
their own financial regimes as the international payment vehicle. There are obvious
advantages they would like to harvest.
It also appears self-evident that in the course of protecting its international financial
interests, the US will be hitting some nations quite hard (just consider the diplomatic
isolation of Iran or Cuba).
But there is another side: there are countries, like China or Saudi Arabia which have
a huge stake in keeping the American economy going because otherwise they would put
their former investments at a risk, too, but would also wager to lose their best customer,
the American economy. Without American consumption, Chinese economic growth
would need to experience a hard landing.
What can a country like Hungary with a very open economy learn and gain from the
current situation?
Hungary is in a very special location and also in a very interesting strategic position.
As a developing country with a typical open economy, Hungary is highly dependent on
American consumption, because it’s markets shrink drastically as soon as US
consumption is cut back (e.g. Considering the value chain of Audi, where Hungarian
small enterprises supply this huge corporation which sells many of its products in the
US). On the other side, as a member of the European Union, Hungary has to honor its
commitments and pledges of binding strong ties beyond economic co-operation with
EU members (like reconciled foreign policies). But Hungary is also dependent on
energy imports from Russia and also on Russia accepting exports originating from
Hungary. In this position it is extremely important for Hungary to maintain a strategy of
balance and guard its good relationship to each of the above mentioned parties.
For people interested in international security issues, it might be of theoretical and
practical interest to maintain tight surveillance over money and oil flows. Considering
the amount of known and suspected oil and natural gas reserves, it may be considered
very likely that these energy sources will keep influencing geopolitics in this century
(DEÁK, SZTERNÁK, 2009). The predictive value of observing money and oil flows lies
in the strong bedrock of American interest of protecting the petrodollar system as an
essential aid to the American way of life. As soon as we can identify any potential
breach to the established way of thought in international finance and trade, we may
have found a potential focal point of crisis (like it was happening in the case of Iran).
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Acknowledgements
I would like to express my special gratitude to BÉLA BEKK, supervisor of the Hungarian Oil and Gas
Company (Mol Nyrt.) for his valuable contributions to my investigation and helping me to gain better insight
into the way this specific industry works.
References
CLARK, W. (2005): Petrodollar Warfare: Dollars, Euros and the Upcoming Iranian Oil Bourse. Energy Bulletin.
CIA (2009): World Factbook – Hungary. Central Intelligence Agency.
COHEN, B. (2002): Bretton Woods System. In: JONES, R. J. B. (Ed.), Routledge Encyclopedia of International
Political Economy.
HIGGINS, M. et al. (2006): Recycling Petrodollars. Current Issues in Economics and Finance Volume 12
Number 9.
NOUNAN, C. (2004): Feasta Review 2: Growth, the Celtic Cancer. Feasta.
NSOULI, S. M. (2006): Petrodollar Recycling and Global Imbalances. CESifo’s International Spring
Conference.
SPIRO, D. E. (1999): The Hidden Hand of American Hegemony. Cornell University.
SZTERNÁK, GY., DEÁK, J. (2009): Az energia, mint az országok és szövetségek biztonsági problémája. Mikós
Zrínyi National Defence University.
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