Why might Russia price its oil in euros? They say for convenience. Russia sells most of its oil to Europe and gets most of its exports from the eurozone. So pricing oil in euros would enable both sides to save on the costs of currency conversion. But this would only represent a very small saving, so in this sense, the move would be economically insignificant. The real importance of such a move would be political. It would be hugely symbolic in the context of Europe’s ambitions to establish the euro as an alternative reserve currency to the dollar. The risk is that it would also do damage to the dollar and to the global economy.
Why might this hurt the dollar?
Because oil importers would need to buy euros to buy oil, so demand for euros would surge, while that for dollars would fall. It would also increase the use of the euro as a reserve currency. At the moment, Russia’s central bank reserves are mostly in dollars, since this is what it receives for its oil. If Russia priced its oil in euros, not only would its own euro reserves increase, but so too might those of the countries that buy its oil, since they will need to use euros to pay for it. If only Russia priced its oil in euros, the impact on currency markets would be minimal, since Russia’s output of 5.4 million barrels a day is worth about $171m a day – peanuts in the context of the daily turnover of global forex markets. But if other oil-producing countries switched to the euro, the impact would be huge.
Are other countries considering such a move?
Yes. Iraq already prices its oil in euros, having made the switch in 2000. Indeed, some conspiracy theorists detect in this act of defiance the real reasons for the Iraq war, on the grounds that the US feared other countries would follow its lead. Iran has also been considering such a switch for several years and the subject has been discussed in Saudi Arabia. Venezuela currently sells part of its output under a barter system to avoid using any currency at all. Last year, a senior Opec official suggested that such a move might one day make economic sense for the oil-producers’ cartel. Nobody thinks any such move is imminent, but post the Iraq war, some oil producers are more willing to consider a move that would deal a massive blow to US interests.
How does reserve currency status benefit the US?
The US derives a small benefit from ‘seigniorage’ – the profit the US makes from the circulation of nearly $3trn worth of US banknotes outside the US, which cost nothing to print but are backed by interest bearing Treasury bills. This is worth about $10bn a year. But the real benefit of reserve currency status is that it ensures a virtually insatiable demand for dollars from the world’s central banks, who need the US currency to boost their own reserves and thereby support their own currencies. This has given the US carte blanche to borrow unprecedented amounts of money to fund its wars, tax cuts and consumer spending at very low interest rates.
What would be the impact of competition from the euro?
It could be devastating for the dollar. If the world’s central banks started switching part of their reserves into euros, or even simply stopped buying dollar assets, the value of the dollar would collapse, since demand for dollars would fall. Worse, the US would find it very hard to finance its giant twin deficits – its trade and budget deficits. The dollar’s reserve currency status has allowed it to run-up debts no other country in history could have got away with. America’s external debts – its trade deficit – now stand at $600bn, equivalent to 5% of GDP. This would have been unthinkable under the gold standard, when those debts would have to have been redeemable in gold. It was because Britain ran up similar debts in the 1930s and 1940s that sterling had to be devalued and thus ceased to be the main global reserve currency.
Why has America been able to get away with its deficits?
Largely thanks to the intervention of Asian central banks. Over the last year, portfolio (private) investment in the US has dried up amid fears that the trade deficit is unsustainable and that a fall in the dollar is inevitable. America shows no signs of being prepared to live within its means: the response to every tax and interest rate cut of the last few years has been a new burst of consumer borrowing and spending. But Asian central banks have spent billions propping up the dollar – and thus funding this debt binge – because they fear a collapse in the dollar would choke off their own recoveries. But despite this intervention, the dollar is still falling. Moreover, the US government is now demanding Asians stop intervening, saying it damages the competitiveness of US industry.
How would a collapse in the dollar affect the euro?
The euro is the main beneficiary of the weaker dollar and this strength has added to its appeal as a potential reserve currency. But a collapse in the dollar could be as much a disaster for Europe as for the US. The US could be faced with higher inflation, higher interest rates and a stockmarket and property market crash, while the eurozone could find its goods priced out of world markets. Unable to rely on exports to the US, the nascent EU recovery would collapse. The eurozone may hope this scenario can be avoided by collective government action, as it was in 1986, following a 44% collapse in the dollar, with the Louvre Accord. The answer then was interest-rate cuts, which led to a boom followed by a stockmarket crash in 1987. This time, a solution would most likely involve big sacrifices by the US – sacrifices that in the current political climate it may not be willing to make.