For
seventy years, one of the critical foundations of American power has been the
dollar’s standing as the world’s most important currency. For the last forty
years, a pillar of dollar primacy has been the greenback’s dominant role in
international energy markets. Today, China is leveraging its rise as an economic
power, and as the most important incremental market for hydrocarbon exporters in
the Persian Gulf and the former Soviet Union, to circumscribe dollar dominance
in global energy - with potentially profound ramifications for America’s
strategic position.
Since World War II, America’s geopolitical supremacy
has rested not only on military might, but also on the dollar’s standing as the
world’s leading transactional and reserve currency. Economically, dollar primacy
extracts “seignorage”—the difference between the cost of printing money and its
value—from other countries, and minimises U.S. firms’ exchange rate risk. Its
real importance, though, is strategic: dollar primacy lets America cover its
chronic current account and fiscal deficits by issuing more of its own currency
– precisely how Washington has funded its hard power projection for over half a
century.
Since the 1970s, a pillar of dollar primacy has been
the greenback’s role as the dominant currency in which oil and gas are priced,
and in which international hydrocarbon sales are invoiced and settled. This
helps keep worldwide dollar demand high. It also feeds energy producers’
accumulation of dollar surpluses that reinforce the dollar’s standing as the
world’s premier reserve asset, and that can be “recycled” into the U.S. economy
to cover American deficits.
Many assume that the dollar’s prominence in energy
markets derives from its wider status as the world’s foremost transactional and
reserve currency. But the dollar’s role in these markets is neither natural nor
a function of its broader dominance. Rather, it was engineered by U.S.
policymakers after the Bretton Woods monetary order collapsed in the early
1970s, ending the initial version of dollar primacy (“dollar hegemony 1.0”).
Linking the dollar to international oil trading was key to creating a new
version of dollar primacy (“dollar hegemony 2.0”)—and, by extension, in
financing another forty years of American hegemony.
Gold and Dollar Hegemony
1.0
Dollar primacy was first enshrined at the 1944 Bretton
Woods conference, where America’s non-communist allies acceded to Washington’s
blueprint for a postwar international monetary order. Britain’s
delegation—headed by Lord Keynes—and virtually every other participating
country, save the United States, favoured creating a new multilateral currency
through the fledgling International Monetary Fund (IMF) as the chief source of
global liquidity. But this would have thwarted American ambitions for a
dollar-centered monetary order. Even though almost all participants preferred
the multilateral option, America’s overwhelming relative power ensured that, in
the end, its preferences prevailed. So, under the Bretton Woods gold exchange
standard, the dollar was pegged to gold and other currencies were pegged to the
dollar, making it the main form of international liquidity.
There was, however, a fatal contradiction in
Washington’s dollar-based vision. The only way America could diffuse enough
dollars to meet worldwide liquidity needs was by running open-ended current
account deficits. As Western Europe and Japan recovered and regained
competitiveness, these deficits grew. Throw in America’s own burgeoning demand
for dollars—to fund rising consumption, welfare state expansion, and global
power projection—and the U.S. money supply soon exceeded U.S. gold reserves.
From the 1950s, Washington worked to persuade or coerce foreign dollar holders
not to exchange greenbacks for gold. But insolvency could be staved off for only
so long: in August 1971, President Nixon suspended dollar-gold convertibility,
ending the gold exchange standard; by 1973, fixed exchange rates were gone,
too.
These events raised fundamental questions about the
long-term soundness of a dollar-based monetary order. To preserve its role as
chief provider of international liquidity, the U.S. would have to continue
running current account deficits. But those deficits were ballooning, for
Washington’s abandonment of Bretton Woods intersected with two other watershed
developments: America became a net oil importer in the early 1970s; and the
assertion of market power by key members of the Organization of Petroleum
Exporting Countries (OPEC) in 1973-1974 caused a 500% increase in oil prices,
exacerbating the strain on the U.S. balance of payments. With the link between
the dollar and gold severed and exchange rates no longer fixed, the prospect of
ever-larger U.S. deficits aggravated concerns about the dollar’s long-term
value.
These concerns had special resonance for major oil
producers. Oil going to international markets has been priced in dollars, at
least since the 1920s—but, for decades, sterling was used at least as
frequently as dollars in order to settle transnational oil purchases, even after
the dollar had replaced sterling as the world’s preeminent trade and reserve
currency. As long as sterling was pegged to the dollar and the dollar was
“as good as gold,” this was economically viable. But, after Washington abandoned
dollar-gold convertibility and the world transitioned from fixed to floating
exchange rates, the currency regime for oil trading was up for grabs. With the
end of dollar-gold convertibility, America’s major allies in the Persian
Gulf—the Shah’s Iran, Kuwait, and Saudi Arabia—came to favour shifting OPEC’s
pricing system, from denominating prices in dollars to denominating them in a
basket of currencies.
In this environment, several of America’s European
allies revived the idea (first broached by Keynes at Bretton Woods) of providing
international liquidity in the form of an IMF-issued, multilaterally-governed
currency—so-called “Special Drawing Rights” (SDRs). After rising oil prices
engorged their current accounts, Saudi Arabia and other Gulf Arab allies of the
United States pushed for OPEC to begin invoicing in SDRs. They also endorsed
European proposals to recycle petrodollar surpluses through the IMF, in order to
encourage its emergence as the main post-Bretton Woods provider of international
liquidity. That would have meant Washington could not continue to print as many
dollars, as it wanted to support rising consumption, mushrooming welfare
expenditures, and sustained global power projection. To avert this, American
policymakers had to find new ways to incentivise foreigners to continue holding
ever-larger surpluses of what were now fiat dollars.
Oil and Dollar Hegemony
2.0
To this end, U.S. administrations from the mid-1970s
devised two strategies. One was to maximise demand for dollars as a
transactional currency. The other was to reverse Bretton Woods’ restrictions on
transnational capital flows; with financial liberalisation, America could
leverage the breadth and depth of its capital markets, and it could cover its
chronic current account and fiscal deficits by attracting foreign capital at
relatively low cost. Forging strong links between hydrocarbon sales and the
dollar proved critical on both fronts.
To forge such links, Washington effectively extorted
its Gulf Arab allies, quietly conditioning U.S. guarantees of their security to
their willingness to financially help the United States. Reneging on pledges to
its European and Japanese partners, the Ford administration
clandestinely pushed Saudi Arabia and other Gulf Arab producers to recycle
substantial parts of their petrodollar surpluses into the U.S. economy through
private (largely U.S.) intermediaries, rather than through the IMF. The Ford administration also elicited Gulf Arab
support for Washington’s strained finances, reaching secret deals with Saudi
Arabia and the United Arab Emirates for their central banks to buy large volumes
of U.S. Treasury securities outside normal auction processes. These
commitments helped Washington prevent the IMF from supplanting the United States
as the main provider of international liquidity; they also gave a crucial early
boost to Washington’s ambitions to finance U.S. deficits by recycling foreign
dollar surpluses via private
capital markets and purchases of U.S. government securities.
OPEC’s
commitment to the dollar as the invoice currency for international oil sales was
key to broader embrace of the dollar as the oil market’s reigning transactional
currency.
A few years later, the Carter administration struck another secret deal
with the Saudis, whereby Riyadh committed to exert its influence to ensure that
OPEC continued pricing oil in dollars. OPEC’s commitment to the dollar as
the invoice currency for international oil sales was key to broader embrace of
the dollar as the oil market’s reigning transactional currency. As OPEC’s
administered price system collapsed in the mid-1980s, the Reagan administration
encouraged universalised dollar invoicing for cross-border oil sales on new oil
exchanges in London and New York. Nearly universal pricing of oil—and, later on,
gas—in dollars has bolstered the likelihood that hydrocarbon sales will not just
be denominated in dollars, but settled in them as well, generating ongoing
support for worldwide dollar demand.
In short, these bargains were instrumental in creating
“dollar hegemony 2.0.” And they have largely held up, despite periodic Gulf Arab
dissatisfaction with America’s Middle East policy, more fundamental U.S.
estrangement from other major Gulf producers (Saddam Husseinn’s Iraq and the
Islamic Republic of Iran), and a flurry of interest in the “petro–Euro” in the
early 2000s. The Saudis, especially, have vigorously defended exclusive pricing of oil in
dollars. While Saudi Arabia and other major energy producers now accept
payment for their oil exports in other major currencies, the larger share of the
world’s hydrocarbon sales continue to be settled in dollars, perpetuating the
greenback’s status as the world’s top transactional currency. Saudi Arabia and
other Gulf Arab producers have supplemented their support for the oil-dollar
nexus with ample purchases of advanced U.S. weapons; most have also pegged their
currencies to the dollar—a commitment which senior Saudi officials describe as
“strategic.” While the dollar’s share of global reserves has dropped, Gulf Arab
petrodollar recycling helps keep it the world’s leading reserve currency.
The China
Challenge
Still, history and logic caution that current
practices are not set in stone. With the rise of the “petroyuan,” movement towards a less dollar-centric
currency regime in international energy markets—with potentially serious
implications for the dollar’s broader standing—is already underway.
As China has emerged as a major player on the global
energy scene, it has also embarked on an extended campaign to internationalise its currency. A rising
share of China’s external trade is being denominated and settled in renminbi;
issuance of renminbi-denominated financial instruments is growing. China is
pursuing a protracted process of capital account liberalisation essential to
full renminbi internationalisation,
and is allowing more exchange rate flexibility for the yuan. The People’s Bank of China (PBOC) now has
swap arrangements with over thirty other central banks—meaning that renminbi already effectively functions
as a reserve currency.
Looking
ahead, use of renminbi to settle international hydrocarbon sales will surely
increase, accelerating the decline of American influence in key energy-producing
regions.
Chinese policymakers appreciate the “advantages of
incumbency” the dollar enjoys; their aim is not for renminbi to replace dollars, but to position the
yuan alongside the greenback as a
transactional and reserve currency. Besides economic benefits (e.g., lowering
Chinese businesses’ foreign exchange costs), Beijing wants—for strategic
reasons—to slow further growth of its enormous dollar reserves. China has
watched America’s increasing propensity to cut off countries from the U.S.
financial system as a foreign policy tool, and worries about Washington trying
to leverage it this way; renminbi
internationalisation can mitigate such vulnerability. More broadly, Beijing
understands the importance of dollar dominance to American power; by chipping
away at it, China can contain excessive U.S. unilateralism.
China has long incorporated financial instruments into
its efforts to access foreign hydrocarbons. Now Beijing wants major energy
producers to accept renminbi as a
transactional currency—including to settle Chinese hydrocarbon purchases—and
incorporate renminbi in their
central bank reserves. Producers have reason to be receptive. China is, for the
vastly foreseeable future, the main incremental market for hydrocarbon producers
in the Persian Gulf and former Soviet Union. Widespread expectations of
long-term yuan appreciation make
accumulating renminbi reserves a
“no brainer” in terms of portfolio diversification. And, as America is
increasingly viewed as a hegemon in relative decline, China is seen as the
preeminent rising power. Even for Gulf Arab states long reliant on Washington as
their ultimate security guarantor, this makes closer ties to Beijing an
imperative strategic hedge. For Russia, deteriorating relations with
the United States impel deeper cooperation with China, against what both Moscow
and Beijing consider a declining, yet still dangerously flailing and
over-reactive, America.
For several years, China has paid for some of its oil imports from Iran
with renminbi; in 2012, the
PBOC and the UAE Central Bank set up a $5.5 billion currency swap,
setting the stage for settling Chinese oil imports from Abu Dhabi in renminbi—an important expansion of
petroyuan use in the Persian Gulf.
The $400 billion Sino-Russian gas deal that was concluded this year apparently
provides for settling Chinese purchases of Russian gas in renminbi; if fully realised, this would mean an
appreciable role for renminbi in
transnational gas transactions.
Looking ahead, use of renminbi to settle international hydrocarbon
sales will surely increase, accelerating the decline of American influence in
key energy-producing regions. It will also make it marginally harder for
Washington to finance what China and other rising powers consider overly
interventionist foreign policies—a prospect America’s political class has hardly
begun to ponder.
No comments:
Post a Comment