Over the barrel: Can non-dollar overpower the petrodollar?

Published: May 6, 2019 4:11:11 AM

The rest of the world must find ways of creating a non-dollar based trading system, particularly with regards to petroleum, and thereby weakening America’s stranglehold over the global financial system. For Trump is pushing the Middle East onto a collision course and the consequences for everyone could be severe.

Over the barrel, dollar, petrodollar, us, india, news, petrol barrelOver the barrel: Can non-dollar overpower the petrodollar?

By Vikram Singh Mehta

One should not be surprised by Donald Trump’s imperious approach to the rest of the world. He has but one concern—to keep his domestic constituency intact and to win the 2020 presidential elections. He may not even care if, in the process, the ‘rest’ goes to hell in a handbasket. His latest missive against Iran is a manifestation of this attitude. The question that one must ask is: What can the ‘rest’ do to prevent such an outcome.

On April 22, Mike Pompeo, the United States Secretary of State, had announced that the exemptions granted to seven countries (and Taiwan) from the US sanctions law CAATSA (Countering America’s Adversaries Through Sanctions Act) against Iran would be withdrawn on May 3. He said these countries would have to bring their imports of Iranian oil/gas down to zero within the next two weeks and the policy objective was to choke off the principal source of revenue of the ‘outlaw regimes’.

Pompeo’s announcement should not have come as a surprise. The exemptions had been granted for six months and were to expire on May 3. It did rattle the market, though, because of the impracticality of the demand. How were these countries going to reduce their purchase to zero at such a short notice. Together, they were purchasing 1 million barrels of oil daily, and Turkey imported almost 15% of its gas requirements via pipeline from Iran. It was also not clear what the US would do if China, Turkey and India cocked a snook at this diktat. Would the government prevent US banks from financing US business in these countries? If so, what and how would these restrictions be implemented? Any way, the uncertainties led to a tightening of the oil market despite Trump’s characteristic tweet that he had “spoken to the OPEC” to make up for the shortfall.

On hearing this announcement, the issue that concerned me was not the impact on the oil market or on India. It was the reaction of Iran and whether this might trigger actions and decisions that could lead to a broader conflagration. I knew that India had already substantially reduced its petroleum imports from Iran and that whilst the costs of making up the 11% that it still imported would push its import bill higher, this increase was affordable and it would not create a major economic disruption. Of course, I did wonder whether India would readily accede to the diktat or whether, on a matter of principle, it would signal to America that it could not compromise its principles and be seen as a fair weather friend and ally. After all, India and Iran have had long-standing strategic, cultural and trading relations. But these were subsidiary thoughts to the contours of a possible disaster scenario that was taking shape in my mind. It was also subsidiary to the follow-up question what if anything can the ‘rest’ do to prevent Trumpian foreign policy from disproportionately and adversely impacting the people in the region?

Consider the following:
The relatively moderate government of Iranian President Hassan Rouhani collapses because of public disaffection with the dire state of the domestic economy and because of an emboldened opposition. It is replaced by a hard-line government opposed to the Joint Comprehensive Plan of Action (JCPOA), the multi-nation agreement that had placed constraints on Iran’s nuclear programme and resumes work on the nuclear programme. John Bolton, the National Security Advisor of the United States and arguably the architect of Trump’s hard-line policy towards Iran, finds he now has the excuse to ‘bomb’ Iran. He has often expressed this wish. Trump signs off on this act of muscularity because he believes it will go down well with his domestic constituency. Iran reacts along multiple fronts. It endeavours to block the Strait of Hormuz through which flow 22 million barrels of oil every day, it intensifies its support to anti-American Shia factions in the region, and it reaches out to China for support. The price of oil shoots up, the global economy hits the skids and…
So, what, if anything, can the global community do to avoid such a scenario? What can it do to ensure that Iran continues to exercise ‘strategic patience’?

The answer clearly does not lie in a ‘jaw jaw’ with Trump, Bolton and Pompeo. They have set their stakes in the ground. They will not ease off until, as Pompeo put it, Iran learns “to behave like a normal country.” Moreover, they are persuaded that the portrayal of Iran as ‘an outlaw regime’ plays well with their Republican base.

So, what are the other possibilities?
One of several reasons for America’s economic leverage is that it sits at the epicentre of the global financial system. The dollar is a reserve currency. Global trade is preponderantly carried out in dollars. Oil is priced in dollars. The US Treasury is the favoured haven for risk-averse investors. And it controls the financial messaging system (SWIFT). Banks, financial intermediaries and corporates would not be able to function if they did not have access to this system. This latter reality is the threat that hangs over every entity that continues to trade with Iran after May 3.

Clearly, this threat would lose its edge if there were an alternative messaging system that enabled non-dollar transactions without SWIFT. The European signatories of JCPOA (Germany, France and the UK) have created such a system. They announced in January the establishment of a special-purpose vehicle (SPV) called the Instrument in Support of Trade Exchanges (INSTEX) to enable companies to trade with Iran without having to deal with dollar-based US banks. It remains to be seen whether companies will avail of this mechanism. Also, the threat would dilute if the countries decided to engage in barter, but this is not a sustainable alternative.

I am sure there is more that can be done. The larger point is that the ‘rest’ must find ways of creating a non-dollar based trading system, particularly with regards to petroleum, and thereby weakening America’s stranglehold over the global financial system. For Trump is pushing the Middle East onto a collision course and the consequences for everyone could be severe.

The author is chairman & senior fellow, Brookings India

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