The euro is finally taking its place alongside the US dollar as a new global reserve currency. This has been further enhanced by the euro’s recent gains against the dollar. But what would happen to the US economy if Opec decides to use euro, instead of dollar, to price oil?

In the best-laid human plans, events rarely unfold as predicted — even by the experts. Mostly, these surprises are the result of “blind spots”, or because experts use different models or specialized approaches and languages — making communication difficult.

One such surprise scenario is rooted in the close relationship between oil, dollars, gold and Europe’s euro currency. Remember back in 1973, Opec countries quadrupled the price of their oil and tied it to the US dollar. Over the years, this flooded the world with the “petro-dollar”, which were recycled through banks as loans. The US dollar reigned supreme as the world’s de facto reserve currency. Everyone wanted to own dollars, which were considered as good as gold.

Gold no longer backs the dollar — or any other currency. All currencies since 1973 are called “fiat” currencies — backed only by faith markets have in a country’s government and its economic fundamentals. Central banks that used to keep gold bars in their vaults have sold much of their precious metal. Now, they try to “manage” their currencies by raising or lowering interest rates, buying and selling them in the open market and other techniques.

Gold is still popular for jewellery and as a safe haven. It trades actively on world’s commodity and futures exchanges, along with platinum, oil, hogs, coffee, sugar — and fiat currencies themselves. These currencies, oil and gold markets are very volatile — dependent on the expectations about the future of millions of their investors and speculators. These markets reflect a collective speculation on the future of such items as Iraq, the US foreign policy, the Middle East, oil supplies, alternative energy sources and technologies, the rise of China, the expansion of the EU — and the weather. They all drive today’s global financial markets, including the $1.5 trillion of daily currency trading.

In the past 12 months, the US dollar has lost some 30 per cent of its value against the European euro. The Bush Administration has played up the bright side. The cheaper dollar makes it easier for the US exporters to sell abroad. The United States needs to increase its exports because it has a whopping trade deficit (currently reading 5.2 per cent of their GDP). Global investors and currency speculators take it seriously — along with the bursting of the US stock market bubble, accounting scandals and heavily indebted corporations and consumers. The list goes on, and includes the US savings rate at almost 0 per cent, the increasing budget deficits due to President Bush’s tax cuts and his build-up of military spending, the Iraq war and the new Bush doctrine of preemptive attacks on any country that might threaten the US future national security. In the light of all that, global investors started unloading dollars and the US assets. No surprises here.

But as countries that formerly held mostly the US dollars in their currency reserves begin to diversify into euros, the currency has taken its place alongside the dollar, as the world’s other global reserve currency. While current data are hard to come by, the euro now accounts for as much as 35 per cent of global trade and reserve holdings. This new reality makes for a more stable world — and takes the unsustainable burden of the sole reserve currency status off the US dollar.

Clearly, with its enormous, open-ended commitments in the global war on terrorism, the US economy cannot at the same time, continue to absorb most of the world’s exports — and remain the locomotive of the world’s economic growth. This new situation seems a surprise to the Bush Administration. It is still keen on expanding its overseas commitments, re-building Iraq and offering aid packages to Turkey, Pakistan and other countries whose support is sought. In the meantime, it has passed a $350 billion tax cut package in late May, 2003.

While Bush tells Americans to continue shopping, travelling and enjoy the American way of life, federal deficits grow, domestic programmes are cut and half of all the US states are engulfed in budget crises. What happens if global investors continue pulling out of the United States and the dollar keeps falling? Many market players expect it to fall by another 20 per cent. Other countries that have lost money in the dollar’s fall may continue buying more euros.

The other shoe may drop, too. Opec may decide to officially re-denominate their oil in euros (since most of the organization’s customers are in Europe anyway). Opec economists have been considering this “no-brainer” scenario for sound financial reasons — even though they feared the US wrath and retaliation. Indeed, many believe that a deeper reason for the US attack on Iraq was its decision in 1999 to require payments for its oil for food programme in euros. The United States — heavily dependent on imported oil — benefits price-wise and in influencing markets through Opec’s US dollar pricing. Iraq’s dinar will also be replaced by dollar if the United States has its way.

Thwarting President Bush’s global dollar diplomacy and its designs on breaking Opec’s oil pricing power provide additional reasons for Opec to switch to payments in euro. This would mean that the United States would have to buy euro with dollar before it could buy Opec oil. The dollar would fall further and the euro would rise. The US economy would eventually have to adjust to $5-a-gallon gasoline (the average world price).