L A TIMES, 10/13/02

MARKETS
Oil Economics Lubricates Push for War
[*] The U.S. may be smacking its lips over the financial benefits expected from a regime
change, but the price could be enormous.

By Thomas Ferguson and Robert A. Johnson, Thomas Ferguson is professor of political
science at the University of Massachusetts, Boston; Robert A. Johnson is former
managing director of Soros Funds Management

BOSTON -- Critics of an American preemptive assault on Iraq have repeatedly warned
about its potentially disruptive short-term effects on the world economy. Much less
attention has been paid to a more fundamental point. By setting a goal of "regime
change" rather than weapons elimination, and by ostentatiously preparing to assume
operational and oversight responsibilities in Iraq for a long stretch of time, the U.S. is
sending a strong message to treasuries and foreign ministries around the world. In
matters affecting either oil supply or the value of the dollar, we will act in our best
interests, with little consideration of the interests or views of others.

A glance backward is the easiest way to see why oil and the dollar inevitably loom so
large in any resolution of the Iraq crisis. The current configuration of the Middle East has
its roots in treaties and understandings that grew out of the post-World War I settlement
of the broken Ottoman Empire. That settlement was based on an assumption that the
Russian Revolution had removed both Russia and Central Asia from the world oil
market. Everything changed, though, in 1989, when the Soviet Union began to
disintegrate and Russia and Central Asia came charging dramatically back into world oil
markets.

With both the U.S. and the U.K. ardently promoting globalization, a traditional "spheres
of influence" redivision of the world among the great powers did not occur. Instead
companies and countries from all over the world started playing the new "great game" in
Central Asia.

The blustering efforts of the Saudis to inhibit the flow of Russian oil to the West have
received some recent publicity. These actions have caused tensions with the West, as
have Saudi campaigns during the '90s to expand the influence of their austere brand of
Islamic fundamentalism throughout Central Asia, including Afghanistan, and their
ongoing rapprochement with Iran.

Then came Sept. 11, which brought into even sharper focus the points at which Saudi and
American interests diverge. Since then, the Bush administration has expanded efforts to
weaken OPEC's grip on supply by developing oil resources in other parts of the world.
Its cultivation of President Vladimir V. Putin and his Russian oil has drawn the most
attention, but its policies toward Africa, Indonesia and South America also show clear
evidence of this concern.

An American-led regime change in Iraq would take this campaign to a whole new level. It
is now an accepted notion that lifting the current sanctions on Iraqi oil exports will put
downward pressure on oil prices in the medium term. More important, however, Russian
and most non-OPEC oil is relatively expensive to produce -- $15 a barrel or more. By
contrast, Iraqi production costs, once damage from the war is repaired, should be highly
competitive with Saudi oil: $5 a barrel or less.

This makes Iraq pivotal for stabilizing oil prices in both directions. If prices rise too high,
Iraq can simply pump more. Less obviously, however, if the Saudis decide, as they have
twice done in recent years, to wage a ruinous price war, lowering prices sharply in order
to deter other cartel members from overproducing, then Iraq's role is again key. With
another low-cost gas station open for business, the Saudis cannot count on maintaining
total revenues as prices fall, because now they will have to split the take with the Iraqis.
This downward price deterrence will be welcome news to marginal producers around the
world, including those in Texas, and it is very important in assessing the long-run impact
of the American move.

The currency implications of such a switch are equally momentous. The tremendous
boom in U.S. stock markets in the '90s led to enormous inflows of foreign capital and
sent demand for dollars soaring. In effect, the stock market bubble created a dollar
bubble. With the stock market now coming back to Earth and American interest rates
falling almost as low as those in Japan, only the prospect of even lower growth in Europe
and Asia now sustains the dollar. In financial markets, the dollar's sharp decline earlier
this year is widely regarded as a harbinger of things to come.

A major prop for the dollar has long been the simple fact that oil is priced in U.S. dollars.
If the new Iraqi petroleum authorities announce that they will accept checks only in
dollars, invest their surplus in dollars, and swell U.S. exports by contracting principally
with American firms for services and goods, the dollar's prospects will brighten. As
pleased as Europeans have been to seize chances to export under the umbrella of a high
dollar, this will not be what they had in mind when they called in recent months for action
to break the dollar's fall: Nascent ventures to create an oil futures market in euros may
well be stillborn, while prospects will diminish for a long-term rebalancing of asset
portfolios away from the dollar and in favor of the Euro.

From a distant mountaintop like Capitol Hill, all this may seem like a vision of the
promised land. In reality it is a desert mirage. The dollar cannot thrive in isolation. The
need for effective multilateral action to shore up the world economy is growing urgent.
We need macro policies to stimulate demand and stabilize the foreign exchange values of
the major currencies.

The economic situation is frighteningly precarious in Latin America, where Argentina,
Brazil and even Mexico have recently suffered currency runs. In Africa, efforts to provide
resources for public health, treatment of HIV/AIDS and social infrastructure are in
conflict with debt burdens that are strangling the capacity of the public sector to respond
to the challenges. In an atmosphere poisoned by U.S. go-it-alone tactics in oil and
financial markets, resolving issues of debt relief and rescheduling and international
banking coordination will surely become more difficult. The current discord between
Germany and the U.S. poses a special obstacle, because Germany remains a financial
powerhouse, whatever its military weakness.

All this takes no account of what may go wrong within Iraq itself or in the rest of the
Middle East after Iraq is liberated. As they did after World War I, tensions between the
U.S. and its major allies may well inflame ethnic rivalries that will run rife in whatever
political structure emerges in the new Iraq. In the worst case, a likely casualty of a
unilateral U.S. attack on Iraq may well be the system of alliances that the U.S. has
maintained since World War II. Going it alone in defense, as the new Bush doctrine
proclaims, is bad enough. Going it alone on oil and the dollar is a momentous error.


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