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To bring the dollar down a little, let Russia and Iran price oil in euros

From Russia, you might say, with love. This weekend, Alexei Kudrin,
Russia's finance minister, dropped a bombshell in Washington.

Attending the annual meetings of the World Bank and International
Monetary Fund, Kudrin caused his American hosts discomfort by openly
questioning the dollar's pre-eminence as the world's "absolute"
reserve currency.

The greenback's recent volatility and the yawning US trade
deficit, "are definitely causing concern with regard to its reserve
currency status," he said. "The international community can hardly
be satisfied with this instability."

Kudrin's intervention coincided with another meeting, also in
Washington, of finance ministers and central bankers from the Group
of Seven - which doesn't include Russia.

Top of the agenda: the effect of ever-rising oil prices on inflation
and interest rates.

G7 countries are worried the spiraling price of crude -- which
closed at $72.79 a barrel on Friday and which has now trebled in
three years -- could inflict real economic damage. The US Federal
Reserve, in particular, has been forced to take drastic action --
raising interest rates 15 times since June 2004 to keep inflation in
check.

Given that fragility, it is significant that Kudrin is now wondering
aloud if the long-standing dollar hegemony can last. For him to do
so is to highlight that America is vulnerable should that status be
lost. That's because Russia, with its awesome oil and gas reserves,
could kick-start a challenge to the dollar's supremacy.

Most nations stockpile their foreign exchange holdings in dollars.
The US currency accounts for more than two thirds of all central
bank reserves worldwide.

This reserve status means that the dollar is constantly in demand,
whatever the underlying strength of the US economy.

And now, with massive trade and budget deficits to finance, America
is increasingly reliant on that status. The unprecedented weight of
US liabilities means a threat to the dollar's dominance could result
in a currency collapse, plunging the world's largest economy into
recession.

That won't happen immediately. The dollar has sat astride the globe
for some time now -- in fact, for most of the last century. But this
statement from Russia -- a country of growing financial and
strategic significance -- still caused the dollar to slide. It also
fuelled speculation that central banks could increasingly diversify
their holdings away from dollars.

Kudrin's statement followed news that Sweden has cut its dollar
holdings, from 37 per cent of central bank reserves to 20 per cent,
with the euro's share rising to 50 per cent. Central banks in some
Gulf states have also lately mooted a shift into the euro. Such
sentiments helped push the dollar to a seven-month low against the
single currency last week.

But Russia's intervention will have raised eyebrows in Washington
because the backbone of the dollar's reserve currency status -- the
main guarantee that status continues -- is the fact that oil is
traded in dollars. And that is something the likes of Kudrin can
directly affect.

For historic reasons, the dollar remains the
world's "petrocurrency" -- the only currency for the settlement of
oil contracts on world markets. That makes the EU and Russia
dependent on it. But with central banks switching to euros, the
logical next step would be for fuel-exporting countries to start
quoting oil prices in euros too.

The EU is Russia's main trading partner. More than two thirds of
Russia's oil and gas is exported to the EU. That makes Russia a
strong candidate to become the first major oil exporter to start
trading in euros. Such a scenario, in recent years, has become
theoretically possible. But now, with these latest comments, Kudrin
has thrust that possibility into the open.

The G7 meeting was dominated, of course, by concern over Iran's
nuclear programme. The threat of military action against Iran,
itself a major crude exporter, is one reason oil prices are now
testing record highs.

It is worth noting that Tehran has ongoing plans to set up an oil
trading exchange to compete with New York's NYMEX and with London's
International Petroleum Exchange. In the light of Kudrin's comments,
it is significant that the Iranians want to run their oil bourse in
euros, not dollars.

Were the Iranians to establish a Middle-East based euro-only oil
exchange, the dollar's unique petrocurrency status could unravel.
That, in turn, would threaten its broader dominance -- which, given
America's groaning twin deficit, could seriously hurt the US economy.

Some cite this as the real reason the US wants to attack Iran: to
protect the dollar's unique position. I wouldn't go that far, but
the prospect of a non-dollar oil exchange in Tehran is certainly an
aggravating factor.

The opening of Iran's new oil exchange has recently been delayed.
But having spoken with numerous officials in Tehran, and western
consultants who've been working with the Iranians for several years,
I think it will go ahead. The exchange entity has already been
legally incorporated in Iran and a site purchased to house
administrative and regulatory staff.

The reality is that as long as most of Opec's oil -- read Saudi
Arabia -- is priced in dollars, the US currency will retain its
hegemony. But the opening of an oil bourse in Tehran, which now
looks likely, will signal at least tacit Saudi consent for euro-
based oil trading. The US knows this, which is why it is nervous
about the dollar's status being questioned.

From the G7's fringe, Kudrin has now touched this raw nerve. This
weekend's meetings have been dominated by questions of global
financial imbalance - in particular, America's huge deficits.

Kudrin's missive comes as central bankers, and currency dealers,
start to conclude the only way to resolve the massive US external
deficit is a somewhat weaker US currency. As the IMF itself warned
yesterday, a "substantial" dollar decline may be needed.

One way to bring that about would be for the euro to enter the
global oil trading system. This is unlikely to happen soon. It might
not happen at all. But the idea is now not only realistic but firmly
on the table in Washington. Perhaps not with love, but it was placed
there by the Russians.

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