The official line from the United States
and the European Union is that Tehran must be punished for continuing its
efforts to develop a nuclear weapon. The punishment: sanctions on Iran's oil
exports, which are meant to isolate Iran and depress the value of its currency
to such a point that the country crumbles.
But that line doesn't make sense, and the
sanctions will not achieve their goals. Iran is far from isolated and its
friends - like India - will stand by the oil-producing nation until the US
either backs down or acknowledges the real matter at hand. That matter is the
American dollar and its role as the global reserve currency.
The short version of the story is that a
1970s deal cemented the US dollar as the only currency to buy and sell crude
oil, and from that monopoly on the all-important oil trade the US dollar slowly
but surely became the reserve currency for global trades in most commodities
and goods. Massive demand for US dollars ensued, pushing the dollar's value up,
up, and away. In addition, countries stored their excess US dollars savings in
US Treasuries, giving the US government a vast pool of credit from which to
draw.
We know where that situation led - to a US
government suffocating in debt while its citizens face stubbornly high unemployment
(due in part to the high value of the dollar); a failed real estate market;
record personal-debt burdens; a bloated banking system; and a teetering
economy. That is not the picture of a world superpower worthy of the privileges
gained from having its currency back global trade. Other countries are starting
to see that and are slowly but surely moving away from US dollars in their
transactions, starting with oil.
If the US dollar loses its position as the
global reserve currency, the consequences for America are dire. A major portion
of the dollar's valuation stems from its lock on the oil industry - if that
monopoly fades, so too will the value of the dollar. Such a major transition in
global fiat currency relationships will bode well for some currencies and not
so well for others, and the outcomes will be challenging to predict. But there
is one outcome that we foresee with certainty: Gold will rise. Uncertainty
around paper money always bodes well for gold, and these are uncertain days
indeed.
The Petrodollar System
To explain this situation properly, we have
to start in 1973. That's when President Nixon asked King Faisal of Saudi Arabia
to accept only US dollars as payment for oil and to invest any excess profits
in US Treasury bonds, notes, and bills. In exchange, Nixon pledged to protect
Saudi Arabian oil fields from the Soviet Union and other interested nations,
such as Iran and Iraq. It was the start of something great for the US, even if
the outcome was as artificial as the US real-estate bubble and yet constitutes
the foundation for the valuation of the US dollar.
By 1975 all of the members of OPEC agreed to sell their oil only in US
dollars. Every oil-importing nation in the world started saving their surplus
in US dollars so as to be able to buy oil; with such high demand for dollars
the currency strengthened. On top of that, many oil-exporting nations like
Saudi Arabia spent their US dollar surpluses on Treasury securities, providing
a new, deep pool of lenders to support US government spending.
The "petrodollar" system was a
brilliant political and economic move. It forced the world's oil money to flow
through the US Federal Reserve, creating ever-growing international demand for
both US dollars and US debt, while essentially letting the US pretty much own
the world's oil for free, since oil's value is denominated in a currency that
America controls and prints. The petrodollar system spread beyond oil: the
majority of international trade is done in US dollars. That means that from
Russia to China, Brazil to South Korea, every country aims to maximize the
US-dollar surplus garnered from its export trade to buy oil.
The US has reaped many rewards. As oil
usage increased in the 1980s, demand for the US dollar rose with it, lifting
the US economy to new heights. But even without economic success at home the US
dollar would have soared, because the petrodollar system created consistent
international demand for US dollars, which in turn gained in value. A strong US
dollar allowed Americans to buy imported goods at a massive discount - the
petrodollar system essentially creating a subsidy for US consumers at the
expense of the rest of the world. Here, finally, the US hit on a downside: The
availability of cheap imports hit the US manufacturing industry hard, and the
disappearance of manufacturing jobs remains one of the biggest challenges in
resurrecting the US economy today.
There is another downside, a potential
threat now lurking in the shadows. The value of the US dollar is determined in
large part by the fact that oil is sold in US dollars. If that trade shifts to
a different currency, countries around the world won't need all their US money.
The resulting sell-off of US dollars would weaken the currency dramatically.
So here's an interesting thought
experiment. Everybody says the US goes to war to protect its oil supplies, but
doesn't it really go to war to ensure the continuation of the petrodollar
system?
The Iraq war provides a good example. Until
November 2000, no OPEC country had dared to violate the US dollar-pricing rule,
and while the US dollar remained the strongest currency in the world there was
also little reason to challenge the system. But in late 2000, France and a few
other EU members convinced Saddam Hussein to defy the petrodollar process and
sell Iraq's oil for food in euros, not dollars. In the time between then and
the March 2003 American invasion of Iraq, several other nations hinted at their
interest in non-US dollar oil trading, including Russia, Iran, Indonesia, and
even Venezuela. In April 2002, Iranian OPEC representative Javad Yarjani was
invited to Spain by the EU to deliver a detailed analysis of how OPEC might at
some point sell its oil to the EU for euros, not dollars.
This movement, founded in Iraq, was
starting to threaten the dominance of the US dollar as the global reserve
currency and petro currency. In March 2003, the US invaded Iraq, ending the
oil-for-food program and its euro payment program.
There are many other historic examples of
the US stepping in to halt a movement away from the petrodollar system, often
in covert ways. In February 2011 Dominique Strauss-Kahn, managing director of
the International Monetary Fund (IMF), called for a new world currency to
challenge the dominance of the US dollar. Three months later a maid at the
Sofitel New York Hotel alleged that Strauss-Kahn sexually assaulted her.
Strauss-Kahn was forced out of his role at the IMF within weeks; he has since
been cleared of any wrongdoing.
War and insidious interventions of this
sort may be costly, but the costs of not protecting the petrodollar system
would be far higher. If euros, yen, renminbi, rubles, or for that matter
straight gold, were generally accepted for oil, the US dollar would quickly
become irrelevant, rendering the currency almost worthless. As the rest of the
world realizes that there are other options besides the US dollar for global
transactions, the US is facing a very significant - and very messy - transition
in the global oil machine.
The Iranian Dilemma
Iran may be isolated from the United States
and Western Europe, but Tehran still has some pretty staunch allies. Iran and
Venezuela are advancing $4 billion worth of joint projects, including a bank.
India has pledged to continue buying Iranian oil because Tehran has been a
great business partner for New Delhi, which struggles to make its payments.
Greece opposed the EU sanctions because Iran was one of very few suppliers that
had been letting the bankrupt Greeks buy oil on credit. South Korea and Japan
are pleading for exemptions from the coming embargoes because they rely on
Iranian oil. Economic ties between Russia and Iran are getting stronger every
year.
Then there's China. Iran's energy resources
are a matter of national security for China, as Iran already supplies no less
than 15% of China's oil and natural gas. That makes Iran more important to
China than Saudi Arabia is to the United States. Don't expect China to heed the
US and EU sanctions much - China will find a way around the sanctions in order
to protect two-way trade between the nations, which currently stands at $30
billion and is expected to hit $50 billion in 2015. In fact, China will
probably gain from the US and EU sanctions on Iran, as it will be able to buy
oil and gas from Iran at depressed prices.
So Iran will continue to have friends, and
those friends will continue to buy its oil. More importantly, you can bet they
won't be paying for that oil with US dollars. Rumors are swirling that India
and Iran are at the negotiating table right now, hammering out a deal to trade
oil for gold, supported by a few rupees and some yen. Iran is already dumping
the dollar in its trade with Russia in favor of rials and rubles. India is
already using the yuan with China; China and Russia have been trading in rubles
and yuan for more than a year; Japan and China are moving towards transactions
in yen and yuan.
And all those energy trades between Iran
and China? That will be settled in gold, yuan, and rial. With the Europeans out
of the mix, in short order none of Iran's 2.4 million barrels of oil a day will
be traded in petrodollars.
With all this knowledge in hand, it starts
to seem pretty reasonable that the real reason tensions are mounting in the
Persian Gulf is because the United States is desperate to torpedo this movement
away from petrodollars. The shift is being spearheaded by Iran and backed by
India, China, and Russia. That is undoubtedly enough to make Washington anxious
enough to seek out an excuse to topple the regime in Iran.
Speaking of that search for an excuse, this
is interesting. A team of International Atomic Energy Agency (IAEA) inspectors
just visited Iran. The IAEA is supervising all things nuclear in Iran, and it
was an IAEA report in November warning that the country was progressing in its
ability to make weapons that sparked this latest round of international
condemnation against the supposedly near-nuclear state. But after their latest
visit, the IAEA's inspectors reported no signs of bomb making. Oh, and if keeping
the world safe from rogue states with nuclear capabilities were the sole
motive, why have North Korea and Pakistan been given a pass?
There
is another consideration to keep in mind, one that is very important when it
comes to making some investment decisions based on this situation: Russia,
India, and China - three members of the rising economic powerhouse group known
as the BRICs (which also includes Brazil) - are allied with Iran and are major
gold producers. If petrodollars go out of vogue and trading in other currencies
gets too complicated, they will tap their gold storehouses to keep the crude
flowing. Gold always has and always will be the fallback currency and, as
mentioned before, when currency relationships start to change and valuations
become hard to predict, trading in gold is a tried and true failsafe.
2012
might end up being most famous as the year in which the world defected from the
US dollar as the global currency of choice. Imagine the rest of the world doing the
math and, little by little, beginning to do business in their own currencies
and investing ever less of their surpluses in US Treasuries. It constitutes
nothing less than a slow but sure decimation of the dollar.
That may not be a bad thing for the United
States. The country's gargantuan debts can never be repaid as long as the
dollar maintains anything close to its current valuation. Given the state of
the country, all that's really left supporting the value in the dollar is its
global reserve currency status. If that goes and the dollar slides, maybe the
US will be able to repay its debts and start fresh. That new start would come
without the privileges and ingrained subsidies to which Americans are so
accustomed, but it's amazing that the petrodollar system has lasted this long.
It was only a matter of time before something would break it down.
Finally, the big question: How can one
profit from this evolving situation? Playing with currencies is always very
risky and, with the global game set to shift to significantly, it would require
a lot of analysis and a fair bit of luck. The much more reliable way to play
the game is through gold. Gold is the only currency backed by a physical
commodity; and it is always where investors hide from a currency storm.
The basic conclusion is that a slow demise
of the petrodollar system is bullish for gold and very bearish for the US
dollar. As for any more specific suggestions on how to profit, check out our
newsletters.
Marin Katusa
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