What is the Real U.S. Concern with Iran – The Petrodollar or WMDs?

February 7, 2012
By

Why is the U.S. really so concerned about Iran? Is it the supposed nuclear threat to the region or the threat to the U.S. Petrodollar?

As much as we Americans would like to believe that our reasons for war are just and righteous, we simply have to wake up to the real situations at hand and take some time to educate ourselves about how the world economy really works. It is not nearly as complicated as politicians and economists would prefer you believe, nor is it as simple as others would hope.

Case in point: the current United States and the European Union bombardment of the airwaves proclaiming that Iran must be punished for continuing its efforts to develop a nuclear weapon. The European Union, who did not support the U.S. invasion in Iraq, is vowing now to stop buying oil from Iran altogether, opting instead to support the supposed U.S.-led weapon of choice–economic sanctions. Specifically, sanctions on Iran’s oil exports, it’s only real commodity.

The goal, absent politics and fear, would appear to the normal observer to be to isolate Iran and depress the value of its currency until the country’s government implodes or the Iranian citizens revolt and the government explodes. Absent that, Israel attacks, or we attack, alleviating Iran’s capability to acquire nuclear weapons; ostensibly for use against Israel or other U.S. interests in the region (i.e., oil).

But is this the actual threat to the U.S. from Iran?

The Evolution of the Petro-dollar

Since 1945, the U.S. has had the luxury of owning the reserve currency for oil. This means that oil purchased or sold on the open market is only legitamtely done with U.S. dollars. This relationship reached a distinct turning point in the early 1970s when President Richard Nixon(R) and King Faisal of Saudi Arabia reached an exclusivity agreement for U.S. Dollars to be the currency for Saudi oil after the debacle of the Arab Oil Embargo.

President Nixon then proceeded to take the U.S. off the gold standard making the U.S. dollar the most important currency world-wide. The dollar, converted into a fiat currency [i.e., "Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves" (Investopedia.com)], has enabled the U.S. to maintain an exceptionally high demand among other currencies despite a current-account trade deficit and an extremely high domestic debt-to-GDP ratio.

Historical Reference

In 1973, President Nixon and  King Faisal of Saudi Arabia agreed that US dollars would be the payment of choice for oil and that Saudi Arabia would 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.

By 1975, all of OPEC agreed to sell their oil exclusively in US dollars. The result was that oil-importing and exporting nations began saving their respective surpluses in US dollars to accommodate their oil purchases. As demand grew for dollars the currency naturally strengthened.

From this position of exclusivity in oil trades, the U.S. Dollar advanced to the position of being the go-to currency for global trades in almost all commodities and goods. This created a huge demand for dollars and elevated the value of the dollar to lofty heights, despite the U.S. gaining the dubious status of a debtor-nation at an exponetially quicker pace when President Reagan first exploded the deficit by a then-astounding 184% during his tenure. Countries all over the world bought more and more dollars to have a reserve of currency with which to buy oil. Eventually and not surprisingly, countries began storing their excess US dollar capacity in US Treasury Bonds, giving the US a massive amount of credit from which they could draw.

As beneficial as it was for the economy, the “petrodollar” system added exponentially to the U.S. dominance in global politics as well. It forced global oil money to flow through the US Federal Reserve, creating international demand for US dollars; but it also allowed US debt to explode with fewer-than-normal consequences. It essentially enabled the US to buy oil for a fraction of what the rest of the market paid, since oil’s value is denominated in a currency that only America controlled. The petrodollar system spread to become the currency of choice for all international trade and virtually every country had to maximize its US dollar surplus from its export trade in order to secure its ability to purchase or sell oil.

Therefore, since only the U.S. may print the petro-dollars, they also control the flow of oil. When oil is denominated in dollars exclusively produced through the U.S. Federal Reserve and the dollar is the only fiat currency for trading in oil, an argument can be made that the U.S. essentially owns the world’s oil for free.

Though Mortal Enemies, Iraq and Iran Similarly Threatened the U.S. Petrodollar

In late 2000, about the time the Commodities Futures Modernization Act of 2000(see  Time For Europe and America to Implement the One-Penny Solution, January 7th, 2012, this site)  snuck through Congress virtually in the dead of night, and signed by President Clinton on his last day in office. France and a few other EU members convinced Saddam Hussein to change the petrodollar process and sell Iraq’s oil-for-food in euros, not dollars. At about the same time, other nations hinted at their interest in non-US dollar oil trading, including Russia, Iran, Venezuela, and Indonesia.

If OPEC decided to follow Iraq’s lead and suddenly began trading oil on the euro standard, it would mean economic meltdown for the U.S.

Oil-consuming nations would have had to divest themselves of U.S. dollars ,via their central bank reserves, and replace them with either euros or whatever currency the party nations preferred. The consequences would be the dollar would crash in value, U.S. currency would collapse, and massive inflation would ensue. Foreign funds would flee from U.S. stock markets and dollar denominated assets, there would be a run on the banks much like the 1930s, and the current-account deficit would become unserviceable. The inevitable result would lead the U.S. budget deficit to go into default creating a severe worldwide depression brought on by the U.S. inability to pay it’s debts.

In March 2003, the US invaded Iraq, abruptly ending the oil-for-food program and Iraq’s euro payment proposal. It will come as no surprise that France was the leading European nation voicing objection to the U.S. invasion and giving birth to “Freedom Fries”, President George W. Bush’s edict that countries were either “for us or against us”,  “cowboy diplomacy”, and eventually the “axis of evil“.

Of course, it has since come to light that there were no weapons of mass distruction (oops). Additionally, Al Qaeda was non-existent in Iraq. So why the urgency to invade Iraq, especially in that said invasion took both resources and focus from the real terrorist threat-Osama Bin Laden who was ostensibly hiding in Afghanistan? A ego-maniacal dictator in Iraq? There were plenty others around that we did not attack. Or the threat to the petrodollar and the very real chance of economic collapse on the heels of the first attack on U.S. soil since Pearl Harbor?

In Iraq, the invisible boogie man was weapons of mass destruction. Now, the growing rumble from Washington regarding Iran is that they are close to achieving the capability to assemble a nuclear threat to Israel and America’s allies (oil-producing allies that is).

Other U.S. Domestic Consequences of the Petro-dollar

As the dollar rose, it became more and more expensive to sell U.S.-made goods due to the exchange rate of the dollar vs other currencies. The US government, under the Reagan through George W. Bush Administrations in particular, (and continuing in the Obama administration due in part to a horrendous recession and high unemployment)became increasingly unable to cover U.S. debts while providing tax reductions in order to further their agendas; primarily with tax incentives to their wealthy constituencies. President after president tried to stem the flow of debt. The closest came at the hands of President Bill Clinton, who at least managed to marginally reduce the rate of growth and left office with a net reduction in the rate-of-deficit growth. When George W. Bush became President in 2001, he immediately passed the “Bush-Era Tax Cuts”. Post 9/11, President Bush was faced with Iraq’s impending petrodollar-busting deal with the European Union and certain economic collapse; thus providing the impetus to invade Iraq under the auspices of “weapons of mass destruction” and his “War on Terrorism”.

If the US dollar loses its position as the global reserve currency, the consequences for America cannot be over-stated. Most of the dollar’s valuation stems from its iron-clad grip on the oil market. Should the U.S. petrodollar monopoly fade, so too would the value of the dollar. Such a major upheaval in global fiat currency relationships would favor some currencies and destroy others. The only certain outcome is that gold would rise even more than it has to date. Again, good for some countries, but given the rise and fall of ALL commodities, huge risk for the U.S., particularly in the short-term. Even if the dollar was still backed by gold bullion(the gold standard), our debt could balloon exponentially out of control when gold eventually falls back to earth in the same way housing fell.

Trade between nations has become a cycle in which the U.S. produces dollars and the rest of the world produces things that dollars can buy; most notably oil. Nations no longer trade to capture comparative advantage but to capture needed dollar reserves in order to sustain the exchange value of their domestic currencies or to buy oil. In order to prevent speculative attacks on their currencies, those nations’ central banks must acquire and hold dollar reserves in amounts corresponding to their own currencies in circulation. This creates a built-in support for a strong dollar that in turn forces the world’s central banks to acquire and hold even more dollar reserves, making the dollar stronger still.

The availability of cheap imports, given the exploding strength of the USD,  hit the US manufacturing industry hard, and manufacturing jobs disappeared essentially overnight. The result is truly the proverbial house of cards for the U.S. All of which is predicated on maintaing the petrodollar.

Now It’s Iran and the Petrodollar

Despite growing U.S. and Western tensions, Iran and Venezuela are advancing huge joint projects. India has pledged to continue buying Iranian oil. Greece opposed the EU sanctions on Iran because Iran was one of very few suppliers that had been letting the nearly-bankrupt Greeks buy oil on credit and now they have been struck with increasingly severe austerity measures. Spains and Italy have double the U.S. unemployment percentage of their respective populations. South Korea and Japan rely heavily on Iranian oil, and economic ties between Russia and Iran continue. Iran also supplies at least 15% of China’s oil and natural gas, as their third largest supplier.

Despite protests from the U.S.,  India and Iran have begun trading oil for gold, supported by rupees. Iran has been dumping the dollar in its trade with Russia in favor of  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.

Iran and China trades will be settled in gold, yuan, and rial.

With the Europeans soon to be out of the mix, and in fairly short order none of Iran’s 2.4 million barrels of oil a day will be traded in petrodollars.

Conclusions/Ramifications?

It seems a reasonable assumption that the real reason tensions are mounting in the Persian Gulf is that the United States is desperate to torpedo this movement away from petrodollars. President Obama, being much more comprehensive in searching for alternative means of dealing with currency than all-out war, is surely hoping to wait until after he wins a second term as President  before deciding what to do to protect the U.S. dollar. The shift, which is being led by Iran and backed by India, China, and Russia, would clearly seem to be sufficient to make Washington anxious enough to seek out an excuse to topple the regime in Iran, but at what price? A nuclear threat would be the perfect cover for any direct military involvement, just as chemical WMDs, which were never found,  were in Iraq. But the clock is ticking and oil is changing hands without the use of the U.S. dollar.

The questions for now are:

  1. To what extent this assault on the petrodollar will be successful
  2. To what extent the Obama administration will go to stop it if investors begin to flee U.S. bonds and currency markets
  3. To what extent will Secretary of State Clinton will be able to convince Iran’s allies that this is a safety issue and not an economic issue
  4. Will America go to war once again under the same pretense as used in Iraq
  5. Are Americans really prepared to know the truth and make the necessary sacrifices to end this insanity with reasoned methodology in burrowing out of it’s self-imposed debt crisis in a bi-partisan way
  6. Is it, once again, too late for all of the above, necessitating a more immediate take-down of the Iranian economy

Harvey Gold

 


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