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, has now stopped 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. India, on the other hand, has been buying oil from Iran on it’s own terms and with its own currency. That has a LOT of U.S. economists worried.
The goal of sanctions against Iran, 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.
But isn’t there a different and very real threat to the U.S. from Iran?
The Evolution of the Petro-dollar
So many American Presidents have been tested by Iran.
- Nixon and the Shah of Iran
- Carter and the Iran Hostages
- Reagan and the Iran-Contra Affair
- Bush, Sr. and Iran-Contra Affair.
- Clinton’s secret dealings with Iran
- George W. Bush and Pro-Shiite Support
- Obama and Iran’s Nuclear capability
All dealings since the 1970s have been nefarious in one way or another.
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 legitimately 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, 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.
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. This would make sense in the context of the U.S. getting in bed with so many dictators and very bad people in the middle east.
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 enormous international demand for US dollars. It also 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.
Compared to all other countries, because of the petrodollar, Americans have enjoyed much cheaper gasoline than even Saudi Arabia. In Germany and most Eurozone countries, the price of gasoline is at least double what Americans pay. Some countries it’s triple what the average price in the U.S. is at any given time.
Therefore, since only the U.S. may print the petro-dollars, they also control the flow of oil. And as long as 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, America will retain its distinct advantage over the rest of the world.
Though Mortal Enemies, Iraq and Iran Similarly Threatened the U.S. Petrodollar
In late 2000, around the time same time of the passage of the Commodities Futures Modernization Act of 2000 snuck through Congress virtually in the dead of night, and was signed by President Clinton on his last day in office. Subsequently, France and a few other EU members convinced Saddam Hussein to reject the petrodollar process and barter with Iraq’s oil in the oil-for-food trades in euros, not dollars. In a short period of 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 in euros or any other denomination, it would have been disastrous for the U.S. economy.
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 could collapse, and massive inflation would ensue. Foreign funds would likely 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 trade 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 its debts.
In March 2003, the US invaded Iraq, abruptly ending the oil-for-food program and between France and Iraq, under vehement protest from France who was the leading European nation voicing objection to the U.S. invasion and giving birth to “Freedom Fries” and a propaganda campaign against anything related to France. 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 destruction I Iraq. Additionally, Al Qaeda was non-existent in Iraq, despite the Bush Administration’s repeated attempt to claim that Iraq was a hotbed of terrorist activity against the U.S.
So why the urgency to invade Iraq, especially in that valuable resources and focus were withdrawn from the real terrorist threat-Osama Bin Laden-who was ostensibly hiding in Afghanistan? Was it that an ego-maniacal dictator in Iraq was threatening to use chemical weapons or some other as-yet-to-be-proven existence of WMDs? There were plenty others around that we did not attack. And Iran and other trouble-making nations in the middle-east were terrified of Hussein which tended to actually keep the otherwise unruly region relatively calm. Or was the real 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 for the last few years is regarding Iran and that they are close to achieving the capability to assemble a nuclear threat to Israel.
Other U.S. Domestic Consequences of the Petro-dollar
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 maintaining the petrodollar for the world’s reserve currency..
Now It’s Iran Threat to the Petrodollar
Despite growing U.S. and Western tensions, Iran and Venezuela are advancing huge joint projects. India has begun 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. Spain and Italy have double and triple the U.S. unemployment. 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, and is their third largest supplier.
With the Europeans out of the mix, in fairly short order none of Iran’s 2.4 million barrels of oil a day will be traded in petrodollars.
It seems a reasonable assumption that the real cause of tensions mounting in the Persian Gulf is that the United States is desperate to torpedo this slow and steady movement away from petrodollars as the reserve currency. President Obama, being much more comprehensive in searching for alternative means of dealing with currency than all-out war, is surely hoping to wait 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, in the same manner that chemical WMDs, which were in Iraq.
Had Mitt Romney been elected with much of Bush’s neo-con advisors intact and present in Romney’s inner circle, I’m sure that we would already be making preparations to bomb/invade Iran. But the clock is ticking and oil is changing hands without the use of the U.S. dollar.
A continued erosion of the petrodollar is a clear and present danger to :
- Cheaper gasoline prices in the U.S. than almost anywhere else in the world
- Continued very fragile economic recovery in the U.S., especially given the dire straits of southern Europe suffering from 15%-26% unemployment and the effect it’s haveing on the Eurozone
- Lack of global demand for goods and services due to severe deficit-obsession and GOP obstructionism in the U.S., prolonged, severe recessions in the UK and Eurozone
- China’s rapidly increasing inventories in steel, suddenly disappearing from warehouses causing concern of renewed number-rigging currency and in the world’s largest steel-producing country
- The biggest drop in defense spending in 40 years due to the GOPs stubborn obstructionism that is likely to force sequestration and drastic spending cuts in government spending across the board at precisely the wrong time.
The precipitous drop in December’s GDP is a direct result of defense contractors laying off workers…lots of them. They are preparing for the GOP obstructionists forcing the sequestor budget cuts. Demand drives employment, not cheap taxes for the wealthy. People with jobs spur demand. Employers are stretching the middle-class as thinly as possible until they see an increase in demand that will require more hiring to keep up.
Laying off workers-any workers-whether in the government, defense, or making Twinkies, is a downward spiral and attempting severe governmental spending cuts at this time would be a mirror image of what took place leading up to the Great Depression. The only missing element would be the UK forcing us back to the Gold Standard that Rand and daddy Ron Paul so often espouse. It would be undoubtedly the worst possible strategy at this time.
Macoreconomics (governmental) is as much about timing as flexibility. The combination of the absense of runaway inlation, low mortgage interest rates and pent-up demand only needs one piece of the puzzle to be inserted to bring about real economic growth. Jobs. The confidence that comes with being employed. Without some sort of push from the government, we are as naked to the end of the petrodollar and many other possible economic disasters, as a deer is to a hunter with an assault weapon.
Gasoline is making it’s spring-time rise in prices early this year which will have a dampening effect on discretionary spending-where it still exists- which could cause further slowing of the recovery. Deficit-obsession is choking the life out of the UK and the Eurozone. Between lack of global demand for goods, and the possible loss of the petrodollar, pressure will increase for America to invade Iran.
But whatever the stated purpose might be blaring over the evening news or FOX Noise, I would bet my mint-condition Beatles Butcher Cover that the real reason–if we do invade Iran–has more to do with reserve currency than the false spectre of possible nuclear weaponry.
Harvey A. Gold