Iran --> Attack on the Dollar?

[RedWine]

Little attention has been given the proposed Iranian Oil Bourse in the media. Instead, the news has been as whispered rumor in fringe media.

The implications are that this oil exchange would trade in euros rather than dollars, impacting the U.S. economy. Some consider this as effective as a nuke while others believe that it will have little impact on the U.S. economy.



A nation-state taxes its own citizens, while an empire taxes other nation-states. The history of empires, from Greek and Roman, to Ottoman and British, teaches that the economic foundation of every single empire is the taxation of other nations. The imperial ability to tax has always rested on a better and stronger economy, and as a consequence, a better and stronger military. One part of the subject taxes went to improve the living standards of the empire; the other part went to strengthen the military dominance necessary to enforce the collection of those taxes.

Historically, taxing the subject state has been in various forms—usually gold and silver, where those were considered money, but also slaves, soldiers, crops, cattle, or other agricultural and natural resources, whatever economic goods the empire demanded and the subject-state could deliver. Historically, imperial taxation has always been direct: the subject state handed over the economic goods directly to the empire.

For the first time in history, in the twentieth century, America was able to tax the world indirectly, through inflation. It did not enforce the direct payment of taxes like all of its predecessor empires did, but distributed instead its own fiat currency, the U.S. Dollar, to other nations in exchange for goods with the intended consequence of inflating and devaluing those dollars and paying back later each dollar with less economic goods—the difference capturing the U.S. imperial tax. Here is how this happened.

Early in the 20th century, the U.S. economy began to dominate the world economy. The U.S. dollar was tied to gold, so that the value of the dollar neither increased, nor decreased, but remained the same amount of gold. The Great Depression, with its preceding inflation from 1921 to 1929 and its subsequent ballooning government deficits, had substantially increased the amount of currency in circulation, and thus rendered the backing of U.S. dollars by gold impossible. This led Roosevelt to decouple the dollar from gold in 1932. Up to this point, the U.S. may have well dominated the world economy, but from an economic point of view, it was not an empire. The fixed value of the dollar did not allow the Americans to extract economic benefits from other countries by supplying them with dollars convertible to gold.

Economically, the American Empire was born with Bretton Woods in 1945. The U.S. dollar was not fully convertible to gold, but was made convertible to gold only to foreign governments. This established the dollar as the reserve currency of the world. It was possible, because during WWII, the United States had supplied its allies with provisions, demanding gold as payment, thus accumulating significant portion of the world’s gold. An Empire would not have been possible if, following the Bretton Woods arrangement, the dollar supply was kept limited and within the availability of gold, so as to fully exchange back dollars for gold. However, the guns-and-butter policy of the 1960’s was an imperial one: the dollar supply was relentlessly increased to finance Vietnam and LBJ’s Great Society. Most of those dollars were handed over to foreigners in exchange for economic goods, without the prospect of buying them back at the same value. The increase in dollar holdings of foreigners via persistent U.S. trade deficits was tantamount to a tax—the classical inflation tax that a country imposes on its own citizens, this time around an inflation tax that U.S. imposed on rest of the world.

When in 1970-1971 foreigners demanded payment for their dollars in gold, The U.S. Government defaulted on its payment on August 15, 1971. While the popular spin told the story of “severing the link between the dollar and gold”, in reality the denial to pay back in gold was an act of bankruptcy by the U.S. Government. Essentially, the U.S. declared itself an Empire. It had extracted an enormous amount of economic goods from the rest of the world, with no intention or ability to return those goods, and the world was powerless to respond— the world was taxed and it could not do anything about it.

From that point on, to sustain the American Empire and to continue to tax the rest of the world, the United States had to force the world to continue to accept ever-depreciating dollars in exchange for economic goods and to have the world hold more and more of those depreciating dollars. It had to give the world an economic reason to hold them, and that reason was oil.

In 1971, as it became clearer and clearer that the U.S Government would not be able to buy back its dollars in gold, it made in 1972-73 an iron-clad arrangement with Saudi Arabia to support the power of the House of Saud in exchange for accepting only U.S. dollars for its oil. The rest of OPEC was to follow suit and also accept only dollars. Because the world had to buy oil from the Arab oil countries, it had the reason to hold dollars as payment for oil. Because the world needed ever increasing quantities of oil at ever increasing oil prices, the world’s demand for dollars could only increase. Even though dollars could no longer be exchanged for gold, they were now exchangeable for oil.

The economic essence of this arrangement was that the dollar was now backed by oil. As long as that was the case, the world had to accumulate increasing amounts of dollars, because they needed those dollars to buy oil. As long as the dollar was the only acceptable payment for oil, its dominance in the world was assured, and the American Empire could continue to tax the rest of the world. If, for any reason, the dollar lost its oil backing, the American Empire would cease to exist. Thus, Imperial survival dictated that oil be sold only for dollars. It also dictated that oil reserves were spread around various sovereign states that weren’t strong enough, politically or militarily, to demand payment for oil in something else. If someone demanded a different payment, he had to be convinced, either by political pressure or military means, to change his mind.

The man that actually did demand Euro for his oil was Saddam Hussein in 2000. At first, his demand was met with ridicule, later with neglect, but as it became clearer that he meant business, political pressure was exerted to change his mind. When other countries, like Iran, wanted payment in other currencies, most notably Euro and Yen, the danger to the dollar was clear and present, and a punitive action was in order. Bush’s Shock-and-Awe in Iraq was not about Saddam’s nuclear capabilities, about defending human rights, about spreading democracy, or even about seizing oil fields; it was about defending the dollar, ergo the American Empire. It was about setting an example that anyone who demanded payment in currencies other than U.S. Dollars would be likewise punished.

[RedWine]

Could the proposed Iranian oil bourse (IOB) become the catalyst for a significant blow to the influential position the US dollar enjoys? Manifold supply fears have driven the price of crude oil to its recent high of US$67.10 - only a notch below its highest price in inflation-adjusted dollar terms. With the world facing a daily bill of roughly $5.5 billion for crude oil at current price levels, it becomes apparent that sellers and purchasers of the black gold are looking into all ways that could lead to a financial improvement on their respective sides.

Non-US-dollar holders so far have been the victim of additional transaction costs in the oil trade. The necessary conversion of local currencies into oil-buying greenbacks can be considered a hidden tax, charged and enjoyed by the international banking sector. The IOB, by eliminating this transaction cost, will become



a factor that could unsettle the dollar's dominant position. While the worldwide bottleneck of inadequate refining facilities and partly dramatic declines in production - for example in the North Sea - are two factors that cannot be eliminated in the short term, there is one area left which could result in smiling faces of oil producers as well as most buyers.

Oil consumers are entangled in a web of supply fears that span the globe. In Venezuela, President Hugo Chavez threatens to divert oil supplies from the US to China, which faces severe gasoline and diesel shortages these days. Attacks on Iraqi oil installations have slowed exports there. Ecuador's oil industry is still recovering from a strike, while Nigerian oil companies are in the middle of efforts to avoid a strike there.

Until now, oil has been solely priced, traded and paid for in the greenback on markets in both London and New York. But monthly worldwide oil revenues of over $110 billion (on a 20-trading-day basis) - a third of which ends up with OPEC (Organization of the Petroleum Exporting Countries) members - raise the question of what happens to these cash mountains. According to the most recent data from the US Treasury Department, OPEC members have parked only a skimpy $120 billion in direct dollar holdings, which are almost equally split between equities and American debt paper. This is a clear indication that oil producers are investing their windfalls elsewhere. The yield spread between US and EU debt papers in favor of the EU is another hint where the petrodollars might be heading.

Especially in the case of Iran, it does not make sense to accept dollars only for its much-desired commodity. Given that Iran is seen as a hostile country by the current US administration for its intention to build its own nuclear reactors, one wonders whether the new IOB will not try to attract buyers other than Americans. Iran has recently announced that the new oil exchange will start up its computers in March 2006.

The proposal to set up a petroleum bourse was first voiced in Iran's development plan for 2000-2005. Last July, Heydar Mostakhdemin-Hosseini, who heads the board of directors of the Iranian Stock Exchange council, said authorities had agreed in principle to the establishment of the IOB, where petrochemicals, crude oil and oil and gas products will be traded. The oil exchange would strive to make Iran the main hub for oil deals in the region and most deals will be conducted via the Internet. Experts from London's International Petroleum Exchange (IPE) and the New York Mercantile Exchange (NYMEX) have reportedly confirmed the feasibility of the project.

The IOB can count on two sharp arrows in its holster. It can - and probably will - lure European buyers with oil prices quoted in euros, saving them dollar transaction costs. And it can strike barter deals with oil-hungry giants like China and India who have a lot of products and commodities to offer. One doubts whether American hamburgers and legal services will be considered adequate collateral for the world's most after-sought resource.

Worse than an Iranian nuclear attack?
Weaned off the almighty commodity, the US dollar can have a deeper impact on the US economy than a direct nuclear attack by Iran. The permanent demand for dollar-denominated paper stems substantially from the fact that until now almost all resources of the world are quoted in it. While this led to the eurodollar (US dollar-denominated deposits at foreign banks or foreign branches of American banks) market in the 1970s, the new terms of trade could ring in the demise of the dollar as the premier reserve currency.

With the world economy depending so much on oil, the black gold itself can be seen as a reserve currency that will be handed out against only the best collateral in the future. Last month, the Federal Reserve Bank of San Francisco published a paper about the progress of the diversification of central banks' reserves around the world. It concluded that the dollar's position is on the decline in many countries. China, the new industrial giant, has officially declared that it will diversify a part of its forex holdings into oil by building a strategic petroleum reserve. Construction of storage tanks has begun this year and will take several years until completion. China has not yet said how many barrels of oil it wants to store. The implications for the oil market can only be guessed as China wants to use its future reserves to smooth out spikes in oil price.

Iran holds a strong hand as the No 2 producer of crude behind Saudi Arabia, pumping 5% of the world's oil demand. Politicians there will also keep in mind that dollar deposits might become a burden in the future, if the US steps up its current war of words to the level of economic sanctions in the attempt to halt construction of Iran's nuclear power plants. Money in the bank does not help when you have no access to it. Substituting Iran's domestic oil demand partly with nuclear power will place the country in a win-win situation. Cheaper nuclear energy and increases in oil exports from the current level of roughly 2.5 million barrels a day will result in a profitable equation for Iran.

[RedWine]

Speculations have begun regarding whether the proposed March 2006 launch of the Iranian oil bourse (IOB), will become the catalyst for a significant blow to the position of the U.S. dollar?

Iran is about to begin pricing its oil in euros. Unfortunately, just about everyone would benefit--except the United States- Without some form of U.S. intervention, the euro is going to establish a firm foothold in the international oil trade.

The U.S. dollar has been the strongest currency of the world for more than half a century, with about 70% of percent of all currency reserves in American dollars.

This could be a logical explanation for why the Islamic republic would be the U.S.’s next target.

This is closely related to the fact that oil, the most important commodity traded in the world, is mostly priced in U.S. dollars. The majority of countries that are oil importers have to buy their oil in U.S. dollars, which forces them to keep most of their foreign currency in dollars.

The crippling U.S. debt crisis makes its fragile economy mostly dependent on the high demand for its currency in order to remain afloat.

There is a move underway by Iran, the world’s second-largest producer of crude oil—and labeled a member of President Bush’s so-called “axis of evil”, that threatens the current dominant position of the American dollar.

Tehran has lately confirmed its plan to create a euro-based exchange in oil—to compete with the London and New York dollar-denominated oil exchanges, both American-owned.

If proved successful, the Iranian oil bourse (IOB) is expected to give the euro a foothold in the international oil trade, solidifying its status as an alternative oil transaction currency. This would eventually lead to a major currency flight from the dollar to the euro—and a disaster for America.

The IOB will see crude oil, petrochemicals and other commodities of the same kind traded in euros.

But the question here is what are Iran’s motives behind such a move?

According to economists, Iran’s move does make sense, especially since the European Union is Iran’s biggest trading partner. Also it will deal a major blow to Iran’s archfoe America, and, by hoping to make Iran the main hub for oil deals in the region; it will drive the Islamic Republic forward in its quest for regional supremacy.

George Perkovich, an Iran expert at the Carnegie Endowment for International Peace in Washington, has made it clear that the move is: “part of a very intelligent, creative Iranian strategy—to go on the offense in every way possible and mobilize other actors against the U.S.” (Christian Science Monitor, August 30).

This economic move could be the best and most effective strike against a mighty military foe, the United States.

According to a report published recently by Asia Times, “Oil in euros would benefit millions … in the EU and its trading partners …. And it would loosen the grip the U.S. has on OPEC members”

“One of the Federal Reserve’s nightmares may begin to unfold in the spring of 2006,” one expert on the subject stated, “when it appears that international buyers will have a choice of buying a barrel of oil for $60 on the NYMEX [New York Mercantile Exchange] and IPE [London’s International Petroleum Exchange] or purchase a barrel of oil for €45 to €50 via the Iranian bourse” (Global Politician, September 2).

The IOB will accelerate the already-existent global trend of shifting foreign currency reserves from dollars to euros would. Thus, “countries switching to euro reserves from dollar reserves would bring down the value of the U.S. currency. Imports would start to cost Americans a lot more …. As countries and businesses converted their dollar assets into euro assets, the U.S. property and stock market bubbles would, without doubt, burst” (The Foundation for the Economics of Sustainability, Nov. 15, 2004).

The impact of a reserve currency switch would be catastrophic for the U.S., according to the Global Politician. The U.S. “would simply have to stop importing” (op. cit.).

If Iran launched its IOB, the U.S. dollar will weaken and the euro strengthen—helping speed up the economic decline of the U.S.

Numerous economists have expressed optimism about Iran’s ambitions, saying that the impact of the Iran oil bourse on the American dollar—and U.S. economy could be worse than Iran launching a “direct nuclear attack.”

[RedWine]

On the 5th of May Iran registered its Oil Exchange, which will become the fifth Stock Exchange of its kind in the world. Other exchanges operate in New York, London, Singapore and Tokyo. Which exact companies will be allowed to trade at this Exchange is, like the official opening, still unknown. Yet the Iranian Exchange will be unique, as all trading will be conducted in Euros. On the already functioning Stock Exchanges business is conducted in dollars and, because of this, the specific term ‘petrodollars’ came into use. If the Iranian Petroleum Exchange allows the major oil companies to trade on its floor then the dollar seriously risks losing its position in the world market. This is a possibility that many experts already consider very plausible.

Will the situation change on the World Oil Market? How will the opening of the Oil Exchange affect the rate of the dollar?

The present happenings in the Oil Market are already well known – the price of oil will continue to grow. But what changes will occur with the creation of the new Exchange? From now on will all the oil have to be purchased from the Iranian Exchange? With the opening of the new exchange neither the price of milk will rise nor will it decrease in quantity. This is a fully political gesture on the part of Iran.

As concerns the introduction of trading with the euro, this corresponds perfectly with the present direction of the world economy: the dollar falls and the euro gets stronger.

If we compare the presumed turnover of the Iranian Exchange and the full turnover of the economy of the USA we will see that the same mistakes are still being made. The dollar will continue to fall while the price continues to grow on oil. The growth will continue as long as American pursues its present political agenda. The USA of course has its dividends - to raise the competitiveness of its own goods.

Iran declares that with the opening of the Exchange it hopes to reduce the influence of America on its own economy and the economy of the region. But can it achieve this?

At present the USA has practically no influence on Iran and its economy. In turn Iran does not have the potential to influence USA politics. Therefore, from the Iranian perspective, they are prepared to make their different political declarations and gestures. The end, however, is easy to miscalculate. It could lead to the liquidation of Iran’s atomic aspirations.

So the creation of this new Exchange, the games of Iran, in which they continue to play, will carry on until Uncle Sam decides to put his foot down, for when he does, the games will soon come to an end.

[RedWine]

If, as is widely believed, the original tales of the 1001 Arabian Nights came out of Persia, then Iran, Persia's modern successor, has just given the world yet another great fantasy: the Iranian oil bourse.
Surely Tehran lost touch with reality when it developed its plan to use a new, euro-based oil exchange, on Kish Island in the Persian Gulf, to dethrone the greenback from its position as the world's reigning reserve currency. Such a project is neither likely to attract much business nor to have Tehran's desired effect on the dollar or the United States.

Tehran's plan of attack has the virtue of economic logic at least. Iran's planners recognize that the heavy use of the dollar in international trade sustains its foreign exchange value by forcing people to hold greater dollar balances than they otherwise would. The dollar's consequent strength encourages its use in other transactions, which requires still greater dollar holdings in a dollar-boosting cycle. Iran's planners hope that their euro-based exchange will disrupt this pattern. By forcing oil traders to hold euro balances instead of dollar balances, Tehran expects the oil bourse to induce dollar selling and consequently force a drop in value. Those foreign exchange losses will draw still more trading away from the dollar, further weakening it, until, ultimately, it loses its world-leading position. Iran's planners expect to do the US great harm in this way.

This economic logic, though reasonable from a theoretical standpoint, misses some very practical hurdles to success. Tehran's exchange simply is not attractive compared with the exchanges in London and New York, where dealers and traders are prospering amid their well-developed networks. On distant Kish Island, they would: (1) lack trained locals to work in their operations, (2) have to deal with a notoriously corrupt bureaucracy, (3) lose contact with a transparent financial, regulatory, or banking system, (4) lack the necessary technological infrastructure, and (5) sever most links to the globe's electronic commercial structures on which trading relies.

Because Iran is not even a member of the World Trade Organization, dealers who move to Kish Island would also miss the kind of legal structures on which they rely to facilitate trading and secure the contracts that support it. Furthermore, a firm's move to Kish would subject any staff assigned there to Islamic sharia law. Western oil company employees tolerate that burden because they must go where the oil is. The same is not true of futures traders.

Against this list of drawbacks, it is difficult to see how such an exchange could even get started. Tehran is unconvincing with its argument that proximity to the Middle East oil fields can overcome other reservations, especially in today's electronic, information-laden world. Neither can Tehran use its oil production, as it has hinted, to force traders and dealers to its exchange. As long as Iran sells its oil onto world markets, it has no control over where it gets traded. And Iran, whatever its political agenda, simply does not have the economic and financial wherewithal to hold back its oil altogether. Petroleum amounts to 80 percent of all Iranian exports, 45 percent of the country's GDP, and 60 percent of the government's revenues. With the economy there already rickety, any shortfall in oil sales would tempt financial, economic, and consequently political suicide for Iran's current regime.

Iran's proposed bourse would also face serious diplomatic and religious problems. To work, the exchange would require a free flow of funds and oil, but Iran's membership in OPEC subjects it to strict production and sales quotas. It is not at all clear how Tehran plans to reconcile one requirement with the other. Most fundamental of all, at least for many Iranians, is the likely violation of Islamic law. The Koran forbids either paying or receiving interest; futures contracts always carry an implicit interest for the time value of money. On this basis, the bourse could pose more of a problem for relations between Iran's government and its people than for the dollar.

Even if by some miracle of legal maneuvering and commercial seduction, Tehran established its euro-based oil bourse, trading there would likely fail to move the dollar from its dominant position. Even a wildly successful Iranian exchange would have only a short-lived currency effect. Once traders and dealers had adjusted their transactions balances to accommodate the euro-based trading, they would have no reason for further dollar sales or euro purchases. Currency values would then stabilize at a new level.

Clearly, Tehran has failed to think through its bourse project thoroughly. For the time being then, such talk of dollar destruction from Tehran resembles hopes and dreams more than practice and probability. To steal a phrase from that inspired Middle Eastern thinker, Fouad Ajami, the Iranian oil bourse would seem then to fit best with the many other Middle Eastern "dream palaces."