So Long, US Dollar
There's
a major shift under way, one the US mainstream media has left largely
untouched even though it will send the United States into an economic
maelstrom and dramatically reduce the country's importance in the world:
the demise of the US dollar as the world's reserve currency.
For
decades the US dollar has been absolutely dominant in international
trade, especially in the oil markets. This role has created immense
demand for US dollars, and that international demand constitutes a huge
part of the dollar's valuation. Not only did the global-currency role
add massive value to the dollar, it also created an almost endless pool
of demand for US Treasuries as countries around the world sought to
maintain stores of petrodollars. The availability of all this credit,
denominated in a dollar supported by nothing less than the entirety of
global trade, enabled the American federal government to borrow without
limit and spend with abandon.
The dominance of the dollar gave the
United States incredible power and influence around the world… but the
times they are a-changing. As the world's emerging economies gain ever
more prominence, the US is losing hold of its position as the world's
superpower. Many on the long list of nations that dislike America are
pondering ways to reduce American influence in their affairs. Ditching
the dollar is a very good start.
In fact, they are doing more than
pondering. Over the past few years China and other emerging powers such
as Russia have been quietly making agreements to move away from the US
dollar in international trade. Several major oil-producing nations have
begun selling oil in currencies other than the dollar, and both the
United Nations and the International Monetary Fund (IMF) have issued
reports arguing for the need to create a new global reserve currency
independent of the dollar.
The supremacy of the dollar is not
nearly as solid as most Americans believe it to be. More generally, the
United States is not the global superpower it once was. These trends are
very much connected, as demonstrated by the world's response to US
sanctions against Iran.
US allies, including much of Europe and
parts of Asia, fell into line quickly, reducing imports of Iranian oil.
But a good number of Iran's clients do not feel the need to toe
America's party line, and Iran certainly doesn't feel any need to take
orders from the US. Some countries have objected to America's sanctions
on Iran vocally, adamantly refusing to be ordered around. Others are
being more discreet, choosing instead to simply trade with Iran through
avenues that get around the sanctions.
It's ironic. The United
States fashioned its Iranian sanctions assuming that oil trades occur in
US dollars. That assumption – an echo of the more general assumption
that the US dollar will continue to dominate international trade – has
given countries unfriendly to the US a great reason to continue their
moves away from the dollar: if they don't trade in dollars, America's
dollar-centric policies carry no weight! It's a classic backfire:
sanctions intended in part to illustrate the US's continued world
supremacy are in fact encouraging countries disillusioned with that very
notion to continue their moves away from the US currency, a slow but
steady trend that will eat away at its economic power until there is
little left.
Let's delve into both situations – the demise of the dollar's dominance and the Iranian sanction shortcuts – in more detail.
Signs the Dollar Is Going the Way of the Dodo
The
biggest oil-trading partners in the world, China and Saudi Arabia, are
still using the petrodollar in their transactions. How long this will
persist is a very important question. China imported 1.4 million barrels
of oil a day from Saudi Arabia in February, a 39% increase from a year
earlier, and the two countries have teamed up to build a massive oil
refinery in Saudi Arabia. As the nations continue to pursue increased
bilateral trade, at some point they will decide that involving US
dollars in every transaction is unnecessary and expensive, and they will
ditch the dollar.
When that happens, the tide will have truly
turned against the dollar, as it was an agreement between President
Nixon and King Faisal of Saudi Arabia in 1973 that originally created
the petrodollar system. Nixon asked Faisal 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 oilfields
from the Soviet Union and other potential aggressors, such as Iran and
Iraq.
That agreement created the foundation for an incredibly
strong US dollar. All of the world's oil money started to flow through
the US Federal Reserve, creating ever-growing demand for both US dollars
and US debt. Every oil-importing nation in the world started converting
its surplus funds into US dollars to be able to buy oil. Oil-exporting
countries started spending their cash on Treasury securities. And slowly
but surely the petrodollar system spread beyond oil to encompass almost
every facet of global trade.
The value of the US dollar is based
on this role as the conduit for global trade. If that role vanishes,
much of the value in the dollar will evaporate. Massive inflation, high
interest rates, and substantial increases in the cost of food, clothing,
and gasoline will make the 2008 recession look like nothing more than a
bump in the road. This will be a crater. The government will be unable
to finance its debts. The house of cards, built on the assumption that
the world would rely on US dollars forever, will come tumbling down.
It
is a scary proposition, but don't bury your head in the sand because
countries around the world are already starting to ditch the dollar.
Russia
and China are leading the charge. More than a year ago, the two nations
made good on talks to move away from the dollar and have been using
rubles and renminbi to trade with each other since. A few months ago the
second-largest economy on earth – China – and the third-largest economy
on the planet – Japan – followed suit, striking a deal to promote the
use of their own currencies when trading with each other. The deal will
allow firms to convert Chinese and Japanese currencies into each other
directly, instead of using US dollars as the intermediary as has been
the requirement for years. China is now discussing a similar plan with
South Korea.
Similarly, a new agreement among the BRICS nations
(Brazil, Russia, India, China, and South Africa) promotes the use of
their national currencies when trading, instead of using the US dollar.
China is also pursuing bilateral trades with Malaysia using the renminbi
and ringgit. And Russia and Iran have agreed to use rubles as a means
of currency in their trades.
Then there's the entire continent of
Africa. In 2009 China became Africa's largest trading partner, eclipsing
the United States, and now China is working to expand the use of
Chinese currency in Africa instead of US dollars. Standard Bank,
Africa's largest financial institution, predicts that $100 billion worth
of trade between China and Africa will be settled in renminbi by 2015.
That's more than the total bilateral trade between China and Africa in
2010.
The idea of moving away from the dollar is also finding
support from major international agencies. The United Nations Conference
on Trade and Development has stated that "the current system of
currencies and capital rules that binds the world economy is not working
properly and was largely responsible for the financial and economic
crises." The statement continued, saying "the dollar should be replaced
with a global currency." The International Monetary Fund agrees,
recently arguing that the dollar should cede its role as global reserve
currency to an international currency, which is in effect a basket of
national currencies.
There is also a host of countries that have
started using their own currencies to complete oil trades, a move that
strikes right at the heart of US-dollar dominance. China and the United
Arab Emirates have agreed to ditch the dollar and use their own
currencies in oil transactions. The Chinese National Bank says this
agreement is worth roughly $5.5 billion annually. India is buying oil
from Iran with gold and rupees. China and Iran are working on a barter
system to exchange Iranian oil for Chinese imported products.
Speaking of Bartering for Oil… How about Those Iranian Sanctions?
The
United States and the European Union based their Iran sanctions on the
financial system behind Iran's oil trade. The country uses its central
bank to run its oil business – the bank settles trades through the
Belgium company Swift (Society for Worldwide Interbank Financial
Telecommunication) and the trades are always in US dollars. Once they
take full effect in July, US and EU sanctions against Iran will make
transactions with the Iranian central bank illegal. When that occurs,
this official avenue of trade will shut down. In fact, Iran was shut out
of Swift a few weeks ago, so that road is already blockaded.
But
the arrogance in the sanctions is the assumption that Iran can only use
this one, dollar-based avenue. In reality, the Islamic Republic is
considerably more agile than that; removing its ability to trade in the
official manner is only encouraging the country to find imaginative new
methods to sell its oil.
Since the sanctions were announced,
Tehran's official oil sales have certainly declined. Iran actually
preemptively halted oil shipments to Germany, Spain, Greece, Britain,
and France, which together had bought some 18% of Iran's oil. But covert
sales have curbed or perhaps even reversed the reduction in shipments.
It is impossible to know the details, as buyers and sellers involved in
skirting the sanctions are being very discreet, but the transactions are
undoubtedly happening.
As mentioned above, Iran is selling oil to
India for gold and rupees. China and Iran are working on a barter
system to exchange Iranian oil for Chinese imported products. China and
South Korea are also quietly buying Iranian oil with their own
currencies.
The evidence? Millions of barrels of Iranian oil that
were in storage in Iranian tankers a few weeks ago now seem to have
disappeared. Officially, no one knows where the oil went. Was it
rerouted? Has production been shut in? Is the oil being stored
elsewhere?
Oil is fungible, which means one barrel of crude is
interchangeable with another. Once it leaves its home country, it can be
nearly impossible to know where a barrel of oil originated, if its
handlers so desire. And it's not just barrels that are hard to track –
even though oil is carried on ships so large they are dubbed
"supertankers" it is surprisingly difficult to keep tabs on every tanker
full of Iranian oil.
And the Iranians are using every trick in
the book to move their oil undetected. In the last week it became
apparent that Tehran has ordered the captains of its oil tankers to
switch off the black-box transponders used in the shipping industry to
monitor vessel movements and oil transactions. As such, most of Iran's
39-strong fleet of tankers is "off radar." According to Reuters, only
seven of Iran's Very Large Crude Carriers (VLCCs) are still operating
their onboard transponders, while only two of the country's nine smaller
Suezmax tankers are trackable.
Under international law ships are
required to have a satellite tracking device on board when travelling at
sea, but a ship's master has the discretion to turn the device off on
safety grounds, if he has permission from the ship's home state. Some
tankers turned off their trackers to avoid detection last year during
the Libyan civil war in order to trade with the Gaddafi government.
And
Iran is about to gain even greater flexibility in disguising the
locations of oil sales, as the National Iranian Tanker Company (NITC) is
about to take delivery of the first of 12 new supertankers on order
from China. The new tankers will add much-needed capacity to NITC's
fleet at a time when the number of maritime firms willing to transport
Iranian crude has dwindled significantly, forcing Iran's remaining
buyers to rely on NITC tankers. Thankfully for NITC, the 12 new VLCCs –
each capable of transporting two million barrels of crude – will
significantly expand the company's current fleet of 39 ships.
Sanctions
or no sanctions, Iran is moving its oil. But even having your own,
off-radar ships to transport oil bought in renminbi or rupees or won
doesn't mean all these tricks and maneuvers don't have a cost.
Freight
costs for each voyage add up to nearly $5 million, a sizeable hit for
Tehran. Iran is often also shelling out millions of dollars in insurance
for each oil shipment, because the majority of international shipments
are insured through a European insurance consortium that is backing away
from Iranian vessels because the EU sanctions will make such
transactions illegal.
And since business is business, buyers are
also demanding much better credit terms from the National Iranian Oil
Company (NIOC) than normal. Traders are reporting agreements giving the
buyer as much as six months to pay for each two-million-barrel cargo, a
grace period that would cost Tehran as much as $10 million per shipment.
For
Tehran to cover freight costs, insurance, and the cost of generous
credit terms wipes out as much as 10 percent of the value of each
supertanker load. Beyond that, customers are also negotiating better
prices. For example, the flow of Iranian oil to China did slow in the
first quarter of the year, but not because China endorsed the sanctions.
Rather, Chinese refiner Sinopec reduced purchases to negotiate better
prices with the National Iranian Oil Company. The country's imports from
Iran are expected to climb back to the 560,000 barrel-per-day level in
April.
That trade, along with non-dollar-denominated deals with
India, Turkey, Syria, and a long list of other friendly nations, will
keep Iran's finances afloat for a long time. The sanctions may be
preventing Tehran from banking full value for each tanker of oil, but
there is still a lot of Iranian oil money flowing.
The mainstream
media is avoiding all discussion of the demise of the US dollar as the
world's reserve currency. Even fewer people are talking about how
sanctions based on Iran's supposed need to use the US dollar to sell its
oil leave loopholes wide enough for VLCCs to sail right through.
Without
acknowledging the elephant in the room, articles about Iranian tankers
turning off their transponders or India using gold to buy Iranian oil
invariably sound like plot developments in a spy thriller. Much more
useful would be to convey the real message: The world doesn't need to
revolve around US dollars anymore and the longer the US tries to pretend
that the dollar is still and will remain dominant, the more often its
international actions will backfire.
