From time to time over the last half-century, we’ve heard that the U.S. dollar’s perch on the pedestal of the world’s reserve currency was threatened. Every time, it turned out to be premature, and the greenback sneered at would-be contenders as its fingers jealously caressed the championship belt around its waist. Being as finance holds about the same excitement level for most people as tofu recipes – most of our interest in money being in spending it rather than understanding its complex structure – most people probably do not grasp just how important it is to the USA that the American dollar remain the world’s reserve currency and that any challenges to it be met and crushed. Those people probably do not realize that the dollar is entering a desperate battle in which its allies may no longer be able to come to its aid.
Let’s start off with a little history, for all those whose interest in money begins and ends with exchanging it for goods and services at something close to the rate at which we acquire it. As Forex Traders helpfully points out here, the United States was the only nation involved in the Second World War to come out of it without smashed cities and broad swathes of chaotic destruction. All other nations had serious rebuilding to their infrastructure and economies in the forefront of their plans, many urgently. The conquerors got together at Bretton Woods, New Hampshire just before the war ended, and hammered out an agreement that put the world’s most powerful nation in the driver’s seat for as far as the eye could see. The U.S. dollar became the world’s reserve currency, freely convertible – if you can stand a rush of nostalgia – for gold at $35.00 per ounce. This was known, for obvious reasons, as the “gold standard”, and it remained in force until the early 1970’s. All other major world currencies were pegged to the dollar. This remained until the USA dropped the gold standard, whereupon all currencies were permitted to float against each other.
Why does having the world’s reserve currency matter? Most of the world’s key exchanges of commodities such as gold and oil are purchased in U.S. dollars. The country that buys them must borrow in or convert to U.S. dollars, and if borrowed the country must pay back in U.S. dollars. This allows the Federal Reserve to print and circulate huge amounts of dollars, which helps to keep the currency stable and dominant, and countries often reinvest their dollar holdings in U.S. Treasury bonds. The country with the world’s reserve currency can borrow at preferential interest rates, and can run up significant debt without the alarm that other borrowers might inspire. Both the International Monetary Fund (IMF) and the World Bank also evolved out of the Bretton Woods agreement, and – thanks to the dollar being the world’s reserve currency – have largely become instruments of American foreign policy, as we will discuss.
First, though, hold on to your seat as we warp back for a minute, to 2006. Chris Cook, former Director of the International Petroleum Exchange, and his group – the Wimpole Consortium – are two years down the road from hatching the idea for a Middle Eastern oil bourse. “Bourse” is a French word meaning “stock exchange” or “stock market”, but what Cook envisioned is both more and less than that – nothing short of a bold plan to take volatility out of the energy market by removing intermediaries and putting the buyer and seller in direct contact. This marketplace would be based on ownership of the assets rather than futures-based contracts – heresy in the oil business, where middlemen amass fortunes hedging and manipulating the volatile futures market.
And it would be denominated in the Euro, not the dollar.
Although Cook did not think that likely or necessarily desirable, that was the direction things moved in. When Chris Cook was interviewed in the reference above, he had explored the initial idea with Iran’s Khatami. The incoming President was Ahmadinejad, and at the time he was struggling to get an oil minister confirmed by his fractious government. Some analysts speculated that Iraq’s Saddam Hussein had sealed his fate in September of 2000, when he announced that Iraq would no longer accept dollars for oil sales under the UN oil-for-food program, and that all further sales would be in Euros. A quick invasion later, and the exchange returned to the greenback – the world was made safe for democracy. The lesson was not lost on Ahmadinejad, but it did not teach him the expected caution; instead, he perceived that this was the United States’ soft underbelly – its reliance on the strategic strength implicit in the dollar as the world’s reserve currency. Accordingly, it was soon announced that the new bourse – to be underwritten and controlled by Iran – would be denominated in the Euro. According to The Prudent Investor, Iran’s initiative was “worse than a nuclear attack”, and had the potential to start an irreversible slide that would see a blurringly rapid erosion of American power.
Iran planned to start up the computers of the new exchange in 2008. Let’s jump to there, and see what happened. Hmmmm…a couple of days before the bourse was due to open, undersea internet cabling serving most of the Middle East was mysteriously severed, crashing service to most of the region, and the opening was delayed. The explanation was that the cables had probably been damaged by ships anchors. What ships were doing trying to anchor in water that deep was never explained, and any seaman knows that anyplace where fouling a seabed cable is actually a risk, signs are prominently displayed in multiple languages that read “Cable – Do Not Anchor”. Coincidence? Maybe.
The Iranian oil bourse opened in Kish, in 2011. And the Iran-is-pursuing-nuclear-weapons rhetoric in the western press, simmering for years, went into overdrive.
We’re not going to get too deeply into the nuclear issue here; suffice it to say that uranium weaponized for use in a nuclear bomb is enriched to better than 85%. Uranium destined for fuel in a nuclear reactor is enriched to a much lesser degree, usually less than 25%. Experts can easily measure the difference. No weaponized uranium has been discovered in Iran, although western sources try to introduce confusion by gabbling about centrifuges, which are simply used in the enrichment process. Iran voluntarily signed an additional protocol (something no other country did) which permitted even more frequent and stringent inspections by the IAEA, and abandoned enrichment altogether although it resumed this when it realized it cut no ice with the west. But the situation may be best summed up this way – as a signatory to the Nuclear Non-Proliferation Treaty (NPT), Iran is absolutely permitted the right to enrich uranium for peaceful development of power generation. There is, to date, no evidence at all that they are enriching uranium to weapons grade or for purposes other than those to which they are legally entitled. It is incumbent upon all nations who are signatories to the NPT to resist demonization of Iran on the nuclear weapons issue without evidence, as the same tactic might be used against them at any time. Just to be clear; Iran absolutely could be building a nuclear weapon – American demonstrations have shown it is far from difficult compared with, say, development of the MOSFET transistor or multilayering of silicon chips, both of which are long taken for granted, and Iran’s government has stated that it has everything it needs to build one although that is not the Islamic Republic’s policy. But why would Iran do that? Both the USA and Israel are going through its garbage like a pack of hounds – as Crosby, Stills, Nash and Young sang in, ironically enough, “American Dream” – every day looking for the slightest, slightest pretext that would justify an attack, and before Iran could get beyond building the fin stabilizers of an actual missile the whole country would be in ruins. The suggestion that Iran wants a nuclear deterrent to discourage attack might make sense if it already had a nuclear arsenal, but it has not and now there is no time to build one; the west is already like a mean dog on a weak leash in its eagerness to smash and rend and destroy.
Fast-forward one more time, to the present. After fits and starts, the Iranian bourse is due to open to full capability, next week. Since the 2008 opening it has traded mostly in products other than crude for energy consumption and kept its operations modest. What was the response? The west cut Iran out of SWIFT, the Society for Worldwide Interbank Telecommunications; an unprecedented step. Clearly, the west is not only desperate to prevent any competition with the dollar, it is prepared to stop at nothing to see it eliminated.
I imagine you were wondering where the Russian connection would come in. At the end of last month, soon-to-be-ex-president of the World Bank Robert Zoellick announced his endorsement of a new World Bank…a BRICS bank, to be created and supported by the top 5 emerging economies: Brazil, Russia, India, China and South Africa. This bank will differ sharply from the present world model in that it will not be tied to the dollar, but will promote trade in local currencies of the sponsor countries and avoid the world reserve currency. Central banks have been quietly buying up gold as a hedge, China possibly acquiring as much as 500 tons last year, while Russia added around 95 tons in a scramble that saw purchases of gold leap from 77 tons worldwide in 2010 to 440 tons in 2011 – the world’s biggest surge in gold acquisitions since 1964.
Monday-morning-quarterbacking is easy; that’s why so many indulge in it. But it seems to me the west – principally the USA – could have avoided things getting to this point – is it even desirable for the dollar to lose its status as the world’s reserve currency? It certainly would spell trouble for countries like the one in which I live, which sends about 80% of its exports to the USA. But once upon a time, the USA remained mostly unchallenged for world leadership. Why? Because it concentrated on being a partner rather than an overlord. Sometime toward the mid-to-late seventies, emphasis shifted to full-spectrum dominance right across the board as American policymakers came to believe they need not entertain a rival in anything. Walking softly was largely abandoned in favour of the big stick. Partnership was for sissies who did not have the world’s most powerful military and the will to use it. Gulf states such as Saudi Arabia, the UAE and Qatar grew fabulously wealthy by going with the trend rather than bucking it.
Which brings us to this moment. The dollar as reserve currency is challenged as never before, by a group that is increasingly dominant in the global economy; a group some say will lead the world by 2050, and which increased its GDP from $3 Trillion to $13.5 Trillion over the last 10 years.
Hillary Clinton warns that “time for diplomacy is running out“. If this was a street fight, those would be the last words out of her mouth before she swung for the chin. The USA doubled its Carrier presence in the region in January. Multinational partners arrived in Bahrain today for 10 days of war games, many of the countries involved enemies of Iran. Conditions are ripe for a “misunderstanding” that could flash into a larger conflict. All of these multi-axis pressures seem concentrated on making Iran back down. Is it too late? Have things gone too far?
High noon, folks; time to pull iron. The challenge has never been stronger, and the dollar has never been weaker. And it looks as if there are more targets than the greenback has bullets.