Will Iran Kill the Petrodollar?
By Marin Katusa, Casey Research
The prevailing stance of the United States and the European Union asserts that Iran must face repercussions for its nuclear ambitions, which are primarily expressed through sanctions on its oil exports. These sanctions aim to isolate Iran and weaken its economy. However, this narrative is flawed, as Iran has maintained robust relationships and support from allies like India, raising fundamental questions about the dominance of the American dollar as the global reserve currency.
To condense the story: a pivotal agreement in the 1970s established the US dollar as the exclusive currency for oil transactions, creating a monopoly that propelled the dollar to the forefront as the global reserve currency. This demand for US dollars led to a strengthened currency, while also allowing other countries to invest their dollar reserves in US Treasuries, providing the US government with ample credit.
However, this situation has resulted in a national debt crisis, stubbornly high unemployment, a volatile real estate market, record personal debt, and an unstable economy. The image of a powerful superpower associated with the dollar’s global status is no longer valid. Many countries are gradually shifting away from using the US dollar, particularly in oil transactions.
If the US dollar relinquishes its role as the global reserve currency, the repercussions for America could be severe. A significant portion of the dollar’s value is tied to its monopoly over the oil industry; should this dominance decline, so too may the dollar’s worth. This transition introduces uncertainty within global currency relations, benefitting some currencies while posing challenges for others. One certainty, however, is that gold will likely see an upsurge in value during such uncertain times.
The Petrodollar System
To understand the current scenario, we need to trace back to 1973. President Nixon approached King Faisal of Saudi Arabia, persuading him to accept only US dollars for oil payments and to reinvest excess profits in US Treasury bonds. In exchange, Nixon assured protection of Saudi oil fields from potential threats, including the Soviet Union, Iran, and Iraq. This partnership laid the groundwork for the US dollar’s unconventional rise.
By 1975, every OPEC member had agreed to transact exclusively in US dollars, prompting oil-importing nations worldwide to hoard dollar reserves. This led to a heightened demand for dollars, further strengthening the currency. Simultaneously, many oil-exporting nations funneled their dollar surpluses into Treasury securities, creating a vast pool of credit that bolstered government spending.
The petrodollar system was an ingenious political and economic maneuver. It ensured global oil revenue flowed through the US Federal Reserve, cementing demand for both US currency and debt. Subsequently, this allowed the US essentially to exploit oil wealth risk-free, as oil’s value was denominated in a currency that the US controls and prints. The repercussions of this system extend beyond oil; the majority of international trade utilizes the US dollar.
While the growing demand for the dollar buoyed the US economy in the 1980s, it also created an imbalance. The influx of cheap imports from strong dollar valuations undermined American manufacturing, contributing to the significant loss of manufacturing jobs—a lingering challenge for the US economy.
Another significant danger lurks just beneath the surface. The current value of the US dollar is inherently tied to oil transactions occurring in that currency. Should these transactions transition to other currencies, a massive sell-off of US dollars could lead to a sharp depreciation of the currency.
This leads to an intriguing line of thought: while many assert that the US engages in military actions to secure its oil supplies, could it be that the primary motive is to uphold the petrodollar system?
The Iraq War serves as a pertinent case study. Until November 2000, no OPEC member dared to challenge the US dollar pricing rule. However, following pressure from France and other EU nations, Saddam Hussein began selling Iraq’s oil in euros instead of dollars. In the lead-up to the US invasion in March 2003, other countries also expressed intentions to engage in oil trading beyond the dollar. The US intervention, thus, may have been aimed at preserving the petrodollar system.
There are numerous historical instances of the US acting covertly to thwart movements threatening the petrodollar structure. For example, in February 2011, the managing director of the International Monetary Fund (IMF) called for a novel world currency as an alternative to the US dollar. Just three months later, he faced severe allegations and was ousted from his post, raising eyebrows regarding the timing of this downfall.
The cost of maintaining the petrodollar system can be substantial, yet the implications of neglecting it could prove catastrophic. Accepting currencies like the euro, yen, or even gold for oil transactions would render the US dollar comparatively irrelevant, drastically diminishing its value.
The Iranian Dilemma
While Iran may be politically marginalized by the US and the EU, it continues to garner significant support from allies. Partnerships, such as a joint initiative with Venezuela worth $4 billion, are just one example. Moreover, India remains committed to purchasing Iranian oil, reinforcing a mutually beneficial partnership. Greece has also resisted EU sanctions, relying on Iranian oil supplied with flexible payment options. Meanwhile, countries like South Korea and Japan are seeking exemptions from impending embargoes due to their dependency on Iranian oil.
Furthermore, China’s strategic interests make Iranian energy resources crucial as Iran supplies approximately 15% of its oil and natural gas. This relationship positions Iran as a more significant partner for China than Saudi Arabia is for the US. Consequently, China is unlikely to abide by US sanctions and will likely navigate around them to protect its growing trade with Iran, which stands at $30 billion and aims for $50 billion by 2015. These sanctions may even enable China to procure Iranian oil at lower prices.
The partnerships Iran has formed will enable it to continue selling oil, albeit not in US dollars. Reports suggest that India and Iran are exploring the possibility of barter deals, trading oil for gold, and using currencies like rupees and yen. Similarly, Iran has moved away from dollar transactions with Russia, opting instead for their local currencies. Additionally, countries like China and Japan are considering converting their engagements into yuan or yen.
As energy trade dialogues between Iran and China progress, transactions may increasingly be denominated in gold, yuan, and rial. With Europe out of the equation, the notion of Iran’s 2.4 million barrels of daily oil supply being traded in petrodollars appears increasingly untenable.
This brings us back to the notion that the United States may feel compelled to act against this shift away from the petrodollar. With backing from India, China, and Russia, Iran’s movement poses a challenge to the US’s economic policies and interests.
Interestingly, recent inspections by the International Atomic Energy Agency (IAEA) revealed no evidence of Iran pursuing nuclear weapons, challenging the narrative that has driven international condemnation. If securing the world from rogue states were the only concern, why do North Korea and Pakistan escape scrutiny?
It’s noteworthy that Russia, India, and China, each major gold producers and members of the BRICs economic alliance, have formed strong ties with Iran. If the move away from the petrodollar accelerates, they can leverage their gold reserves to facilitate oil trade, a fallback strategy that has proven reliable throughout history.
2012 could very well be marked as a turning point where nations began defecting from the US dollar as their primary currency for transactions. Slowly, countries may pivot towards utilizing their local currencies and invest less in US Treasury securities, gradually undermining the dollar.
This shift may not necessarily be detrimental to the US; its overwhelming debts may be untenable as long as the dollar holds its value. Should the dollar decline alongside its status as the global reserve currency, a path to debt repayment could open up, albeit with the loss of the benefits that come from currency hegemony. The sustainability of the petrodollar system has become increasingly questionable, making the breakdown of its dominance inevitable.
In conclusion, how can one capitalize on these developments? Currency trading is often perilous, particularly with the impending changes on a global scale. A stronger strategy is to invest in gold, which remains a tangible asset and a safe haven during times of currency volatility. The gradual decline of the petrodollar system signals bullish prospects for gold while posing a bearish outlook for the US dollar.
Sincerely,
Marin Katusa
for Economic Prism
[Editor’s Note: Marin Katusa, a seasoned investment analyst, serves as the senior editor of Casey Energy Opportunities, Casey Energy Confidential, and Casey Energy Report.]
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