Wednesday, May 10, 2006
THE OIL STORY - REVISITED
CAN OIL BECOME THE NEW RESERVE "CURRENCY" & DESTROY THE U.S. DOLLAR? Will Iran accelerate the process? The simple questions require complex thought with a variety of factors all pulling at the world's tapestry - along myriad threads of the weave and waft. The follow-up question becomes "will it really matter?" The question arises from Iran's announcement a year ago that an Iran Oil Bourse – IOB (Exchange) would be operational by March 2006 and trade in crude oil, refined petroleum products and petrochemicals, making Iran the hub of oil deals for the region. Experts from the International Petroleum Exchange (IPE) and New York Mercantile Exchange (NYMEX) have apparently confirmed the feasibility of the project. Since Dubai, a member of the United Arab Emirates structure in the Persian Gulf has tried and so far failed to create a similar Exchange, does this project really matter? Did hurricane Katrina matter? As one erudite thinker stated "a boom and modern renewal disaster inevitably follows for the distressed region. There has always been a silver lining". But what if several Katrinas with wider paths, hit at around the same time, reaching much, much farther inland, all the way up America? Could she handle it? Hurricane Katrina's current visuals and reporting on TV provide an easy mental backdrop for what could happen in a more extensive natural or man-made disaster – including a financial disaster similar to the Great American Depression of the 1920s and 1930s. Memories of the recent Asian Tsunami devastation notch the picture closer to what might happen. With any major change or upheaval, created by Nature or by man, the environmental and political circumstances and the people involved create the results passed on to their citizens or globally. Hopeless and destitute people, faced with no financial future they could handle, jumped off buildings in the Great Depression. In New Orleans, some police officers committed suicide or handed in their badges when faced with a choice of first looking after their own families or helping others. The human factor plays a key role in how events transpire. As with Katrina, where pundits had warned for decades of the consequences of the breaching of the levies and flooding of New Orleans, on the highest economic levels, top of the field experts like Warren Buffet, George Soros and a variety of topnotch think tanks all currently warn of an impending crash of the U.S. Dollar. Even former U.S. Reserve Chairman Paul Volcker has stated that he estimated a dollar crash in the next five years to have a 75% likelihood. Buffet and Soros have put billions of dollars at risk toward being right about their prediction, not just words. In addition, in his bet against the dollar, Soros recently took a beating when the dollar suddenly shot up over the Euro in what most market experts describe as a short-lived blip and not a trend. Yet he still bets "against" the dollar. Something about currencies must matter relative to the Iranian Oil Exchange coming into existence when Heydar Mostakhdemin-Hosseini of Iran's Stock Exchange Council moved on September 7th, 2005, to calm global fears about this Exchange dealing in Euros rather than Dollars. He tried to smooth out the new President Mahmoud Ahmadi-Nejad's bombshell statement of his intent to deal oil in Euros as well as creating huge oil and natural gas barter deals with China, India and other growing users of petroleum products. And diverting Iranian oil sold to Japan and sending it to China instead. Because no immediate alternative exists to the dollar as the worldwide reserve currency, common wisdom of economists, relative to currency market values, has been to let matters alone as they "always self-correct" and absorb fluctuations. While Soros can be accused of manipulating the currency market for his own profit, he takes strong issue with the above laissez-faire approach, though it might serve him well. Commonsensical self-interest by the world economies to maintain a stable dollar and protect global trade and commodity markets – and until recently a relatively low price of oil – has combined to keep the dollar in its position of primary reserve currency. The August 2005 takeover of the Islamic government in Iran by fundamentalist military people, which some call the "third" revolution, meaning not by students or Reformists but by the Revolutionary Guard, skews potential Iranian activity and methods away from anything resembling common sense. A glut of dollar holdings by Central Banks and among Asian lenders plus the current low interest rate offered to investor/lenders by the USA has put the dollar in jeopardy for some time. Including, potentially, by some inexperienced Third World central bank employee, who seeing an over stock of dollars in the bank's currency portfolio, decides to diversify his holdings. That imaginary person then puts several billion dollars on the market and triggers a panic sell-off by everyone else – similar to a run on a bank - because the first seller will receive full current value, the later ones will be lucky not to lose bankrupting fortunes. Unless, like Soros, you bet against the dollar. A twitching finger on currency's hair-trigger can shoot down the dollar without any purposeful ill intent. Most estimates place the likely drop at a rapid 50% loss in value for a presently 40% overvalued Dollar. Not too long ago, a mid-level official of the Korean Central bank casually mentioned currency "diversification" at an obscure lunch. The US Stock Market fell by 100 points in 15 minutes, because of an implied desire for Korea to decrease its dollar holdings. What would the drop have been had he actually sold dollars? When Long Term Capital Management, a hedge fund of derivatives – something fully understood by probably less than half a dozen people in the world – failed, US Federal Reserve Chairman, Alan Greenspan had to help bail it out to save the dollar and the US economy. This fund had Nobel Prize winning economists writing their trading algorithms and top-drawer traders involved and still went down in flames. What about the expertise level of other hedge funds trading daily in the USA - approaching some 8,000 in number? About $6,000 Billion worth of derivatives (easier to conceptualize as "huge" instead of a mere "six trillion"), trade on the international market – daily - so the already built-in prospect of disaster surpasses all possible safety factors. Compare this daily amount to the annual USA national Budget of approximately $2,350 Billion (2.35 trillion) in expenditures and $1,900 Billion (less than two trillion) of revenues. The deficit between revenue and expenditure amounts automatically endangers the value of the dollar as we borrow the difference by selling Treasury Bonds and contract other loan instruments. Moreover, we pay interest on the loans. Most pundits encourage people not to worry, despite the teeter-tottering position of the dollar, since compensating factors tend to mitigate or diminish the dangers, even in an artificially stable profile. Into this at best "delicately balanced" economical environment, introduce an ever more openly hostile Iran with a new President, Ahmadi-Nejad at the helm, whose view of the world and Islam and the West differs from what we have preciously faced, uncomfortable as it was with the Ayatollahs, except during the time of direct rule by Khomeini himself. Among the forces in play in a potential change of the global dollar status are the psychologies or personalities of key players. Their perception of the best interests of their countries – as felt by them - not as we hope and wish them to perceive matters. An outline encapsulation of Ahmadi-Nejad's almost certain inner character and psychology would offer the following important input into analysis: 1. Coming from the humblest of beginnings and extreme poverty in Iran, presently an income of less than a dollar a day for much of the country, he would barely have accumulated, even today, an objective economical overview of national Iranian matters let alone international ones – including the connectivity and interaction of the global societies and economy. 2. He was born into poor circumstances at a time when prosperity and freedom to thrive were rampant under the late Shah Mohammad Reza Pahlavi. Growing up in his personally deprived environment, the general cultural and fervent religious mindsets and traditions of the poorer classes in Iran would definitely influence his formative childhood years and youth. Including the anti-Shah sentiments of the clergy and bazaar merchants, during his mid-teens, bringing Ayatollah Rouhallah (Spirit of Allah) Khomeini to power. 3. His lifestyle in his early years would be minimalist. His humble abode may not have had piped water nor an indoor toilet. Most likely, the family, neighbors and equals, would temporarily spread a tablecloth on the floor for meals, drink out of a communal bowl, eat with their hands, using unleavened bread to scoop up food instead of utensils and sleep on the floor, rolling up the bedding against the walls in the morning to make room for family activity. They would bathe and change their underwear once a week, usually on Thursdays, when men were encouraged to perform their sexual duties to their wives. Vast majorities of the poorer and provincial families in Iran still live like this and the life style descriptions illustrate the quantum leap needed for the new President – or the Iranian population - to relate to Western ways and thoughts. The world still pictures Iranians based on whom they meet in their countries, usually refugees from the Islamic takeover or from the prior, more modernized representatives or citizens of Iran at the time of the late Shah. The Mullahs themselves come from the same lower class social and lifestyle origins and their psychology has emanated from there, too. Until stolen riches during the past quarter of a century of corruption turned them into an "uneducated, uncultured upper class" living in mansions and palaces, instead of the hovels from which, for the most part, they originated. 4. When Khomeini took over in Iran, he ordered desks and chairs to be removed form government offices – since if he had sat all his life on the floor on a cushion so could his government; obviously finding an ardent follower in teen-age Ahmadi-Nejad, who still holds Khomeini up as his hero and philosophical guide. 5. Khomeini's worldview of Islam governing and dominating the world autocratically and dictatorially clearly appeals to the new President as evidenced by a recent comment that "Ayatollah Khomeini did not create a revolution to bring Democracy". He appears to have been comfortable with Khomeini's statement in early days that there was no need for a Ministry of Justice. "Anyone who opposes me (Khomeini) opposes Allah and must be killed on the spot. So why complicate everything with any other system of law or justice except what I find and personally interpret in the Koran?" 6. Ahmadi-Nejad's choice of a Spartan, not highly paid, military career filled with Islamic prayer and rhetoric would point to an autocratic "give and take orders" mindset without too much collateral reasoning and his studies at the Institute of Science would also tend toward a rigid thought process of science. 7. His resentment of wealth would make him a true populist, angered by the rich, prosperous at the time of the Shah, leaving him loyal to his religious mentor, Khomeini's "sit on the floor" ideals. Resentment increased after the revolution at seeing the ongoing corruption of the Ayatollahs in power and their claws digging into all revenue channels. 8. To give him his due, the new President proved himself a reasonably good manager as Mayor of Tehran, the highest position of responsibility he held in government other than whatever he did within his military environment. The new mayor, however, describes residents of Tehran, the capital city, as "not living here, just enduring it". Nevertheless, coupled to a Napoleonic complex likely to flourish in this man of short stature, the prospect of his having a good grasp of or even a desire to understand the rest of the world is slim. After all, foreigners are infidels and other than enemies to destroy have nothing worthwhile for him to emulate. Persians explain the complex of short men by warning that they are the same height as all of us but the rest is hidden underground and a hidden danger. Personal characteristics become an imperative consideration when evaluating Iran's forthcoming role in oil and the global economy through implementation of the new oil exchange. We tend to think of others as generally similar to ourselves and wrongly start our analytical minds from there, failing to see underlying reasons for otherwise unbelievable or inexplicable actions and thought processes. Iran's ability – beyond intense philosophical hostility - to influence or trigger a sharp decline or total depression of the world's economy and crashing it around everyone's ears, has more of a catalytic nature than a powerful proactive one, taking advantage of pre-existing physical and psychological factors, such as: 1. The ongoing vulnerability of the dollar as the world's prime reserve currency, noting how easily a sudden swing or change could devalue it. 2. The exponential increase of petroleum and natural gas consumption by high population, rapidly industrializing, countries like India and China. 3. The willingness of the mostly Islamic oil producing countries to adopt an anti-USA profile – covertly or overtly – to survive themselves or avoid fundamental Islamic terrorist attacks on their own autocratic governments. In addition, a desire to increase the windfall profits of higher oil revenues either achieved by price hikes or perhaps by a link to the Euro compared to a weakening US Dollar. 4. The fear and apprehension of non-Islamic countries, some of them like Britain or Norway, also oil producers, over the rising discontent or civil disobedience within their Moslem populations. This results in reluctance to confront or annoy them politically or socially. Meanwhile, strident Wahabbi or Salafist preachers abuse the freedoms in their host countries to encourage death and destruction onto Westerners and their property. Without thought to the wounds they would inflict on themselves in the process. Ahmadi-Nejad's thought process would echo this. In the USA, constitutional rights, increasingly politically liberal judges, activist social power centers like the ACLU (American Civil Liberties Union), political correctness to an extreme, supported by a left leaning Main Stream Media, all exacerbate the situation. Energy, required for defending America or opposing countries like Iran, ends up squandered on internal political challenges and sniping than on direct security and war on terrorism. In the end, often preventing and sabotaging active and effective counter-measures against either terrorist or economical disaster. In Europe, the recent London bombings, murder of a Dutch descendant of painter Van Gogh and the ever-rising threat from Islamic leaders of former Yugoslavian territories, acting on behalf of Al Qaeda, have begun to reverse liberal attitudes and laws. Britain, with a previously "cradle to grave" socially structured approach to government has now put in place comparatively draconian measures and statutes out of self-protection. 5. "Old Europe" governments, with France predominantly at the helm or pulling strings, resent loss of old glory and superpower status to, in their eyes, an uncouth nation like America and hold little love for the country which took away the corrupt billions of oil for food revenues from their banks and national budgets. In addition, the USA refused to accommodate their wishes by unilaterally, so to speak, taking down Saddam Hussein. Having lost Iraqi revenues, France and Germany still insist on accommodating the Islamic regime in Iran for purely financial reasons, such as multi-billion dollar rail projects and petroleum related contracts. Even Britain, a staunch ally, has tried to negotiate the impossible with Iran to receive a more than welcome income. All three overlook reality. Moreover, tacitly support anti-USA trends under the guise of diplomacy, which they knew in advance, could not work, but prevent an easy confrontation of the issues. 6. President Vladimir Putin of Russia emits similar regrets, of a former superpower leader, as he was in the Soviet Union and the loss of revenues from Iraq. His recent government restructuring toward the good old days has finally forced him to deny he wants to create a Soviet style autocracy. Unlike Europe, that has no worry about losing the USA market for his exports if the value of the dollar drops and the Euro rises. Russia selling very little to America will benefit from a change from the dollar as the primary oil currency. Thus selling vast Russian crude oil capacity and reserves at a higher income rate than the dollar provides. Moreover, giving a satisfying poke in the eye of a former enemy without receiving blame; a lingering pleasure dating to the days when he headed the Soviet KGB. 7. Intentional harm to the USA by leaders like Chavez of Venezuela, who threatens to divert the two daily oil tankers Venezuela sends to US shores to China instead, or Iran's announced redirection of oil previously sent to Japan also to China, provide examples of economically painful punishment or retaliation that can be meted out directly and indirectly. Iran's ploy kills two birds with one stone: hurt a strong, totally oil-import reliant Western ally like Japan and encourage China's veto power at the UN to take Iran's side in future non-proliferation discussions at the Security Council. 8. Increasingly thirsty for oil and natural gas for its industries, China has moments of multiple personality disorder despite natural Chinese multi-tasking abilities. It has to balance out its own currency status, presently directly linked to the dollar, a desire to clinch deals, barter or otherwise, with Iran for oil and natural gas and a concern about the effects of unlinking of the dollar as the primary oil currency on the USA market, to which so much of their exports find their way. At the same time, with probably dubious results from floating the Chinese Yuan conflicting with negative production costs if their currency stays fixed to the dollar, the Chinese have major unemployment dilemmas to resolve. Among these comes the prominent need to find work for vast rural populations and occupy the minds and energies of out of work homeland migrants to the cities. Negative production comes about if the Chinese insist on of linking the Yuan the Dollar – after the Dollar falls. The cost of raw materials they need to manufacture goods they sell to the USA could eventually be higher than the value of the dollars they receive. To create jobs and deal with currency factors, the Chinese have started building huge oil reserve tank farms with a primary aim of controlling or leveling peaks in oil prices. Although it could take as long as a decade to complete this project, it becomes another factor in turning oil rather than dollars or even the Euro into the "prime reserve currency". As a proponent, supporter and financier of anti-Western religious Islamic fervor, Iran receives support even from the Sunnis, who normally consider the Shia Moslem Iranians as infidels and non-believers. The newly "elected" or more accurately "selected" Iranian President and his cabinet, secular though they may outwardly be, have tightened the imposition of strict Islamic code and mores on their population and garnered additional support for their actions from international Islamic groups or adherents such as the Afghan Taliban. This new government of mostly former or active Revolutionary Guard members and the Bassij (an organization created to act as enforcers by Khomeini, which, in the last few weeks, has received vastly expanded powers to attack and suppress) holds little or no regard for the welfare of the world and the family of nations. Ahmadi-Nejad would prefer to be famous for crashing the world economy and destituting all civilized countries than for praise for a measured global commonsense approach to politics and economics. Imposing Islam on a socially and financially staggered or crushed global community would be easier to accomplish and make him a hero in the history of Islam. Specially, when the crash would bring Iran, with a wealth of oil and natural gas reserves with which to barter to the fore, in a future scenario where money or currency might have no value, probably as a new superpower. A superpower additionally backed by nuclear weapons that the West would not be able to prevent Iran from making and deploying. Poorer Islamic and Third World nations, used to living off their land and internal production, will suddenly find themselves better off than the Western nations who offer services and technology instead of tangible assets for trade. They will eagerly support Iran for their potential rise in a suddenly reversed, upside-down world. As a whole, Iran can be counted on to behave in a totally selfish, irrational to Western logic, manner without consideration of the well being of other nations or the misery that might be caused by the crash of the dollar. Ahmadi-Nejad will feel he has vindicated the ideals of his mentor Khomeini and justified the support of the person behind his rise to power – Ayatollah Mesbah Yazdi – himself a full-fledged follower of Khomeini's philosophy of exporting Islam to rule the world. Ayatollah Yazdi considers the current Supreme Ruler, Ali Khamenei, an upstart and devoid of any clerical or religious qualifications, changing Khamenei's alliance to the hard core military government, with which he allied himself out of necessity more than desire, into only a temporary delay in being removed from power. While many would agree with the criticism, it does appear to be a pot calling the kettle black. Khamenei's response to this danger has been to appoint a military man from the Shah's era to head the Armed Forces and obstruct the Revolutionary Guard clique, which Ahmadi-Nejad has brought to power. Naysayers offer several reasons to dispute the likelihood of Iran succeeding, willingly or unintentionally from crashing the dollar and the consequent 1920s and 1930s style depression of the USA sweeping the whole world. Primarily, logical minds cannot envisage nor conceive of a nation, even Iran, cutting off its nose to spite its face as crashing the dollar would generally do to most of the world. Forgetting, however, Iran would emerge smelling of roses and financially stronger than the rest of the world. Iran's determined ability to ignore any internal demands and suppress their population also removes one tool the West could use to weaken or hamper Iran. Economists equally scoff at the currency market being unable to right itself in the face of fluctuations if left to its own devices. Equally overlooking the fragility of the dollar and the lack of any desire or motivation by the new Iranian government to assist in an adjustment and help prevent global economic mayhem. The lack of success of the UAE through Dubai to form a successful Oil Exchange fails to address the same criteria of Iran's readiness to sacrifice anyone and anything to succeed and additionally having far greater reserves with which to accomplish their ends without hurting their own revenues now that oil prices have risen so high. A more realistic argument posits that the Iranian oil fields are old and require huge investments to continue production or to keep them at anywhere near current levels. New oil fields will take time to bring online and curtail the speed of Iran's actions. In addition, Iran's natural gas fields, the second largest reserve in the world after Russia, have yet to be developed fully and cannot provide a big enough supply to make a significant difference in the markets. Left out of the thought equation of actual production targets here is that oil is not the principle factor but oil-currency will be. Even with the infighting already underway in Iran among the Mullahs jockeying for position or survival, the new hardnosed military regime and various other parties at the table, like the Ministry of Oil, practical ways of preventing Iran from accomplishing global currency upheaval has been beyond the ability of any scenarios offered up. Other than a Nagasaki/Hiroshima destruction of the Islamic regime in the form of either the clerical or semi-secular guise it now has. Unfortunately, Americans as a nation, tend to refuse to take firm action until disaster strikes making preventive measures difficult to put into place. Assuming that any measures would suffice, which many have begun to doubt they would. Declines in the value of the dollar would make US Treasury Bonds harder to sell, to finance deficit spending, requiring raising interest rates to attract investors, - immediately raising US national debt payments and depleting the Federal Budget even more. Higher interest rates would slow economic growth with declines in the Stock Market and Real Estate – potentially creating Stagflation (inflation during a stagnant growth). One disbeliever in the potential dire straits of a dollar crash and loss of value stated that there would be no negative effect since the national debt would also be paid in devalued dollars. Perhaps he never encountered or heard of banks suddenly raising the interest rate on a credit card's outstanding balance from below ten percent to 30% overnight, if they could show a couple of late payments or decided the credit rating of the card holder was below what they desired. Similarly, investors in the US economy through Treasury Bonds or other financial instruments, including the Stock Exchange would not tolerate a reduction of profit or equity from a suddenly greatly lower valued dollar. The mildest example of what to expect with mildness perhaps possible only if the transitional devaluation of the dollar takes a slow downward spiral instead of a sudden fall, would be a repeat – with more severity - of the Jimmy Carter administration era: 1. Interest rates were so high nobody could afford to finance a house, so this market sector, like many other big-ticket items such as automobiles, slowed to almost a halt in some instances. 2. Grocery items had multiple superimposed price stickers as the cost of goods rose faster than they were bought. Imported retail merchandise normally sells or gets distributed through national chains like Walmart or food chains, so a drop in the dollar makes these more expensive for the buyer and leads to layoffs as the retail chains find their sales volumes and profit margins eroded. 3. The price of energy shot up so much people resorted to wood burning stoves to stay warm at a price they could afford. The quality of life went down. 4. People on fixed incomes could no longer afford to live and the more solvent could not keep abreast of rising prices and interest rates. A drop in the dollar immediately cuts into the value of saved money. 5. Running a business became almost impossible as the price of goods and materials skyrocketed. Sales to a greatly less solvent market plummeted and marketing assumptions needed for advertising, budgeting and planning became wild guesses at best. What might happen if the dollar devalued rapidly? Any potential benefits of a fast drop in the dollar, American goods being less expensive to manufacture, leading to increased exports, or tourism income rising from cheaper vacations inside the USA would be short lived as the infrastructure collapses into bankruptcy, disrepair or become too expensive for anyone, including the government, to operate. There would be no public transportation, no hotels and no restaurants. If the actions of some of our citizens in reaction to Katrina are anything to go by, the USA will become less safe than Iraq. Neighborhoods would become armed camps protecting whatever food and material reserves they had against visitors of any kind – domestic or from overseas. The potential return of outsourced jobs to the USA when domestic manufacturing becomes less expensive, as a benefit of a lower dollar, becomes spurious hopefulness when we ask, "return to what?" To a bankrupt economy unable to bear their weight or to operate within non-functioning infrastructure and unemployment not seen even in the Great Depression of the 1920s and 1930s? Third World countries would be financial paradise compared to the American domestic situation. Iran would most likely intentionally sabotage any chance of stability and adjustment with an unstoppable vehicle with which to achieve this end. Their newfound nuclear deterrent would discourage use of force against them. Unless someone will act before they have operational weapons of mass destruction. Otherwise, Iran can throw the USA and the world into the tribulations of the Weimar Republic of Germany after World War I. High inflation and interest rates drove the value of the Mark into the ground and allowed Hitler to present himself as a possible savior. In the present scenario, unlinking of the Dollar as the primary currency for oil purchases creates the same outcome. Or worse. To provide an adequate cash flow to the working class, Hitler promised to pay them once a week, then twice a week, then once a day. When this failed, he allowed workers two hours off work every day to trundle wheelbarrows full of German currency, which barely sufficed to buy a loaf of bread. To deny history repeating itself ever more forcefully with Ahmadi-Nejat filling in for Hitler, suggests an ostrich head forced into the sand and a refusal to have to counteract an indescribable menace beyond Western logic but totally in alignment with Islamic fervor and more often than not totally destructively constructed plans and emotions.