The Last Gasp of the Dollar?

Iran bourse opens next week

By Mike Whitney

05/07/06 "ICH" -- -- If one day the world's largest oil producers demanded euros for their barrels, "it would be the financial equivalent of a nuclear strike.” Bill O'Grady, A.G. Edwards commodities analyst

“Everybody knows the real reason for American belligerence is not the Iranian nuclear program, but the decision to launch an oil bourse where oil will be traded in euros instead of US dollars….The oil market will break the dominance of the dollar and lead to a decline of global American hegemony.” Igor Panarin, Russian political scientist

Overnight the story of Iran’s proposed oil bourse has slipped into the mainstream press exposing the real reasons behind Washington’s ongoing hostility towards Tehran. Up to this point, analysts have brushed aside the importance of the upcoming oil-exchange as a Leftist-Internet conspiracy theory unworthy of further consideration. Now, the Associated Press has clarified the issue showing that an Iran oil bourse “could lead central bankers around the world to convert some of their dollar reserves into euros, possibly causing a decline in the dollar’s value”.

Currently, the world is drowning in dollars, even a small movement could trigger a massive recession in the United States. There’s nothing remotely “conspiratorial” about this. It is simply a matter of supply and demand. If the oil bourse creates less demand for the dollar, the value of the dollar will sink accordingly; pushing energy, housing, food and other prices higher.

Oil has been linked to the dollar since the 1970s when OPEC agreed to denominate it exclusively in dollars. This provided the US a virtual monopoly which has allowed it to run huge account deficits without fear of crippling interest rate hikes. As Bill O’ Grady of A.G.Edwards said, “If OPEC decided they didn’t want dollars anymore, it would be the end of American hegemony by signaling the end to the dollar as the sole reserve currency.”

“If the dollar lost its status as the world’s reserve currency, that would force the United States to fund it massive account deficit by running a trade surplus, which would increase inflationary pressures.” (Associated Press)

There’s no prospect of the US running a trade surplus anytime soon. Bush has savaged the manufacturing sector outsourcing over 3 million jobs and shutting down plants across the country. His short-sighted “free trade” policies and enormous tax cuts for the rich ensure that Americans will be left to face skyrocketing energy costs and a hyper-inflationary greenback. There’s no way we can retool fast enough to “manufacture our way” out of the quagmire of red ink.

Currently, the national debt is a whopping $8.4 trillion with an equally harrowing $800 billion trade deficit. (7% of GDP) The ever-increasing demand for the greenback in the oil trade is the only thing that has kept the dollar from freefalling to earth. Even a small conversion to euros will erode the dollar’s value and could precipitate a sell-off.

Presently, oil is sold exclusively on the London Petroleum Exchange and the New York Mercantile Exchange both owned by American investors. If the bourse opens, central banks around the world will reduce their stockpiles of dollars to maintain a portion of their currency in euros. This is the logical step for Europe which buys 70% of Iran’s oil. It is also the reasonable choice for Russia which sells two-thirds of its oil to Europe but (amazingly) continues to denominate those transactions in dollars.

Washington has succeeded in maintaining its monopoly by propping up the many corrupt and repressive regimes in the Gulf States. The prudent choice for Saudi Arabia would be to move away from the debt-ridden dollar and enhance its earnings with the stronger euro. Regrettably, Uncle Sam has a gun to their head. They understand that such a transition would invite the same response that Saddam got 6 months after he converted to euros and was removed through “shock and awe”.

Regardless, of the outcome, the profligate spending, budget-busting tax cuts, and the shocking increase in the money supply (the Fed has doubled the money supply in one decade) has the greenback headed for the dumpster. Already, China and Japan (who hold an accumulated $1.7 trillion in US securities and currency) are gradually moving away from the dollar towards the euro (although the Fed has blocked the public from knowing the extent of the damage by abandoning the M-3 publication of inflows) The European Central Bank (ECB) and Japan’s central bank are frantically trying to conceal the probability of a dollar collapse by issuing carefully worded statements to allay public fears while they to prepare for an “orderly” retreat.

But, it won’t be “orderly”. The dollar has lost 5% against the euro since April and is quickly headed south. The Iran bourse could be the final jolt that pushes the greenback over the edge. This is the bitter lesson for those who choose to ignore economic fundamentals and build their house on sand. Paul Volcker anticipated this scenario in a speech last year when he said that account imbalances were as great as he had ever seen and predicted “a 75% chance of a dollar crash in the next 5 years”.

Volcker was right, but economic advisor, Peter Grandich summarized it even better when he opined, “The only one who doesn’t know the US dollar is dead is the US dollar.”

Prepare for the requiem.