Marin Katusa: So Long, US Dollar
Saturday, April 28, 2012 at 5:29PM Contributed by Marin Katusa, Casey Research
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.
[The end of dollar dominance is a very ominous sign for the US economy… especially since the federal government seems to be ignoring this enormous elephant. Ignore it at your peril – or get advice from over 30 financial experts that will help you thrive during the tumultuous times ahead.]
Reader Comments (12)
The U.S. Federal Reserve in coordination with the European Central Bank, Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Swiss National Bank and China’s Monetary Authority agreed to temporarily “dollarize” the euro. Facing a vicious bank liquidity crisis and a political nightmare; the German dominated European Central Bank (ECB) agreed to the virtual outsourcing of Europe’s monetary policy to the U.S. Federal Reserve. Although described as a precautionary arrangement for political cover; the “dollarization” of Europe has re-established the U.S. dollar as the world’s only reserve currency.
Twenty years ago, European nations sought to form their own reserve currency to limit the power of the United States in controlling their economic destiny. Following World War II, the U.S. took control of European monetary policy by pouring over $50 billion of cash into the war shattered economies. Over time, sovereign currencies were re-introduced; but the U.S. maintained dominance over each nation’s monetary policy through its reserve currency status.
In 1971, President Richard Nixon exercised this domination in a trade dispute with Europe and Japan by suspending the convertibility of the U.S. dollar into gold, setting wage and price controls, cutting taxes, and placing a 10% surcharge on all imports in an effort stimulate the U.S. economy by devaluing the exchange rate of the dollar. U.S. stock markets had their largest one day rally in history; while foreign stock markets crumbled. Four months later; the United States forced agreements for currency appreciation by Japan of 16.9%, Switzerland of 13.9%, Germany of 13.6%, France of 8.6%, and Britain of 8.6%. This effective devaluation of the dollar is credited as creating 700,000 American jobs and cementing President Nixon’s reelection in 1972.
Having suffered from such manipulation under America’s control over European financial affairs; in 1992 the nations of Europe began creating an economic integration that would lead to the introduction of the euro currency on January 1, 1999. Overnight, Europe became the largest trading block in the world and the euro with €890 billion in circulation became the world’s second reserve currency.
Prior to the introduction of the euro; the southern European nations of Portugal, Italy, Greece, and Spain (PIGS) regularly devalued their currencies to remain competitive with the highly industrialized and sophisticated northern European countries. The introduction of the euro permanently fixed exchange rates for all euro members; but gave the PIGS access to loans from northern banks at less than half their prior interest costs.
The euro currency seemed to be a tremendous success as Greece, Spain, and Portugal experienced huge real estate booms powered by low interest rates. With the southern nations forbidden to devalue under euro membership regulations; the sales and profitability of German and other northern companies increased due to their higher productivity growth against southern companies. But after the 2008 credit crisis; German banks demanded the PIGS pay higher and higher interest rates. These higher rates crushed real estate prices and devastated the economies of the PIGS.
The ECB may have called itself the “Central Bank of Europe”; but it has virtually no ability to act as “lender of last resort”, like the U.S. Federal Reserve that prints unlimited amounts of money in an American banking crisis. As fear of potential defaults caused large depositors to pull money out of European banks and convert euros to dollars; the ECB was incapable of stopping a system-wide run on the banks. In desperation; the ECB was forced to surrender its sovereignty back to the U.S. Federal Reserve by agreeing to engage in 90 swaps of euros for dollars.
Given that U.S. banks operate with half the leverage of the European banks; the short-term structure of these arrangements will put pressure on the European banks to deleverage or risk the Federal Reserve refusing to roll over the swap by demanding repayment of dollars. This “dollarization” will create intermediate term stability. Eventually, the PIIGS must seek to devalue by re-issuing their currencies back to escudos, lira, drachmas, pesetas and other pretty paper. But whatever happens, it seems clear that from now on decisions regarding European monetary policy will now primarily be made in Washington D.C.
As long as China runs a big trade surplus, it's almost impossible for their currency to get reserve currency status, since there's just not enough debt floating around outside China to make for a liquid market.
Only if the US started to run a trade surplus, I'd start to worry about the US dollar as a reserve currency.
Cugat - a US trade surplus would be great in a million ways, but I just can't see it happening. Unless the American consumer changed personality. There were a few months during the financial crisis when I thought it might be happening, but it didn't happen after all. And we're back to normal. So I don't think we need to worry about that. :)
The Fed went overboard in responding to 9-11. Tech bubble had bust and the military style attack on World Trade encouraged Greenspan to generate a quick fix by pumping up the real estate bubble. By 2006 he was talking about irrational exuberance. He should know about exumberence, because he funded it with negative interest rates. This coupled with the repeal of Glass-Steagel provided the juice for a massive over-shoot in real estate financing.
When the markets cracked in 2008, Bernanke had to contimplate the 20% risk that the system would completely collapse. If you or I were delt that hand as Chairman of the Fed, you would have to go all in to prevent such a low risk probility event. We are now four years downstream and U.S. banks have massively deleveraged compared to the rest of the world.
America is transitioning through a period of tremendous interference in the economy by the Executive and Congressional branches of government. Voters on the left and the right are now in full rebellion against crony capitalism and much more supportive of policies to bring manufacturing back to the U.S. This includes substantial support for energy exploration, development a infrastructure.
In economics, powerful trends happen at the margin. America's support for big government has peaked. Last year was the first year since 1946 that state and local spending declined and this year will be the first year since 1948 that federal spending will decline. I believe this is a tipping point event.
Agreed, during the financial crisis, the Fed saved the system. But the system is broken and didn't need to be saved. We have bankruptcy laws to clean up the messes of capitalism, and they do a pretty good job. The Lehman bankruptcy went just fine. A bunch more would have really cleansed the system. Lots of pain for a couple of years, and then a fresh start and a booming real economy. And we would have demonstrated to the world how capitalism works, and how it cleanses itself.
But we didn't that. What we got instead was the old system that didn't work, only now it's even much worse.
I think the Fed and Congress are joined at the hip. One cannot live without the other. And I don't see the kind of popular outrage needed to get the Fed out of the business of market manipulation, and to get Congress to balance the budget -- at least in good times (or even come up with a budget). What I see is huge deficits for years to come, and a Fed that will do whatever it takes to monetize them, indirectly of course. And regardless of how elections turn out. There simply is no will to balance the budget. There is plenty of talk, but no will. It's just so much easier to borrow the money from the future and not worry about it.
im afraid i disagree with you too for all sorts of reasons. Ill try and be as thoughtful as you were in putting forward my case.
1. Structural deficits in Europe on a per country basis, esp in southern Europe< do seem exceedingly high but when taken as a Hold Co, those numbers pale in reference to the US. The us has a debt to GDP ratio of 101% and that is just public debt. this number does not include medicare and social security shortfalls and other off balance sheet debt which if taken to proper accounting rules, bring up this ratio to well over 500%! Total debt in the us is 55 TRILLION usd. Public securities debt is only 15 TN of that number.
2. Political paralysis in the us has seen voters having to decide between a man the right loathes and the left thinks has sold out (obama) and a man who really doesnt have any views at all (romney). Either one will not break the childish stalemate in both houses. The GOP has refused to even consider tax hikes. Refused!!! im not saying thats what we need, but any party that makes its members sign a non tax pledge is puerile and pathetic. This paralysis will push us to the brink of a fiscal cliff well before Europe.
3. Spending in the us has never abated even under a GOP President. Lets not forget we have just spent 1.5tn?usd on two foolish wars. We need to cut spending by close to 50%!!!! to even have a chance of balancing our books.
4. owners of US debt are by far and away mostly american. however China owns close to 1.5tn?? im not sure how benign china will be if we resort to the kind of trade war Romney exhorts. they could easily push yields up to 5% in 10 year bonds..maybe higher.
5. US banks have indeed recently delevered faster than european banks as per the press. although how one really knows this is amazing because banks are typically very difficult to pin down on assets and Value at risk as we have just seen from JP Moron this morning. In the evnt that yields rise and they must at some point?, how do you think the banks balance sheets will look as mortgage defaults accelerate? imagine your mortgage resets 300bps higher next month and you can hardly afford this rate. The banks are still sitting on a ton of real estate and its not looking pretty. Will the fed bail them out? sure but by the time QE8 happens the dollar game will be over.
6. Inflation is the usual result of money printing. the fed has printed 5 tn by its own measure although once again im not quite sure because they have refused to publish M3 for some time.Inflation is another word for devalutaion. Yes europe has printed but they are LENDING LTRO money to the banks, not printing. the FED is printing and buying treasury bonds. VERY VERY different.
7. Geopolitics. the us has made no friends in the last decade. i cant stop thinking of countries who would see us fail if they could. one day they will all trade oil and other trade in other currencies literally just to spite us and our totally insane foreign policy. Venezuela, Saudi et al. lets not forget that 17 of the high jackers were SAUDI. and we invaded IRAQ??? seriously, our utter racism will come and bite us in the ass.
8. central bank diversification away from usd. this is well documented and no need to go there. whats of relevance is the size of these investments. as EM countries grow over the next two decades, this number will dwarf trade.
9. Demographics. China and India have 2.5 bn people. we have 300mm. lets do the math? no lets not.
sorry for being verbose but IMHO we are fu ked.
1) The "structural" deficits are not the problem for periphery of Europe, it is competitiveness. Germany knew that the PIIGS regularly devalued to remain competitive, that's why Germany financed the creation of the euro. For the first 7 years, the periphery got to borrow money at German levels, then they collapsed. For the first 7 years Germany consollidated the leveraged buy out of East Germany. Today Germany has "conquered" Europe financially. There is some partisan guerilla activity, but Germany has 3% unemployment and rising wages. You can't do that with Panzers!
2) There is no political paralysis in Congress, Republicans are effectively looking to take Congress and the Presidency. Obama squandered the Left's mandate by over-reaching.
3) Last year was the first year since 1946 that State and Local spending actually declined. This year will be the first year that federal spending declined since 1948. This is a historic tipping point.
4) In wars, countries "confiscate" their opponents assets. The Chinese have been selling their Treasuries because they are having a growing banking crisis. Europe is a bigger trading partner than the U.S. for China and the euro is falling v. the Yuan. China has big problems that are about to become visible.
5) U.S. banks are leveraged 13/1; British & French banks are leveraged 24/1; German banks are leveraged 35/1 and Chinese banks are leveraged 45/1. JP Morgan engaged in 17 more dollar leverage than Lehman Brothers. They have a $2 billion loss with mark to market and that loss will probably grow big time, since they have not "unwound" the trade. The bottom line is that JPM borrowed from the Fed at .10% and arbitraged a hedge at .5% on huge dollars. Earlier in the year they were up $8 billion and now they are down. This is going to force a new Glass-Steagle seperation of brokers and banks. This is a good thing for Ameriica, because banks will have to go back to lending to make profits.
6) Inflation is a monetary phenomenon if there is no change in volocity of money. The Fed has mostly been involved in asset stabilization. QE 1 and QE 2 are inflationary. I think the Fed is boxed in from further stimulus.
7) Empires do not have friends, they have interests. During the globalization era of 1990 to 2010, access to oil was a U.S. priority. That game is over as the U.S. will soon be energy independent and manufacturing is returning for the lower costs of production and access to really cheap oil and gas. The U.S. is Saudi Arabia on steroids due to fracking and new technologies. Welcome to the the biggest infrastructure boom of the new millenium.
8) Soon Europe will jetison the euro for lots of new pretty paper. China is the loser as globalization fades.
9) 2.5 billion people looking to export their goods as globalization fades is a loser. China is at risk of big violence as the demand for exported goods fades. India is better positioned to build a domestic market, but this is not for allot of people.
China has 1/4 of the average water per capita in Han China, their agricultural area. It only gets worse in the western part of China. Fracking for oil and gas is water intensive and America's mid-west is water intensive. I believe that America is the Saudi Arabia on steroids for oil and gas in the future. Private enterprise is going to spend $2 trillion to build out this capability. In 5 years America will be the largest exporter of LNG in the world. Fasten your seat belt because this is the road forward.
I have been writing for the last two years about peak China. Six months ago, I got ask to lecture Chinese state owned enterprise executives and regional senior burreaucrats on the road forward. I believve that globalizim has peaked and the terms of trade have "flopped" in America's favor. The Chinese know that this is a problem and come to the U.S. to try to understand how to create a consumer economy. They do not believe this is possible for a 1.3 billion population.