Is it just me, or does the value of the U.S. dollar and the U.S. involvement in wars seem to follow one another around like high school best friends? The Bretton Woods Accord and the status of the U.S. dollar as the world reserve currency coincided with the end of World War II (1939-1945). The Korean War (1950-1953) was followed only six years later by the Vietnam War (1959-1975) during which the U.S. exited , for the third time, from the Gold Standard(the economic Land of Oz for the hordes of young, badly-informed Ron Paul faithful) .
Free from the restrictions inherent with gold backing after 1971, the U.S. dollar became the blunt instrument with which the U.S. beat the Soviet Union to a bloody death during the Cold War (1945–1991).
“Synchronicity: An Acausal Connecting Principle” (Carl Gustav Jung)
Now, I’m sorry but I just don’t believe in coincidence. And each war mentioned above corresponded with an increase in the U.S. money supply. Following this string of historical facts further, the First Gulf War (1990-1991) was followed by wars in Afghanistan, beginning in 2001, and in Iraq, beginning in 2003( a reason for which a logical explanation has NEVER been given). Simultaneously, the U.S. also began the intentionally vague, conflict-with-no-borders War on Terror that began in 2001. Just like the wars that came before them, the recent propensity for the U.S. to launch wars is directly correlated with corresponding increases in the U.S. money supply. The Iraq war, for example, is estimated to have cost as much as $4 trillion in hard cost.
Unfortunately for the U.S., the decline in value of the U.S. dollar, caused by excessive expansion of the money supply with rising demand for raw materials from emerging economies, has led to permanently higher global commodity prices. Higher crude oil prices, in particular, have put pressure on the U.S. economy, which is mired in a sluggish recovery from the recession that began in 2007. At the same time, international trade has begun to move away from the U.S. dollar, threatening its world reserve currency status. Given the history of the U.S. dollar, it seems highly probable that the logical end of the U.S. dollars reign as the world reserve currency will be marked by yet another “convenient” war that will coincidentally require the U.S. dollar to remain the reserve currency.
The Petrodollar and Iran Remain On A Collision Course
The most current and opportune villain for U.S. politicians who need a convenient target on which to focus their clamoring for war is Iran. Here’s just how convenient:
- They are the third largest oil exporter in the world.
- Iran refuses to sell its oil for U.S. dollars.
- If Iranian oil were traded in U.S. dollars, it would moderate the U.S. dollar price of crude oil and ease pressure on the U.S. economy, as well as extend the world reserve currency status of the U.S. dollar and give the U.S. economic leverage over consumers of Iranian oil, which include China and India.
The U.S. news media (and the political “insiders” that feed it), is not-so-subliminally preparing the American public for a war with Iran daily. The most prominently cited risk from Iran is attributed to the possibility of their becoming a nuclear power, despite no evidence that they could produce, package, or launch ANY nuclear threat except to their own inept Iranians tasked with nuclear assemblage. Television news reports and Republican Presidential Candidates have routinely, and sans evidence, speculated with growing false alarm that Iran would immediately wipe out Israel if it obtained a nuclear weapon, despite the fact that a thermonuclear exchange would wipe out Iran as well.
Of course the “chicken littles” at Fox News daily fear-monger that Iran might carry out nuclear strikes on U.S. soil using “suitcase bombs”, “dirty bombs”, or even ICBMs despite the fact that Iran possesses neither the skill nor money nor scientific knowledge to accomplish such a feat. In fact, there is no evidence that Iran is currently building any type of nuclear weapon whatsoever.
Although combat in Europe and in the Pacific continued into 1945, the impending end of World War II led to the creation of the Bretton Woods System in July 1944. Subsequently, the U.S. dollar, which was convertible into gold, became the dominant mechanism for international trade settlement. For the BWS, the price of gold was set to the pre-war price of $35 per troy ounce, which was deflationary at the time. There was nothing in the Bretton Woods Accord, however, that prevented the U.S. from issuing more currency than was backed by gold other than the threat of a run on U.S. gold reserves.
After seventeen years, the Bretton Woods System had outlived its usefulness and the London gold market, which had been closed during World War II, reopened in 1954. In only seven years, upward pressure on the price of gold prompted the establishment of the London Gold Pool by the U.S. Federal Reserve and major European central banks (including the central banks of the United Kingdom, Belgium, France, Italy, the Netherlands, Switzerland and West Germany). The London Gold Pool defended the $35 per troy ounce price through interventions in the London gold market, but upward pressure on the price of gold still grew. To try and assuage the upward pressure on the gold valuation, President John F. Kennedy mandated in July1962 that Americans were forbidden to own gold abroad.
In what would become one of many French attempts to break the U.S. hold on the dollars reserve currency status, French president, Charles de Gaulle, publicly denounced the U.S. for abusing the world reserve currency status of the U.S. dollar. And in March of 1968 the London Gold Pool collapsed after France withdrew from the group setting off a surge in gold demand that caused the London gold market to completely shut down for a two week period.
The End of the Bretton Woods Gold Standard and the Rise of the Petrodollar
By 1971, to a large extent due to the cost of the Vietnam War, the U.S. had leveraged its gold reserves to a tipping point. The U.S. Consumer Price Index (CPI) had increased by more than 6% in 1970 and it remained above 4% in 1971. When U.S. President Nixon “closed the gold window” in August 1971 and instituted price controls, the Bretton Woods system ended and an ad hoc floating exchange system (fiat currency) was instituted among all westernized countries.
In February 1973, the U.S. devalued the dollar and raised the official dollar price of gold to $42.22 per troy ounce. By June of the same year, the market price in London had skyrocketed to more than $120 per ounce.
Although CPI inflation was below 4% at the start of 1973, it had jumped to 9% by early 1974. With the last vestiges of gold backing having been removed from the U.S. dollar, Americans were once again allowed to own gold as a hedge against inflation. Bumping up against an environment of runaway U.S. inflation, the Organization of the Petroleum Exporting Countries (OPEC), proclaimed an oil embargo in October of 1974. Officially, U.S. support of Israel in the Yom Kippur War was the reason for the embargo, but it was also a challenge to the un-backed U.S. dollar’s position as the world reserve currency, as the exclusive currency for crude oil sales.
After the end of the Yom Kippur War in 1974, OPEC members, including Iran (before the Iranian Revolution in 1979), began to accumulate hundreds of billions of devalued U.S. dollars due to current trade-account surpluses linked to rising oil prices. Arab “petrodollars” were recycled into US Treasuries, invested in financial markets around the world and loaned to commercial banks.
But by 1979, oil prices had roughly quadrupled and the price of gold was increasing rapidly. Paul Volcker, Federal Reserve Chairman, in an effort to halt the retreat in the U.S. economy, raised the Federal Reserve’s funds rate to an average of approx. 11% in 1979. Despite the intense efforts, in 1980 the state of the U.S. economy was nevertheless in full retreat:
- CPI inflation soared to 13.5%
- The price of gold hit $850 per troy ounce
- The price oil averaged $37.42 per barrel, more than ten times the average price of $3.60 per barrel less than a decade before in 1971
- The stagnant U.S. economy slipped into a serious recession
- In a desperate attempt to save the U.S. dollar, Volcker increased the funds rate to an unprecedented 20% in mid 1981, pushing the prime interest rate to a usurious 21.5%
- Finally, Volcker’s radical intervention slowed the rate of CPI inflation and restored confidence in the U.S. dollar
At long last….
The price of crude oil plummeted along with the prices of gold and silver.
Volcker’s success with manipulating currency value in the early 1980s caused the price of gold to decline while leaving the price of oil basically stable for roughly two decades, despite the fact that interest rates declined as well. This was no small feat in the annals of economic policy.
Success and Considerable Luck Leads To Ill-Advised Complacency
The success of these new (and some would argue reckless) methods in U.S. monetary policy, (developed principally by Robert Rubin, Larry Summers and Paul Volcker’s successor, Alan Greenspan) helped make it possible for the United States to gain the upper hand in the continuing Cold War with Russia. By 1991 the U.S.S.R. finally collapsed under its ill-suited attempt to maintain parity with the U.S. Other things being equal, the U.S.S.R. had simply been spent into oblivion by the U.S. The fall of the U.S.S.R. seemed to guarantee the domination of the U.S. dollar for the foreseeable future.
Unfortunately for the U.S., this allowed Greenspan, together with Larry Summers, who was Deputy Secretary of the U.S. Treasury under Robert Ruben at the time, to champion the cause of deregulation in the 1990s. This misplaced confidence in their own ideas and fiscal acumen, allowed the so-called “committee to save the world” to successfully prevent regulation of over the counter (OTC) derivatives by effectively repealing the Banking Act of 1933 (the Glass–Steagall Act), and implementing the Commodity Futures Modernization Act of 2000, which allowed commodity traders to control huge amounts of commodities with relatively small amounts of capital.
The famous trio’s approach to deregulation encouraged banks to take risks that later threatened the entire U.S. financial system. A year before their magazine fame, they thwarted efforts by Brooksley Born, then-chairman of the Commodity Futures Trading Commission, to regulate the over-the-counter derivatives market, which ballooned to include the toxic instruments that ravaged American International Group Inc. (AIG) and Lehman Brothers Holdings Inc. (LEHMQ). Those decisions helped set the stage for the worst global recession since World War II, with aftershocks that are still being felt from Washington to Athens.
In hindsight, it’s all too obvious that Greenspan held interest rates too low for too long in the 1990s resulting in the dot-com bubble. The bursting of the dot-com bubble was a clear and obvious warning that went completely ignored by the established economic experts of the time.
The Federal Reserve moderated the downturn beginning in 2000 by lowering interest rates and they left them low for too long. U.S. banks, never ones to turn down a risk with someone else’s money, took advantage of deregulation and low interest rates to engage in reckless speculation and to increase their leverage, particularly in the mortgage market, while hedging the additional risks in the fast growing OTC derivatives market. A real estate bubble grew, as a direct result, and the derivatives market based on them eventually exceeded $600 trillion on a global basis (more than ten times world GDP). The result, of course, was that the financial services industry profits expanded to 40% of S&P 500 business profits.
The Best Laid Plans of Mice and Men
The price of gold began to move up after having hit an historic low in June of 2001. As was totally foreseeable, 2006 saw the price of crude oil began to rise at an accelerating rate revealing a fundamental flaw of de-coupling interest rates from prices.
The glaring error in the Federal Reserve’s plan was that the Federal Reserve completely lost control over the flow of increased liquidity resulting from its narrow-minded policies. The fallibility of the “committee to save the world” became evident with the flooding of the world with cheap U.S. dollars. Increased liquidity linked to low interest rates was fueling unprecedented levels of financial speculation and increasing the risk and magnitude of asset price bubbles, such as the dot-com bubble and the real estate bubble. To exacerbate matters, the excessive monetary expansion was weakening confidence in the U.S. dollar.
Pressured, yet again, by rising oil prices, the U.S. economy began to tank in 2007. As the U.S. housing bubble began to burst, beginning with sub-prime loans, the price of West Texas Intermediate (WTI) crude oil hit an all-time high of $145 in June 2008. President George W. Bush resorting to personally traveling to Saudi Arabia to beg to increase production, was embarrassingly turned away by Saudi leaders. Roughly four months later, a financial crisis far larger than the Bank Run of 1929, the Savings & Loan Collapse in the 1980s, and the dot-com bust combined took place in the bursting of the largest credit bubble and largest monetary expansion ever in history.
In October 2008 Greenspan testified before the U.S. Congress saying “…I found a flaw…in the model that I perceived is the critical functioning structure that defines how the world works…”
War At The End of the Rainbow
As stated in previous articles, it is my belief that the primary, if not lone reason, that the U.S. has yet to experience a sovereign debt crisis is its continuing stranglehold on the world reserve currency status of the U.S. “Petrodollar”. It is this grip on the oil currency which supports demand for the U.S. dollar and for U.S. federal government debt, and as long as it retains this advantage, the U.S. remains buttressed against a disastrous decline in the demand for U.S. currency.
But, the U.S. dollar is in the process of gradually losing its world reserve currency status hedge. Global trade is fragmenting into increasingly autonomous trading blocks, defined by currencies and trade relations, such as the BRIC nations (Brazil, Russia, India and China), together with South Africa.
Demand from emerging economies, particularly China, is placing steady upward pressure on the price of crude oil. Higher oil prices resulting from a combination of a weaker U.S. dollar and increased global demand threaten to push the U.S. economy back into another, deeper recession. Just the fact that the price of gold has risen roughly 500% in a single decade suggests much higher oil prices in the future.
Iran, the world’s third largest oil exporter and a major supplier of oil to China, lies outside of U.S. control and Iran steadfastly refuses to sell oil for U.S. dollars, partly as a consequence of the overthrow of the democratically elected government of Iran in 1953, orchestrated by the U.S. Central Intelligence Agency, and partly as a consequence of current U.S. policies in the Middle East (read support of Israel).
In March of 2012, the U.S. unilaterally removed Iran from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, effectively cutting it off from world commerce. However, wielding the U.S. dollars world reserve currency status as a blunt instrument could backfire badly given the current international climate. If the U.S. dollar were to lose its world reserve currency status over a short period of time, a U.S. sovereign debt crisis would mean a certain and a catastrophic collapse of the U.S. dollar, i.e., hyperinflation.
Having decided to take a unilateral combative stand against Iran, the U.S. may be forced to resort to more extreme measures should the world reserve currency status of the U.S. dollar continue to erode.
Of course, the U.S. does not control the oil trade solely through financial means. With Israel as a close ally, Iraq and Afghanistan occupied by U.S. forces, close ties with Turkey, Saudi Arabia, Kuwait, Qatar and other Middle Eastern countries, Iran is surrounded by more than 40 U.S. military installations as illustrated below :
A successful invasion of Iran, by either a unilateral U.S. move, though an Israeli straw-man attack, or some convincing prodding of its allies, the U.S. would eliminate the largest non U.S. dollar oil exporter, delaying the breakdown of the U.S. dollars status as the world reserve currency for an extended period of time.
Although a war with Iran would cause a spike in oil prices, as did the U.S. attack on Iraq, U.S. control of Iran’s oil would increase the supply of oil available for purchase in U.S. dollars. This, of course, would bring the U.S. dollar price of oil down and enhance the ability of the U.S. to manage the price of oil to meet the needs of the U.S. economy. Controlling a major supplier of crude oil to China and India would give the U.S. additional leverage to support the U.S. dollar and U.S. debt, as well as a means of influencing the policies and economic growth of the two largest nations. Of course that window of opportunity is rapidly closing.
Several Other Possibilities
- A limited U.S. military action might leave a weakened Iranian regime in place and reignite the moderate, pro-democracy Green Movement that was brutally suppressed in 2009.
- Regime change from within might restore democracy to Iran after twenty six years of U.S.-imposed monarchy and more than three decades of quasi-democratic religious oligarchy.
- Unfortunately, regime change is unlikely to result in the sale of Iranian oil in U.S. dollars or to extend the ruling position of the U.S. dollar as the world reserve currency.
- Should a preemptive strike by the U.S. fail, it could also strengthen political support for the current Iranian regime.
There seems to be no political will in Washington D.C. to change course from a U.S. military conflict with Iran. A U.S. attack on Iran would increase anti-U.S. sentiment in the region and amplify the Islamic extremist dimension of the U.S.-led War on Terror, but the consistent drip-drip-drip to war in the U.S. news media is loud and clear.
If history is any guide, the U.S. will soon, (read- after the 2012 presidential election) once again prove an adage that I believe describes U.S. philosophy:
The Price of War is a Good Buy when Non-Aggression is Politically Perilous.