Petro-Dollar & Protection Racket
The term "Petro-Dollar" has been bandied about for years. In my travels, much has been mentioned in indirect terms about it, with assumptions of its nature and structural significance. It is mentioned often carelessly when talking about crude oil and its Persian Gulf sales. Yet little is written on the topic, and little is easily found to read and learn. A recent radio show with Al Korelin delved into this subject, although we only scratched its surface to identify some warning signals on economic impact. Changes are occurring under our feet to a critical foundation of both world commerce and world banking.
The Petro-Dollar system is a vast banking and commerce system designed by major world economies. Japan, South Korea, France, Germany, Argentina, these nations are typical in purchase of oil without the benefit of domestic production. So they must create a system for having cash ready to make timely payments, much like a checking account. The system's overt original purpose was to enable and facilitate payment for extremely large supplies of delivered energy products, principally crude oil but also natural gas. The commodity payment system has actually evolved to become much more far reaching. Try to purchase copper or cotton or forest timber or grains, and payment is almost assuredly demanded in USDollar terms, the international currency for commerce in commodities generally. What we have is a system for purchasing minerals and resources, totally bound in US$ denomination pricing and transaction settlements. The most visible element is energy trade, whose supplies clearly make for the largest bill payments. Definitely the most important payments for economic survival are for energy, the lifeblood of industry and transportation. Nations keep funds liquid, and use 3-month TBills almost like cash. It bears an interest yield. Money does not sit in banks without bearing a yield in return, a practical measure. Considerable lead time is involved for orders and payment, for both inventory management and delivery. The typical time lapse is 45 days from Persian Gulf port shipment to exit from domestic refineries, according to an energy expert colleague.
In response, due to an established system, world bank centers accumulate US$-based liquid assets in what act like checking accounts. Nations must be constantly prepared to be in position to pay for energy supplies. Industrial & transportation costs are much larger bills than the human food necessities. The Petro-Dollar system is the practical commercial flipside, the visible evidence to the USDollar as world currency reserve in central banks. The financial effect is for banking systems across the globe to accumulate reserves in US$-based assets. Major components are USTBonds across the maturities (3-month, 12-month, 2-year, 5-year, 10-year), and in addition even GSE Agency mortgage bonds. Longer maturity bonds "shore up" and fortify short-term bonds like the highly liquid 3-month TBills. The entire world accumulates US$-based reserves for the purpose of buying their commodities, principally crude oil.
Two regions are unique, however. The primary export giants in Asia have stockpiled $1800 billion in reserves. Their hoard is primarily US$-based. What began as a checking account for oil payments has morphed into a gigantic bloated beast of a dangerous financial pyramid whose foundation has corroded and weakened as the USDollar bear market progresses. Unless Asian banks print money to purchase (monetize) more USTBonds, they will see erosion in their entire banking system capital base. South Korean and Japanese painful pronouncements testify to this corrosion and weakness. What is not reported in the intrepid US press is that the entire banking system of South Korea is at risk. Their reserve base has shrunk by 20% in value this last summer in the face of a noteworthy SKwon currency rise. It has additional risk from principal loss, as our rates rise. With fractional banking practices entrenched, stress to bank portfolio ratios is clear but not emphasized. All we hear in the USA is how Asians are showing lack of support for our beleaguered US$ currency, showing lack of loyalty to their ally, are not grateful for our open markets, and are doling out harmful effects manifested in domestic inflation. This is shallow reporting, to be sure.
The other region of note is Europe. For thirty years, Europe has employed a clever instrument as a device in banking. The EuroDollar was created for many purposes. One was to facilitate payment for energy supplies in US$ terms, without the necessary step to convert trade surpluses back to DeutscheMarks or Swiss francs or British pound sterling. Thereby a double currency conversion is averted. The money was kept sterilized, in order to avoid pushing up the mark or franc or sterling currencys. A rising continental currency trend would change the export pricing structure to the detriment of European businesses. A EuroDollar is a US$ held in European banks, not converted to local currency units, and serves as a buttress to support the Petro-Dollar system. It becomes more complex when futures contracts are involved, where bearing yield is offered. The world is awash in USDollars, for many reasons ranging from our abandoned manufacturing base, our depletion of oil resources, our dependence on foreign commodities, our profligate spending waste, to our lack of discipline in federal budgets, and military spending for adventures and annexations.
PRACTICAL USA ADVANTAGE, ABUSED USA PRIVILEGE
Practical advantages to the USA are two-fold, industrial but mainly monetary. World banks are absolutely drowning in US$-based assets, which grants US firms a favored position in contract awards. Numerous large contracts are won with large US firms, downstream in their economies. See Halliburton, General Electric, Bechtel, and others. Large US energy service firms typically win contracts with oil producing nations. It is part of the Petro-Dollar game, with attached military protection unwritten into the contracts. We protect their governments, even if they are corrupt. We induce both monetary corruption and bank dependence, even when other governments are honest and object to pressured tactics. We are the big bully on the block.
With the USDollar as world reserve currency, the USGovt abuses the privilege on a grand scale. Sure we donate heavily to charitable causes, like disaster relief. But we are heavy handed in order to maintain the privilege of running an uncontrollable printing press, which in private circles is known as a counterfeit operation. That press funds our operations, which in my view have clearly gone amok. In essence, the USGovt runs the largest protection & extortion racket in modern history, perhaps ever. The world is "obliged" to sop up and purchase all the debts we generate, whether they approve or not of our policies, behavior, tendency, or justification for military actions. Almost without enforced discipline, the US system has evolved with unchecked abuse on a massive scale. Do Europe or Asia have a say in Congressional decisions which lead to huge federal deficits? Do they have override in decision to go to war in the Persian Gulf? How about an unwise tax law change based upon faulty self-serving analysis? The entire US system can extend credit at will with seeming impunity, with little consequences. Surely political repercussions surface.
US federal debt, mortgage debt, and indirectly household debt are all absorbed by Asia. Exporters are somewhat bound to buy our US Treasury debt in order to continue selling in our market. Foreign central banks have few alternatives to sock away $20 to $30 billion per month, each month, every month. Are they supposed to acquire a major US pharmaceutical firm or major US technology firm or major retail chain every two to three months? No, since that would cause alarm among the US public. The US consumer market drives the Asian economies. Practical implications are frightening. The USGovt can run a war on a credit card, with foreigners paying the costs with no say on the prosecution of that war. The USGovt can cut taxes without business growth, run deficits, without paying the costs. The USGovt can fund pork projects to satisfy Congressional members in certain key states. The USGovt can stimulate and subsidize its financial asset bubbles, with foreign money used to push the bubbles, all the bubbles. The USA provides security & protection of shipping lanes and ocean ports in a grand international contract. We harm our credit providers, by subjecting their debt holdings on a regular basis to losses. If foreigners retaliate, they hurt both their bank systems (from currency loss) and their export trade with the USA (from currency changes).
THE PROTECTION RACKET DYNAMICS
Where the Petro-Dollar system seems to break down is in the writedowns foisted upon participating nations. The racket seems complex but can be described in extremely effective and simple terms. The US runs up horrendous debts, which foreigners finance at $1.8 billion per day. We continue to print money to pay bills and fund operations, with credit supply taken for granted even though our national security on a financial basis is routinely undermined. Our accelerating money supply growth renders the USDollar vulnerable. The USDollar declines in value, making for a constant "writedown" to foreign holders. Foreigners continue to supply capital to the US system, to feed our USTreasurys, as they recycle their trade surpluses. Asian surpluses are on the order of between $250 and $300 billion per year. European surpluses are between $100 and $120 billion annually. As the fabled Senator Everett Dirkson once said "a billion dollars here, a billion dollars there, before you know it, you are talking about real money."
If foreigners halt capital supply, their bank systems implode worse than they did inside Japan in the 1990 decade. Our US assets (housing, bonds, stocks) rise in "value" without work, as our debts accelerate and jobs disappear. If Asia withdraws support, then US consumers witness a sudden disappearance of wealth and purchase power which immediately is felt by Asian producers of finished products. If Asia withdraws support, then the entire price structure for consumer products rises within the US Economy, for a host of items like stereos, DVD's, video recorders, cameras, photocopiers, printers, PC's, cars, engines, even construction equipment.Asia feels obliged to continue, in order to keep their industries and work force busy (avoid unemployment), and to prevent their banking systems from imploding. They cannot abandon support for the USDollar, and demonstrate that support with frequent central bank interventions. One must suspect that some interventions are ordered by the USGovt for execution overnight by the Bank of Japan, which my description calls the Fed's Far East outpost. They do the Fed's bidding, often under the cover of darkness. The question of the BOJ truly being independent is a very big question nowadays.
RUSSIA & OPEC UNDERMINE THE PETRO-DOLLAR
The Petro-Dollar system is under new attack. Russia and fringe nations of OPEC are responsible for dissension. Their motive is self-preservation. They strive to avoid selling crude oil output in a falling currency, which cuts into revenues. They dislike buying commodities in US$ terms, as inherent prices are rising. Rather, they desire a stable or rising currency. The rogue nations involved in the act of insurrection include Russia, Iran, Venezuela, and Indonesia. Being a European nation, Norway should also be so motivated, but so far they have not made any rumbling noises. An added motive for selling oil outside the US$ sphere addresses a larger economic issue. If a nation can manage to trade a host of commodities (like oil, natural gas, copper, iron, cotton, coffee) in euro denomination, that national economy would be far less subject to the distress of systemic rising prices. For instance, the Russian ruble is down 30% versus the euro, in part from selling oil supplies in US$ terms, in part from the horrible fallout from the Yukos legal treachery, in part from unusual fallout from tampering in the Ukraine elections. Regardless of why, the faltering Russian currency has contributed to 11.7% price inflation inside this enormously important commodity powerhouse nation. Russia might lead the pack in output for as many as a dozen commodity items such as platinum, cobalt, titanium, tin, zinc, aluminum, and others. Russia sells 81% of its oil exports to Europe, with 65% of its overall trade with the EuroZone. Therefore, it is in Russia's best interest to sell oil in euro denomination. It appears Russia is the spearhead behind the transformation toward the Petro-Euro and creating a new system.
Few observers seem to attach many military implications to the Petro-Dollar, its defense, its dismantling, and geopolitical shifts it might cause. Not here, no way! The Iraq War has numerous grounds for its justification, surely the weapons of mass destruction among them (although not taken seriously by me here). Any curious thinking person with a pulse must consider that establishment of military bases in the hot Middle East was another motive. Locking in multi-billion contacts with oil field renovation and restoration is yet another motive. We did not share such contracts with European firms, much to their anger. Also, stemming the sale of Iraqi crude oil in euro denomination was another motive, which in my view was far more important even in March 2003, just as important two years later now. The Petro-Dollar system is that important to defend.
The sleepy US press & media has given weapons of mass destruction 50 hours of air time for every 5 minutes of serious discussion of petro sales in euros. Saddam Hussein's defiant sale of Iraqi oil for euros made for a highly profitable maneuver. In my analysis, Russia is attempting to take the front position to attack the Petro-Dollar system directly, first by selling oil and gas to Europe in euro terms, second by attempting to lead OPEC in secret fashion with little publicized meetings.OPEC refuses to confront the USA, since it owns no military and is quite dependent upon the USA for its protection. They sell us oil; we protect their leadership (see Kuwait and Saudi Arabia and Qatar). Russia is willing to confront the USA, an adversarial role which it seems unwilling or unable to be put to rest, a certain remnant from the Cold War. The fact that Iran nuclear armament is no longer in the news in the last few weeks speaks volumes about the tactical weakness of the USA. Our nation is extraordinarily vulnerable to sales of USTBonds by foreign central banks, and to sales of foreign produced oil in euros (not USDollars). In my view, Putin showed Bush his weapons last month, and the USA backed off.
Behind the scenes is anger by Russia for the construction of numerous small bases for the US Military in former Soviet Republics like Uzbekistan and Kazakstan. Their erection might have helped to drain world cement supplies last year. We seem in Putin's eyes to be encircling Russia, who might retaliate by knocking the Petro-Dollar system off its foundation pillars. The new Shanghai Cooperative Group represents a potential supply network which will have member nations of China, India, Russia, former Soviet Republics, and Iran as its core. New nations are being actively courted, such as Venezuela and Brazil. Energy (crude oil & natural gas), industrial metals, and more are to be bought and sold by this new network, outside OPEC and its gaggle of disunity and diverse puppet strings held by Washington DC. In my view the "COOP" is likely to have been organized to be a direct assault on the Petro-Dollar, if not a consciously designed network to blockade the USA from the supply chain. The COOP is a direct answer to the corrupted OPEC cartel, which seems overly influenced by US leaders. The Saudi oil minister sounds as though he has been trained in FedSpeak, when he talks of hiking oil output from already strained capacity (if it exists). It is highly likely that the COOP creates the framework to undermine the dollar-based supply system that is the PetroDollar. My guess is the euro will be the COOP's transactional currency.
The latest development is the creation of an Iranian commodity exchange market. The US press has yet to report on it, despite the extreme importance. Would even 10% of the viewing audience understand the story or its importance??? So why bother to air it? Its plan is to sell crude oil and natural gas in euro denomination. So far China is a central customer to participate in the new exchange. Again, behind the scenes, deals are being struck. The CIA and other agencies warn that China is selling far more than scud missiles to Iran, which fears an invasion by the USA. Perhaps the most important factor of all which pertains to Iran is the decision made independently by at least three multi-national energy firms (including Agip of Italy and Elf Aquitaine of France) to construct an oil pipeline south from the Caspian republics through Iran. A pipeline through Georgia or Chechnya might not come to completion, due to smaller measured oil deposits in the surrounding Caspian region. If the key oil pipelines are to routed through Iran, then Iran rises in strategic importance almost beyond what words can describe. Look for stories by the obedient lapdog US press & media on Iran's nuclear threat, which might be about as accurate as Iraqi warnings weapons of mass destruction. Fool me once, shame on you. Fool me twice, shame on me. NOT ME. Iran sits in the most important location in the entire Persian Gulf, and they are not friendly nor cooperative with the USA. Any attack of Iran by US Forces will involve the Russian and Chinese militaries !!!
FAILING TOOLS & THE VULNERABLE USA
Previously useful weapons used by the USA are likely ineffective here. The IMF and World Bank have been used in devious ways in past years. These organizations have been accused of serving as fronts for securing contracts for US contractor firms, for disrupting foreign governments, and more. Evidence abounds that the IMF blocked attempts for member OPEC nations to firm the usage of an Islamic Dinar to be used in oil sales. A gold-backed Dinar is not used much for international settlements, but still is talked about between Iran and Indonesia. The role of the World Bank might become more strategically important with Wolfowitz as its new head. If you think this is a maneuver of no importance or consequence, YOU ARE BRAIN DEAD.
The power of the IMF is blatantly evident in the 2001 collapse of the Argentine bank system, and in frequent Brazilian debt writedowns. In recent months, Argentina has since defied the IMF with a gold backed new peso currency. Financial weapons prove ineffective in defending the Petro-Dollar from Russian maneuvers. They sell directly to Europe. It is an obvious next step. Not only will Russia continue to sell energy supplies in euro terms, but Russia will balance its central bank reserves toward the EuroBonds. Reserves will reflect their commerce.
My assessment is that a currency war is underway between USA and Russia, with the Petro-Dollar the central battle ground. THAT WAS THE HIDDEN AGENDA BEHIND THE PUTIN VS BUSH TALKS LAST MONTH. We are long past the buddy-buddy horseback rides in Crawford Texas with Vladimir Putin. This man Putin comes from the KGB and knows how to play chess. Our USGovt leaders know how to use sledge hammers, not move chess pieces on a complex chess board. A transition is in place to have the euro replace the USDollar as world reserve currency, or at least to share it with the euro during a transition phase. Russia, China, India, Indonesia, South Korea all announced "diversification" away from the US$-based debt securities in their central bank reserves management. Such pronouncements serve as verbal after-shocks to basic shifts underway in the Petro-Dollar foundation earthquakes.
Pricing oil in euro terms will help oil producing nations and oil consuming nations to transfer higher costs to US Economy!!! They will realize more supply sale income; the USA will realize higher costs for those supplies. Pricing oil in euros helps nations to reduce domestic price inflation within their own economies, and to add to incoming revenue from oil sales. It is a zero-sum game with the USA the loser when the Petro-Dollar fractures and slowly erodes into oblivion. Removal of the Petro-Dollar system will have a magnificent effect on the crude oil price or the USDollar exchange rate or US Treasury yields. Its removal might have a significant effect on oil AND the USDollar AND the USTBonds. The initial effect is to be an effect on the oil price and a slew of commodity prices. Then might come an effect on currencys and bonds as a secondary effect. Then we might see a gold effect. An acceleration down with USDollar could trigger a world bank crisis. Foreign banks have responded with diversification into the euro and to a minor extent into gold. The Petro-Dollar foundation is being shaken under our feet.
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