Iranian Oil Bourse

[DarkWaters]

Hi,

My friend who is a fan of both Objectivism and Austrian Economics sent me this article the other day. This article discusses Iran establishing an "Iranian Oil Bourse", which would allow for the trading of oil for non-U.S. currency. The article also advances a conspiracy theory incriminating the U.S. government since FDR that I perceive to be too farfetched, but I have nevertheless, discussed it below.

Economic implications of Iranian Oil Bourse:

The part of the article that really caught my attention was the economic implications of the proposed actions of Iran. If Iran goes through with its oil bourse, this would allow for the trading of oil for non-U.S. dollars, primarily the euro. If this does happens, I believe this will be the first mechanism for major world powers in the European Union, Russia, Japan, China and the like to purchase oil without using U.S. dollars (USDs). The article alleges that this in turn should encourage the aforementioned powers to significantly reduce their investment in U.S. treasury notes, bills and bonds. This would in turn significantly weaken the fiat U.S. dollar, which according to the article, is essentially backed by oil.

I do not think I understand economics well enough to properly assess the dire economic implications alleged in the article. It sounds somewhat plausible to me but I recognize that I might be oblivious to any technical or factual errors made during the analysis. Do any of the economics or finance gurus on here have an opinion on the validity of dire predictions for the USD if the Iranian Oil Bourse is up and running?

Conspiracy theory discussed in article:

The conspiracy theory advanced within seems too farfetched by presupposing too much collaborative long-term planning, premeditated malice and sophisticated understanding of Austrian economics on powerful U.S. officials. Nevertheless, if anyone is interested in the conspiracy theory, I tried to summarize it below. I put my comments on paranthesis.

1.) FDR took the U.S. off of gold. In 1945 the U.S. adopted the Bretton-Woods standard, allowing for USDs to be convertible to gold only for foreign governments.

2.) In 1970-1971 foreign governments demanded payment for their USDs in gold, but the U.S. defaulted on these payments. Thus began the political movement under Nixon to take the U.S. off of the Bretton-Woods Standard. Feeling cheated, foreign governments still felt powerless to do anything about this. According to the author, the U.S. government could now force (!?) other countries to sell their economic goods for the ever depreciating USD and thus, in a sense "tax" the rest of the world.

3.) In 1972-1973, the U.S. made an iron-clad agreement with the House of Saud to politically support them in exchange for Saudia Arabia to only accept USDs for oil along with the rest of OPEC (but I am not sure how this was negotiated; perhaps the author intends to say that the U.S. wanted Saudia Arabia to pressure its fellow oil petroleum exporting countries to do the same). Now, the USD is essentially "backed" by oil as any country that wishes to purchase oil from a member of OPEC, must have a reserve of USDs.

4.) No oil exporting country ever demanded a different kind of currency for oil until Saddam did after the year 2000. Once it became apparent that other countries might follow suit, the author alleges that Bush Administration invaded Iraq not because of WMDs or the bring the Iraqi's freedom but because he wanted to protect the USD. (this also does not make sense to me as a primary motivation since the war in Iraq seems to have done more damage to the USD through deficit spending than Saddam ever could. Also, why would the Bush Administration be so insistent on staying in Iraq anyway?)

5.) Iran is now taking similar action to allow for oil to be traded for non-U.S. currency hence the U.S. government's attempts, according to the article's author, to engineer a war with Iran.

Anyway, I summarized this in a rush so if you really want to know what the author said, I suggest that you read it yourself. Although I disagree with the theory, I have no intention to misrepresent it in my haste.

Edited January 16, 2008 by DarkWaters

[adrock3215]

The part of the article that really caught my attention was the economic implications of the proposed actions of Iran. If Iran goes through with its oil bourse, this would allow for the trading of oil for non-U.S. dollars, primarily the euro. If this does happens, I believe this will be the first mechanism for major world powers in the European Union, Russia, Japan, China and the like to purchase oil without using U.S. dollars (USDs). The article alleges that this in turn should encourage the aforementioned powers to significantly reduce their investment in U.S. treasury notes, bills and bonds. This would in turn significantly weaken the fiat U.S. dollar, which according to the article, is essentially backed by oil.

Firsly, I will state that I do not agree with the conspiracy theory aspect of this article. When one ponders why America has taken the actions it has with regards to its monetary system, one can conjure up many theories to try to explain the insanity. Personally, I am less concerned with asking why this happened than I am with actually fixing it. Anyone trying to explain why America did this is engaging in speculation anyway.

Any move to sell oil in a currency other than dollars will indeed cause a devaluation of the dollar. American interests were, for this reason, concerned when Saddam wanted payment for oil in an alternative currency, although any attempt to link this to the invasion of Iraq is speculative. A bourse which allows for oil to be traded in an alternative currency will likely become very popular at this time, granted the current downward spiral of our currency, and will additionally lead to more downward pressure. I strongly believe that what needs to occur at this time is for the US to become the leading proponent in the world for a move to a full gold standard. Unfortunately, I have never seen this topic discussed by politicians in the United States, with the exception (sorry DarkWaters, I know you dislike him) of Ron Paul.

[softwareNerd]

The actual immediate fact of denominating a trade using in a particular currency does not imply a direct impact on that currency. If people and governments around the world decide to reduce their US$ holdings, that will have a downward push on the US$. However, people do not hold US$ balance primarily because oil trades are denominated in dollars. If oil trades were denominated in Euros, a buyer could enter two trades: sell US$ for Euros and buy Oil for Euros. This is only slightly more complicated than the single trade: sell US$ for oil. People do not trust and hold dollars because oil-trades are denominated in dollars; closer to the truth is that oil is traded in dollars because people trust it and want to hold it.

The Iranians can sleep at night, though. The U.S. government will undermine people's trust in the US$ better than the Iranians ever can.

[DarkWaters]

Unfortunately, I have never seen [the topic of sound currency] discussed by politicians in the United States, with the exception (sorry DarkWaters, I know you dislike him) of Ron Paul.

I do dislike him but not for this reason. It is nice to see a candidate who vocally expresses the need for objective value in currency. Unfortunately, to change people's minds on this, we still need a philosophical revolution in the vein of economic thought before any meaningful political reform can be achieved. It will be more meaningful when we see major candidates discuss the problem with the devaluation of the U.S. dollar (USD).

People do not trust and hold dollars because oil-trades are denominated in dollars; closer to the truth is that oil is traded in dollars because people trust it and want to hold it.

This definitely makes more sense leaving aside any initial political pressure that might have been put on Saudia Arabia to only sell oil for USDs. I imagine that the European Union governments will not exactly be angels either when it comes to maintaining sound currency.

Edited January 16, 2008 by DarkWaters

[adrock3215]

I imagine that the European Union governments will not exactly be angels either when it comes to maintaining sound currency.

We may be surprised here, because there is a major difference between the two. The European Central Bank only has one mandate - price stability. On the other hand, The Federal Reserve has a dual mandate of price stability and full employment.

[softwareNerd]

We may be surprised here, because there is a major difference between the two. The European Central Bank only has one mandate - price stability. On the other hand, The Federal Reserve has a dual mandate of price stability and full employment.

Yes, whether the Fed keeps inflation within bounds depends more on the Chairman and politics than it does on written law. On that topic, there's a long, but well-written, article in the NYTimes (today) that's well worth a read.

On the oil-trading topic, there was once a time when a lot of international trade was denominated in pound sterling, and this lingered on into the 1900's among "commonwealth" nations. This was slowly replaced by the US$. If oil trades in Euros some day, for genuine economic reasons, it will be symptomatic of the fall of trust in the US$, but it would not be the cause of such a fall.

[DavidV]

The European Central Bank only has one mandate - price stability. On the other hand, The Federal Reserve has a dual mandate of price stability and full employment.

This mandate is intentionally misleading. If the goal of Europeans was to maintain price stability, they would switch to a gold standard. The real function of the Central Bank, like all central banks, is to maintain price instability - to redistribute wealth according to the political pull of its constituent nations. It does this by manipulating interest rates and printing billions of Euros in order to create inflationary bubbles and prevent markets from self-correcting. In this regard, it is no different than the Federal Reserve. It creates the very instability that it uses to justify its coercive powers.

[adrock3215]

Just a quote I found last night that may be pertinent to the article's conspiracy theory:

"The dollar is our currency, but your problem." - John Connally, Secretary of Treasury under Nixon speaking to a delegation of Europeans after they expressed concern about exchange rate fluctuations (the duo responsible for removing America from the gold standard)

This mandate is intentionally misleading. If the goal of Europeans was to maintain price stability, they would switch to a gold standard.

Of course I agree with you about the mandates being misleading. I think it is accepted that over a given period of time the gold standard will result in maximum price stability, but it is also accepted that given a short period of time, a fiat currency will result in greater price stability. So these central banks sacrifice the long-term for the short-term, which comes as no surprise to anyone I'm sure.

The real function of the Central Bank, like all central banks, is to maintain price instability - to redistribute wealth according to the political pull of its constituent nations. It does this by manipulating interest rates and printing billions of Euros in order to create inflationary bubbles and prevent markets from self-correcting. In this regard, it is no different than the Federal Reserve. It creates the very instability that it uses to justify its coercive powers.

On a philosophical basis, neither central bank is different from the other and neither is justified. But from a practical standpoint (assuming they are both already there), the European Central Bank has a greater interest in protecting the international purchasing power of its currency. This results from it having the mandate of price stability, and not having to worry equally about employment statistics. The Federal Reserve has its hands tied, because often times price stability and maximum employment are at odds with each other. But the Fed, according to its 1913 mandate, must give each equal weight. This allows the Fed to ignore inflationary aspects of its policies if they judge those inflationary aspects to be relatively less important than a potential employment loss. The ECB has an explicit primary goal of price stability and all other data comes secondary to price statistics.

The ECB is much closer than the Fed to the type of central bank that Chicago school economists such as Milton Friedman wanted. My hope is that Austrian economics becomes the next school in the spotlight, which would mean, no central bank.

Edited January 17, 2008 by adrock3215

[DarkWaters]

Just a quote I found last night that may be pertinent to the article's conspiracy theory:

"The dollar is our currency, but your problem." - John Connally, Secretary of Treasury under Nixon speaking to a delegation of Europeans after they expressed concern about exchange rate fluctuations (the duo responsible for removing America from the gold standard

This quote is definitely relevant but I do not think that it supports the conspiracy theory. I also think that it is very believable as the Nixon Administration would surely anger the international community than the American public who would surely (and foolishly) blame his administration for the effects of the devaluation of the dollar. The latter would be analogous to how every President today receives credit or blame for any prosperity or recession that transpires under his administration, as if these are all short-term phenomena.

The current status of the United States as a huge debtor amongst the various world powers is more likely to be the result from 70 years of short-term planning financial planning from each administration (which is still bad). The explanation that this was a conscious, collaborative and surreptitious effort between the various administrations over 70 years to build and maintain a shadowy U.S. monetary empire is much less likely.