Iran Squeezes the Petrodollar

I have, these last few months, been documenting the current state of geopolitics —specifically the growing isolation of the West, the ditching of the dollar as the global reserve currency, the growing unity between the authoritarian Eurasian nations, and the brewing storm in the middle east between Israel and Iran.

Now another piece of the puzzle falls into place.

From Zero Hedge:

Much has been spun in recent weeks to indicate that as a result of collapsing trade, Iran’s economy is in shambles and that the financial embargo hoisted upon the country by the insolvent, pardon, developed world is working. We had a totally different perspective on things “A Very Different Take On The “Iran Barters Gold For Food” Story” in which we essentially said that Iran, with the complicity of major trading partners like China, India and Russia is preparing to phase out the petrodollar: a move which would be impossible if key bilateral trade partners would not agree to it. Gradually it appears this is increasingly the case following a just released Reuters report that “Iran will take payment from its trading partners in gold instead of dollars, the Iranian state news agency IRNA quoted the central bank governor as saying on Tuesday.”

The Eurasian powers — centred around the troika of Russia, China, and Iran — continue to ransack the dollar’s legitimacy as the global reserve currency.

Meanwhile, in a Foreign Affairs piece, the architect of our current world order, Henry Kissinger, seems to see the writing on the wall:

The current world order was built largely without Chinese participation, and hence China sometimes feels less bound than others by its rules. Where the order does not suit Chinese preferences, Beijing has set up alternative arrangements, such as in the separate currency channels being established with Brazil and Japan and other countries. If the pattern becomes routine and spreads into many spheres of activity, competing world orders could evolve. Absent common goals coupled with agreed rules of restraint, institutionalized rivalry is likely to escalate beyond the calculations and intentions of its advocates. In an era in which unprecedented offensive capabilities and intrusive technologies multiply, the penalties of such a course could be drastic and perhaps irrevocable.

Kissinger recognises the Eurasian endgame — also described by me quite throughly over the six months:

Some American strategic thinkers argue that Chinese policy pursues two long-term objectives: displacing the United States as the preeminent power in the western Pacific and consolidating Asia into an exclusionary bloc deferring to Chinese economic and foreign policy interests. In this conception, even though China’s absolute military capacities are not formally equal to those of the United States, Beijing possesses the ability to pose unacceptable risks in a conflict with Washington and is developing increasingly sophisticated means to negate traditional U.S. advantages. Its invulnerable second-strike nuclear capability will eventually be paired with an expanding range of antiship ballistic missiles and asymmetric capabilities in new domains such as cyberspace and space.China could secure a dominant naval position through a series of island chains on its periphery, some fear, and once such a screen exists, China’s neighbors, dependent as they are on Chinese trade and uncertain of the United States’ ability to react, might adjust their policies according to Chinese preferences. Eventually, this could lead to the creation of a Sinocentric Asian bloc dominating the western Pacific. The most recent U.S. defense strategy report reflects, at least implicitly, some of these apprehensions.

He ends the piece flatly:

Both sides should be open to conceiving of each other’s activities as a normal part of international life and not in themselves as a cause for alarm. The inevitable tendency to impinge on each other should not be equated with a conscious drive to contain or dominate, so long as both can maintain the distinction and calibrate their actions accordingly. China and the United States will not necessarily transcend the ordinary operation of great-power rivalry. But they owe it to themselves, and the world, to make an effort to do so.

But — in reality — American and Western policy is nothing like as respectful toward China as Kissinger might hope.

As I wrote earlier this month:

The last hope for American imperial hegemony is to bring the Arab Spring to Moscow, Beijing, Tehran, and Islamabad.

Kissinger — while not explicitly endorsing such an eventuality — recognises the possibility:

The political scientist Aaron Friedberg writes, for example, that “a liberal democratic China will have little cause to fear its democratic counterparts, still less to use force against them.” Therefore, “stripped of diplomatic niceties, the ultimate aim of the American strategy [should be] to hasten a revolution, albeit a peaceful one, that will sweep away China’s one-party authoritarian state and leave a liberal democracy in its place.”

And — for all the hullabaloo about war with Iran —the Arab Spring model is the State Department’s last best hope for maintaining American primacy in the face of (as Tyler Durden puts it) insolvency. War, proxy war, or trade war with the Eurasian powers is too costly, too risky, too open-ended for America today.

44 thoughts on “Iran Squeezes the Petrodollar

  1. These trends are the wave of the future. Brazil, Russia, Iran, China…100% realize that bypassing the Dollar/Euro hegemony is the best way forward to their respect prosperities.

    By the way, I had a conversation with one of my best buddies. He bought a house in CA in 2006. He is currently underwater on his mortgage to the tune of $300,000. My buddy’s income is guestimated at $150,000+ a year (He is very successful.) But, because he is underwater by a such a huge amount on his mortgage, he is thinking of mailing the keys back to bank. His rational is this (paraphrased as much beer was involved),

    “Here I am making boatloads of money and I feel poor. I am now a father of 2 young children, but I rarley get a chance to see them because my commute is 2+hours a day. It makes more financial and quality of life sense for me to stop making to mortgage payments and move my family to within 5 miles of work. I can save the spread (The difference between the PITI and renting) and in 7-10 year buy my current house in cash. I also will get to watch my young family grow-up.”

    My buddy is in the top 10% in earned income. He is a self-made man. He is not stupid. He is doing what he thinks is best for him and his family.

    Moral hazard, coming to your town in 2012.

    • Is it really moral hazard? Strategic defaults are sane and rational. If a position is unsustainable and underwater, you liquidate.

      Or am I being simplistic? Is the moral hazard the banks ending up with lots of losses stacking up and needing some big bailouts?

        • Your buddy isn’t thinking it through enough. He should hold on to the keys, stop paying the mortgage (the first mortgage that is.if he has a heloc he should probably pay it fast and wipe it out as it likely has recourse). Save up the money and when the foreclosure paperwork gets settled in 18-36 months, just move out. Why pay rent when you can live in the house for free? Granted the commute… but if he’s saving the $4,000-$6,000/mo his mortgage cost, he could really come out ahead. The backlog on foreclosures, combined with the fact that banks don’t want to foreclose a property that is so underwater (and have to mark the asset to market) is what really produces the moral hazard.
          Mailing the keys back and moving out? That’s either the honorable approach or the sucker’s move… depending on your perspective.

        • Another good point or two made by hawks.

          I believe he has that moral thing working against him. He is a honest man.

      • “Is it really moral hazard? Strategic defaults are sane and rational. If a position is unsustainable and underwater, you liquidate.

        Or am I being simplistic? Is the moral hazard the banks ending up with lots of losses stacking up and needing some big bailouts?”

        I agree 100% with the strategic default. The banks took a known risk by funding the purchase of a home, and they knew they would get the home back if the buyer defaulted. It’s a contract like any other.

        Strategic default, however, would not be possible under an equity-based contract now would it Aziz?

        • So… Sell the home?

          Still not as simple as walking away is it? I was under the impression thought that by defaulting on his mortgage, the bank would get an equity stake int he income of the individual…

        • Depends on the terms of the contract. This is all very hypothetical. I would imagine different loans would be securitised differently. Mortgages could still be equity in the home. Personal loans could be equity in personal income. Business loans could be direct equity in the business, or equity in the property of the business, or equity in future revenue streams, etc.

        • I don’t know Aziz, just seems riddled with problems. Sure it’s hypothetical but if a hypothetical system can’t withstand a hypothetical scenario, I won’t have much chance of going past the hypothetical stage will it?

          Imagine an equity based contract for a mortgage, with equity in the home as you state. Buyer buys a home for 450M, bank lends. home value goes down to 150M, buyer chooses to default. Bank now owns part of the home (instead of all of it as the current system works, correct?) Then you have a disgruntled buyer, who still owns 50% of a home he doesn’t want and the bank owning the remainder (or 10/90%, 20/80%, etc).

          How would that work? The bank would charge rent to the individual? I’m sorry to be a nag but I just don’t see how this would be possible. It’s alot easier for the bank to foreclose and mitigate its loses in the current system. That way the bank mitigates its losses, and the disgruntled individual can walk away and start fresh.

        • Don’t worry, I’m trying to understand this as well.

          Under the present model, in such a situation the house is liquidated, the homeowner loses everything, and the bank gets a sliver of the initial capital back.

          There is a hidden and dangerous effect here: the present system favours liquidation and nothing hurts mark-to-market values more than mass liquidation . Thus, you get a feedback loop: as more houses are liquidated, prices fall (mark-to-market), more homeowners end up underwater, more houses are liquidated, and prices fall more.

          Under an equity-based model — ignoring the fact (explained above) that such a drastic fall in prices is much less probable — the problems of such a fall are smaller. The disgruntled buyer can sell out (either to the bank, or another buyer) and pick up a decent sum of cash (perhaps less than they put in, but still a decent amount — probably enough for the downpayment on another house, or clearance of further debts), whereas under a foreclosure they’d likely get nothing. The bank — rather than automatically liquidating (and thus driving house prices, and thus their own asset base even further into the mud) — could sit on the asset and collect rent from a tenant, thus achieving some cashflow.

          What is completely non-hypothetical by the way (and the point I was trying to raise in my initial post) is that bubbles happen, and that equity bubbles (e.g. NASDAQ bubble) tend to be much less damaging than debt bubbles (e.g. Subprime bubble).

        • Thanks for the explanation. I will continue to think about this one. It would require a new type of bank as banks as they are now are not interested in becoming landlords, or business partners.

          I can foresee a small problem – if a bank has the potential to become part owner of a business/asset/venture, it might INTENTIONALLY push the borrower to default in order to obtain the equity. through corruption like this, isn’t it a possibility that these new banks might end up owning a vast majority of the world’s assets, as well as a vast majority of the world’s businesses?

          In any case, thanks for giving my brain cells something to digest.

        • No particular economic system is particularly strong against direct and deliberate criminality. It’s a judicial matter, and you need a strong judicial system to protect equity holders.

          However, I’d say that liquidation today tends to benefit banks more than it would under my proposed system — banks get all the months and years of repayments, and post-default they tend to take the whole house. For that reason, post foreclosure, it’s much, much, much easier for banks to break even (when including past mortgage payments and interest) than it is for homeowners (when deducting past mortgage payments and interest).

        • I have no idea about the details of how that would have worked. But perhaps the underlying idea is more important.

          And I think the underlying idea is about adding more “continuity” to the processes in the economy. This would avoid the unexpected outcomes when those “discontinuities” occur – and more importantly when they occur simultaneously for many different processes.

        • PS: Obviously, things like “smoothing” the economic cycles are not policies that add more “continuity” – they falsely do it at the expense of later and harder crashes (“discontinuity”). The “continuity” I’m envisaging is one that on the contrary, would apply an opposite pressure to inflating bubbles before they become too dangerous.

    • We haven’t had our crash in Australia yet. We have the absurd situation where our capital city lies in the middle of farmland, with real estate prices propped up by not releasing any land for new housing. I’m trying to tell a work friend to invest in something other than real estate as she has about 4 houses, all leveraged. Dangerous times ahead for Aussie real estate owners.

  2. Bah. The Arab Spring gimmick didn’t even work in the Middle East. Why should it do so in China or Russia? (We have yet to see any liberal democracies emerging in Libya, Egypt etc.)

    • At a deeper level it’s not really about liberal democracy. It’s about adherence to American interests.

      Of course, there’s no guarantee of that either. I expect the Arab Spring nations to emerge as less friendly to America than ever.

      But what this captures is the level of desperation in Washington.

  3. “the ultimate aim of the American strategy [should be] to hasten a revolution, albeit a peaceful one, that will sweep away China’s one-party authoritarian state and leave a liberal democracy in its place”

    LOL, do these people never learn? How did this work out in the past? Actually, how did even grassroots revolutions (not started by outside powers deliberately) turn out on average?

    • The top theorists and practitioners of international relations in America do not take this rubbish and nonsense seriously. But America cannot afford any more proactive measures.

      The people running the White House’s policy unfortunately have a strong penchant for this kind of magical thinking, and so are committing an unwise amount of intellectual and financial resources to such projects.

  4. The best advice I heard about this situation is:

    “Iranians are Persians, and in their mind have a historical superiority over other nations. This confidence gives them an intellectual edge to wait out this end game”.

    • The batshit-insane neocon corollary:

      “Iranians are Persians, and in their mind have a historical superiority over other nations. This confidence means they will turn their entire 3,000-year old nation into a suicide bomb in the hope of taking out a few Jews”.

  5. I do not see how liberal democracy would prevent hostilities, unless Kissinger is saying that with a liberal democracy the owners of capital become globally united or bought out by a smaller group.

    • When Friedberg says “liberal democracy” what he actually means is “getting our people into power”.

      In the Arab world, more democracy has meant more hostility to America and the West. I can only imagine China would be similar. They hold a grudge, because of the way they were treated by the Anglosphere in the 20th Century.

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  16. I’m not sure I really get this everybody trades in dollars bit. I think it might be one of those ignorant erroneous internet theories. I’m not sure I buy the every thing trades in dollars, euros, and yen theory. Because, trade had been historically and also presently done a different way!

    When I order an oil tanker of oi,l do I drive a pickup truck full of hundred dollar bills across a boarder to pay for it? (I once figured roughly how much money it would be.)

    In the days of gold and silver money it was much, much, much, better for mutual traders to use bills of exchange instead of gold and silver! Double entry bookkeeping helps understanding this.

    Here is why it:
    1. With the bills of exchange you need much less or no bullion.
    2. Bullion in transit is vulnerable
    3. Money for the whole amount was not needed just the differences of the trade. And, the difference could be paid in future goods by agreement. Bills can be used.
    4. The goal of the merchant traders is to trade goods between them selves to sell at a premium.
    5. The bills allowed twice as many trades because traded goods can be moved both ways at the same time. If you waited for gold before you sent some thing you would make half as many profitable transactions. Maybe square rooting your profits compared to using bills! Because your material wealth compounding rate is 1/2.
    6. Usually traders would have agents on both sides or the trade partner might be a good agent.
    7. This has been used for hundreds if not thousands of years. Maybe 10,000s of years.
    8. It is real trade. If there was a trade deficit. People might correct it or add more trade partners. And if not bills would be sold at discounts and premiums.
    9. So there is a bill market too. Today I thinkg mutual funds are a bill market.

    So, I guess trading in a few currencies is an ignorant error. Maybe trading denominated in those units of account. But, that is different than trading with money.

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