IRANIAN WORLD IMPACT
With oil the anchor for currency, America needs to open its eyes
to Middle Eastern tension
BY DOUG WAKEFIELD
Some say that I have gone too far. Others question my sanity and my business savvy. They insist I could lose readers, or business, or your respect with the painful topics I'm about to address. As investment advisors, Ben Hill and I are told to always be optimistic. But, I figure, if you didn't believe that the huge imbalances our world is currently experiencing pose a threat, you probably wouldn't be reading this piece. By necessity, we all talk every day with family, friends and associates who feel that optimism is the only constant need in life. Plainly, based solely on the fact that it doesn't leave them with "warm fuzzies," many of them will dismiss the material in this article.
As investment advisors, we are taught to always conclude with profits. Our conversations should go something like, "Bird flu could kill millions, so here are the five companies you need to invest in to get rich." To me, that's always seemed barbaric, or at least extremely calloused. Richard Russell says, "Everybody loses in a bear market. The winner is the one who loses the least." I like that. It's much closer to reality.
We will all read this and other sources, and make our best calculations and judgments and invest accordingly. Yet, the distinct probability remains that we may invest and make money, and perhaps a lot, but we will likely feel less secure than we do today. That's the part that's guaranteed. That's why I like what Russell has to say.
I am an American. My father and mother were depression-era people who struggled greatly through that period of our nation's history. At the age of 17, my father entered the Army Air Core to fight in World War II. He was a tail-gunner on a B-24. At the age of 19, he was shot down over Austria, and survived as a prisoner of war from November of 1944 until he was set free in April of 1945. Over the past 60 years, my father's story is one of the many American Dream stories that has inspired me.
My point is this: in speaking about America's shortcomings, it is never my intention to be disrespectful to those who have sacrificed far more than I have for our freedom. Indeed, it is by their sacrifice that I am able to write freely about our nation's past.
Economist Dr. Marc Faber said, "Now, you may think that I have become insane. That is partially true because I am convinced that the U.S. Fed's monetary policies will lead to exponentially widening wealth inequity and impoverish the majority of U.S. households, which will then lead to social strife, protectionism, war, and the breakdown of the capitalistic system."
Dr. Faber called the Crash of 1987, the Japanese stock market crash of 1990, and the Asia-Pacific financial crisis of 1998. As such, I tend to respect his opinions. A few months earlier, while speaking at a Dallas luncheon, Dr. Faber touched on the same topic. Because his comment was so different from what we normally hear in the world of investment advice, it was quite memorable.
He said, "Today the brokerage industry does not have analysts whose specific job is to evaluate geopolitical risk. I think, over the next several years, this will change to where we will see analysts who specialize in areas such as this."
I am certainly not a geopolitical analyst. Yet, I have begun to monitor circumstances with which some of you are already familiar. With the gravity and scope of the potential effects of this situation, I feel compelled to present an orderly and balanced account. Depending on how far back one wants to look, these events have been unfolding for decades, if not longer.
All of this has led us to a point where Iran has taken center stage. Dr. Krassimir Petrov, a Ph.D. from Ohio State who is currently a professor at the American University in Bulgaria, has recently completed a very informative article titled, "The Proposed Iranian Oil Bourse." This article opened my eyes to the immediacy of the tensions that have been building in the Middle East. These developments carry with them such a massive potential for detrimental change to the United States, that "financial warfare" could be considered a fitting term.
Financial warfare is not a term of my own creation. Rather, the term comes from a book, Unrestricted Warfare, which claims to be a direct translation of an original Chinese document, written by Colonels Qiao Liang and Wang Xiangsui of the People's Liberation Army and published in China in February of 1999.
The book notes that the original document is well-known by the CIA and America's national security establishment. In addressing various types of "unrestricted warfare" where "there are no rules," the authors introduce "Financial War."
"Financial warfare has now officially come to war's center stage - a stage that for thousands of years has been occupied only by soldiers and weapons, with blood and death everywhere. We believe that before long, 'financial warfare' will undoubtedly be an entry in the various types of dictionaries of official military jargon."
But China is neither the focus of this article. On March 20, a historic occurrence will take place, which does not bode well for the reserve currency status of the U.S. dollar. On that date, Iran is scheduled to open an Oil Bourse (Exchange) that will trade in Euros. As always, it is only in understanding the past that we can perceive the magnitude of this exchange.
In August of 1971, Nixon took the United States off of the gold exchange standard and the last bastion of gold-based currencies ceased. Prior to this point, foreign central banks had the ability to exchange any U.S. dollars they accumulated for gold. Because we were expanding our money supply rapidly, many central banks around the world had done just that. As such, from 1958 to 1971, our gold stock had fallen from $19 billion to $10 billion, and over the same time, U.S. liquid liabilities to foreign central banks had risen to over $60 billion. Though, this is, comparatively, a pittance to the trillions we owe today, the demand, especially from France and Britain, became so strong that the United States reneged on this agreement, and the world embarked on the current free floating currency system we know today.
But the world needed something to take the place of gold as the "anchor" for currencies. Oil became this benchmark. According to David Spiro's book, The Hidden Hand of American Hegemony, OPEC had discussed pricing oil with a basket of currencies. An unpublished proposal involved currencies from the G-10 (Group of Ten) nations. The members were to include the Bank of International Settlement, Austria, Switzerland, Germany, France, the UK, Japan, Canada, the Saudi Arabian Monetary Authority and the United States. Even though a basket of currencies was discussed, something happened which caused oil to trade solely in dollars.
In his book, Petrodollar Warfare, William Clark offers an explanation: "In order to prevent this monetary transition to a basket of currencies, the Nixon administration began high-level talks with Saudi Arabia to unilaterally price international sales in dollars only - despite U.S. assurances to its European and Japanese allies that such a unique monetary/geopolitical arrangement would not transpire. In 1974, an agreement was reached with New York and London banking interests that established what became known as 'petrodollar recycling.' That year the Saudi government secretly purchased $2.5 billion in U.S. Treasury bills with their oil surplus funds, and a few years later Treasury Secretary Blumenthal cut a secret deal with the Saudis to ensure that OPEC would continue to price oil in dollars only."
To this day, when oil trades on the New York Mercantile Exchange (NYMEX) or the London International Petroleum Exchange (IPE), all of the transactions are made exclusively in dollars. This means that every country in the world has to exchange their currency for U.S. dollars in order to buy or sell oil.
Again, if Russia, Argentina or Iran wants to sell oil to China, India or France, they must do so in U.S. dollars. Because of this, each country keeps an ample supply of dollars on hand, hence the term "reserve currency." Needless to say, this gives the United States certain economic advantages.
Yet, all of this is about to change. On March 20, Iran is scheduled to begin trading oil contracts on its own exchange and, you guessed it, none of the contracts will trade in U.S. dollars. Instead, they will trade in Euros. This threatens the reserve currency status of our dollar, and, as such, has huge implications for our heavily indebted and fiscally unbalanced nation.
The following comments from Jerome Corsi's February 2006 article titled, "Iran, Venezuela declare war on petrodollar," point to the fact that some OPEC countries are already divesting themselves of U.S. dollar reserves, and that China has declared this intention as well.
Venezuela and Iran have in mind a politically motivated decision to move out of foreign-exchange currency holdings in the dollar as a conscious decision to wage economic war against America. Beginning in 2003, Iran began demanding oil payment in Euros, not dollars, although the oil itself was still priced in dollars. In October 2005, Venezuelan President Hugo Chavez announced that Venezuela was ready to move the country's foreign-exchange holdings out of the dollar and into the Euro.
In 2004, the Switzerland-based Bank for International Settlement reported that the U.S. dollar-denominated deposits of OPEC countries fell from 75 percent of their total deposits in the third quarter of 2001 to 61.5 percent by the end of 2003. In the same period, the share of euro-denominated deposits of OPEC countries rose from 12 percent to 20 percent. OPEC member Euro-denominated deposits reached 44 billion in June 2004, nearly double the 23.4 billion Euros these countries held in the third quarter of 2001.
In 2005, China negotiated major oil and natural-gas rights from Iran. Now under pressure of being referred to the United Nations Security Council over their nuclear program, Iran is counting on China to veto any strong move by the United States to have Iran sanctioned.
China has the world's second-largest cache of foreign-exchange currency - some $800 billion today. In January, China announced an intention to reduce 75 percent of its foreign-exchange reserves currently held in the dollar. Whether we realize it or not, we are already involved in an economic war that could easily turn in to a shooting war, starting with Iran.
But before we move this discussion further, let's look at one more aspect of the strained history of American and Iranian relations. The Jimmy Carter Presidential Library gives the United States' official version of the events leading up to the Iran Hostage Crisis.
Mohammed Reza Pahlavi, Shah of Iran, began his reign in 1941, succeeding his father, Reza Khan, to the throne. In a 1953 power struggle with his prime minister [Mohammed Mossadegh], the Shah gained American support to prevent nationalization of Iran's oil industry. In return for assuring the U.S. a steady supply of oil, the Shah received economic and military aid from eight American presidents.
Early in the 1960s, the Shah announced social and economic reforms but refused to grant broad political freedom. Iranian nationalists condemned his U.S. supported regime and his "westernizing" of Iran. During rioting in 1963, the Shah cracked down, suppressing his opposition. Among those arrested and exiled was a popular religious nationalist and bitter foe of the United States, the Ayatollah Ruhollah Khomeini.
Between 1963 and 1979, the Shah spent billions of oil dollars on military weapons. The real price of military strength was the loss of popular support. Unable to sustain economic progress and unwilling to expand democratic freedoms, the Shah's regime collapsed in revolution. On Jan. 16, 1979, the Shah fled Iran, never to return.
The exiled Ayatollah Khomeini returned to Tehran in February 1979 and whipped popular discontent into rabid anti-Americanism. When the Shah came to America for cancer treatment in October, the Ayatollah incited Iranian militants to attack the United States. On November 4, the American Embassy in Tehran was overrun and its employees taken captive. The hostage crisis had begun.
Like so much U.S. history, this account is partially true. The Shah did gain the support of the American government to prevent the nationalization of Iran's oil industry. In his book, Petrodollar Warfare, William Clark gives another account of the underlying stressors that may have led to the Iran Hostage Crisis.
"During the 1940s, the Anglo-Iranian Oil Company reaped over 80 percent of the profits from Iran's oil exports. For example, in 1947 the British oil company reported an after-tax profit of $40 million but gave Iran only $7 million and failed to live up to its earlier agreements to spend some of the profits to improve the deplorable conditions at the main oil fields in Abadan. The widespread abuses and arrogance of the British-controlled company had increased the level of social discontent within Iranian Society. These sentiments were shared by an Iranian politician in his early 60s, Mohammed Mossadegh, a staunch nationalist and anti-communist."
George McGhee, of the U.S. State Department, took notice of the Anglo-Iranian Oil Company selling its oil for 10 to 30 times production cost. He warned the British that they were "genuinely hated by the Iranians." Still, the company refused to offer any financial disclosures or to change the distribution of its profits.
The company's intransigence on this issue ignited Mossadegh's candidacy for prime minister. In 1951, he was elected to the Iranian parliament by a vote of 79 to 12. Upon election, Mossadegh pursued his campaign promise and sought a more equitable distribution of Anglo-Iranian Oil Company's profits, but again the company refused. Mossadegh then nationalized the oil company and offered the Anglo-American Oil Company a 50-50 split on the profits.
In and effort to block Mossadegh's actions, British Prime Minister Arden froze Iran's financial assets, and claimed that the nationalization of their country's oil was illegal. But, the world court upheld Mossadegh's actions.
In 1953, CIA director Dulles, an attorney who had represented various U.S. and U.K. oil interests, told Eisenhower that "a communist takeover was becoming more and more apparent." In response, Eisenhower agreed to a covert operation known as Operation Ajax, in which the CIA successfully overthrew Mossadegh and installed the previously mentioned Mohammed Reza Pahlavi as Shah. As noted in the Carter library, Pahlavi fled Iran as the Ayatollah Khomeini took power in 1979.
I should make something perfectly clear. As disappointed as I am at America's unseemly dealings with Iran and other countries in the past, I am glad that I do not live in Iran and am not na�ve enough to believe that the Ayatollah Khomeini is anything close to a benevolent dictator. Since the Ayatollah Khomeini took power in 1979, the country's economic situation has drastically worsened and their track record on human rights has become increasingly atrocious.
The following comments from Congressman Curt Weldon's Iranian contact, "Ali," point to Iran's abysmal economic track record. In 1975 and 1976, following an increase in oil revenues, Iran paid back all of its international debt. In 2003, even after rescheduling its debt several times, Iran's foreign debt exceeded $20 billion. In 1979, per capita income was $2,300. In 2003, it had declined to $750. In 1979, the foreign exchange rate was $1 to 70 rials. In 2003, the rate was $1 to 8,500 rials, an increase of 1,200 percent. The inflation rate is well above 250 percent per year. In 2003, Iran's unemployment rate was around 30 percent.
In regards to Iran's human rights violations, in 2004: "Scores of political prisoners, including prisoners of conscience, continued to serve prison sentences following unfair trials in previous years. At least 159 people were executed in 2004, including at least one minor. Scores of others, including at least 10 people who were under 18 at the time the crime was committed were sentenced to death. At least 36 people were sentenced to flogging. Torture continued to be routine with many prisons. The true number of those executed or subjected to corporal punishment was believed to be considerably higher. On Aug. 15, Atefeh Rajabi, reportedly aged 16, was hanged. She was sentenced after a grossly unfair trial. If a woman does not wear her veil properly, or is caught wearing vulgar shoes or sunglasses, she is sentenced to 76 lashes."
It is painful for me to write such things, but we must realize that we are not dealing with kind leaders who are only retaliating against U.S. actions. Many, writing about our currency issues of late, write only of U.S. grievances and omit the fact that we are dealing with a government that crushes its own citizens under a state of terrorism and oppression.
Over the last three years, in seeking to understand and assess Iran as a military threat to the United States, I have read a fair amount on the subject. When I read Petrov's piece on the Iranian Oil Bourse, the history of the petrodollar allowed me to see an angle to this conflict that had previously eluded me. The American history that I was taught is bent toward idealism. Yet, America has a darker side to her past. In reading Petrov's article, I was confronted with the proposition that America is capable of being the aggressor in a financial war. Now I have to face the fact that American leadership and Iranian leadership seem to be moving our world into the broader war that the Chinese described in 1999.
We have seen that official and unofficial versions of our past dealings with Iran vary. The same is true when we look at Iran's potential nuclear capabilities. Since geopolitical risks are a valid risk to investors, this topic is not some irrelevant discussion of war and politics. We can see the situation that has come about as the result of the U.S. domination of oil trade. Yet, some who write of U.S. dollar hegemony seem na�ve in their assessment of terrorist states.
While I have written about our country's historical mistakes, the view that the Mullahs, Iran's religious leaders, and Mahmoud Ahmadinejad, Iran's president, are honest leaders who have no nuclear weapons is dangerous and keeps us from seeing developments in a bigger picture. As evidence of dichotomy, on one side we see the discussion of U.S. attempts to preserve its reserve currency status, and on the other side we see the discussion of Iran's nuclear and terrorist capabilities. Indeed, Iran's nuclear capabilities are far more advanced than many sources have led us to believe.
Consider the following. One perspective notes, "CNN will have you believe that Iran is causing nuclear problems by refusing to scale back its nuclear program."
Yet, the following description of a visit by General Mohammad El Baradei, head of the International Atomic Energy Agency, a United Nation's Agency, can be found in Kenneth Timmerman's book, Countdown to Crisis. "The project manager [Baradei] was visibly nervous when Aghazadeh [chief of Iranian Atomic Energy] ordered him to open the heavy blast doors that lead down the Ushaped tunnel to the cavernous underground halls. As they quickly scanned the vast space, Heinonen's [Head of the IAEA top-secrets safeguards unit] enrichment experts were stunned by what they saw. They all had read the reports of Iran's clandestine procurement of centrifuge equipment. But none had expected to see a well-designed underground production plant, scaled to accommodate 50,000 enrichment centrifuges and all the fittings: piping, chillers, power inverters - the works. It was not an industrial facility like any they had ever seen, but a hardened military plant, built to withstand a missile strike.
"There were two square production halls, each roughly 320,000 square feet, the project manager said. It was big, impressive, and, until then, totally secret. The Iranians always had denied they had built an enrichment plant. Here was incontrovertible proof that they had been lying. Heinonen's top expert did some quick math. Once all the centrifuges were installed, the facility reasonably would produce around 150,000 separative work units of lowenriched uranium (LEU) per year - barely enough to feed the mammoth Busheir plant, if that was indeed Iran's intention. But if they fed the LEU back into the cascade instead of extracting it for reactor fuel, they could produce roughly 500 kilograms per year of bomb-grade material - enough for 25 to 30 bombs, even with a lot of waste."
Again, in an article separate from his earlier mentioned book, William Clark notes: "The Washington Post reported that the most recent National Intelligence Estimate (NIE) of Iran's nuclear program revealed that, 'Iran is about a decade away from manufacturing the key ingredient for a nuclear weapon, roughly doubling the previous estimate of five years.'"
Again, Timmerman describes Iran's firing of a long-range missile, the Shahab-3, on July 21, 1998 and CIA director George Tenet's response. "Under the watchful eyes of Russian technicians and Revolutionary Guards, officers from the newly formed Missile Corps, the first Shahab-3 prototype was hoisted into a vertical position on its Mercedes launch vehicle, and the huge, liquid-fueled engine fired. Seconds later a warning flashed on the giant video screen in the war room inside Cheyenne Mountain, when U.S. Air Force Space Command early-warning satellites and long-range phased array radar picked up the launch. Later that day, photo analysts at the National Reconnaissance Office poured over the imagery. CIA director George Tenet was stunned. And angry. Just months earlier he had told a congressional panel that Iran was still 'five to 10 years away' from developing medium-range missiles capable of reaching Israel and would not be capable of building a missile that could threaten the United States before 2010."
Ron Paul, a congressman I highly respect, recently stated the following: "The administration announcement in 2001 that Iran was part of the axis of evil didn't do much to improve the diplomatic relationship between our two countries. Recent threats over nuclear power, while ignoring the fact that they [Iran] are surrounded by countries with nuclear weapons, doesn't seem to register with those who continue to provoke Iran. With what most Muslims perceive as our war against Islam, and this recent history, there's little wonder why Iran might choose to harm America by undermining the dollar. Iran, like Iraq, has zero capability to attack us."
Yet, Congressman Curt Weldon, whom I also highly respect, is Vice Chairman of the House Armed Service Committee. Weldon received the following communiqu� from an Iranian contact, "Ali," on April 29, 2003. "Iran is going to experiment with a missile in the next weeks. Iran has several missiles with a range of 3,500 km. I gave you a memorandum on Iran's atom bomb program. I am trying to get you the information you asked me. As you emphasized yourself this is of utmost importance. Tehran believes firmly that with regard to its program of missiles and atomic bomb, Israel deserves no future in the region, and Iran is concentrating more and more on a second 11 September attack against the United States."
Timmerman corroborates this extreme terrorist view. "Dr. Hassan Abassi was the top theoretician for the Revolutionary Guards. In the early 1980s, he formulated the doctrine of export of the revolution that led to the creation of Hezbollah in Lebanon. He'd been inspiring and indoctrinating young Iranians ever since. Abassi believed the Islamic Republic of Iran had a mission to expand the Dar al Islam - the House of Islam - until Islam had conquered the world. It had been the Prophet's mission at the birth of Islam. Imam Khomeini had made it Iran's mission today."
As further evidence of Iran's growing instability, Iran's President, Mahmoud Ahmadinejad, stated the following on Oct. 26. "Speaking at a seminar entitled 'World without Zionism' Ahmadinejad said that Israel was the product of an ideological war between the 'Arrogant World Order' and the 'Islamic rule,' adding that the Jewish state had to be wiped off the face of the earth. The creation of the occupying regime in Qods [Israel] is a strong action by the ruling arrogant (imperialist) world order against the world of Islam. There continues a historic war between the World Arrogance and the Islamic world, the roots of which go back hundreds of years ago," Ahmadinejad said. "Over the past 100 years, the last bastions of the Islamic world have collapsed. The World Arrogance turned the Zionist regime occupying Jerusalem into a staging-ground to dominate the Islamic world."
I believe that, whether their focus is on financial or militarily aspects, we can and must learn from those who are experts on Iran's impact to our world. Both groups have excellent points that must be considered. If we exclude one side of the equation, we will come to skewed and incorrect conclusions. We must listen to both the financial and military sides of the discussion of Iran. In so doing, we will avoid the rhetoric of political infighting and the dualism that keeps us from seeing some of the crucial elements of this risk that we all face.
While most of us have spent a great deal of time looking at the systemic risks that are growing in the financial landscape, it should come as no surprise that the military landscape has many parallels. In this article I have outlined the problem. Soon I will address four patterns that we have become familiar with on the financial side and will show how these patterns are present in the military and diplomatic side of this issue as well. The Iranian Oil Bourse may turn out to be one of the most important developments of our lifetime. LW
Doug Wakefield is president of Texas-based Best Minds Inc., a Registered Investment Advisor, whose objective is to educate investors on what the �best minds� in the world of finance are saying and doing. To sign up for Best Minds Inc.�s free newsletter, visit www.bestmindsinc.com.
