The Oil Drum

Also note that the Federal Reserve announced in Nov. 05 that it will no longer be publishing data for the M3 money supply.  This will take effect in March of 2006.

Even another twist for an interesting March is the Israeli preparation for an attack on Iran...

Dec 11, 05
http://www.timesonline.co.uk/article/0,,2089-1920074,00.html

Excerpts from the article:

ISRAEL'S armed forces have been ordered by Ariel Sharon, the prime minister, to be ready by the end of March for possible strikes on secret uranium enrichment sites in Iran, military sources have revealed.

The crisis is set to come to a head in early March, when Mohamed El-Baradei, the head of the IAEA, will present his next report on Iran. El-Baradei, who received the Nobel peace prize yesterday, warned that the world was "losing patience" with Iran.

"Defence sources in Israel believe the end of March to be the "point of no return" after which Iran will have the technical expertise to enrich uranium in sufficient quantities to build a nuclear warhead in two to four years."

Or a combination of the two.  I've followed both Petrov and your slow change method.  I dumped 60% USD overnight (@ 0.8215) then slowly bought other stuff with the remaining 40% USD (until 1.0425), meanwhile collecting on invoices in Euros, until ... no more USD.  <Not making any claims to brilliance, mostly just a feeling that the Euro wouldn't drop any lower .. and tonnes of dumb luck.. at least so far.>  Cohabitation of the two currencies doesn't seem to be a good fit and it did supercomplicate the bookkeeping figuring day to day equivalencies.  At one time I had accounts in Riyals, USD, Euros, Pounds, Swedish K and Colombian Pesos.  MSMoney lost it.  Doing things slowly helps you gain confidence as you go, rather than getting heartburn from the putting all your eggs in one basket  syndrome.  On a central bank level slow would prevent large changes from being noticed and causing a panic, so it could protect your remaining account balance as you continue to unload, provided the cat stays out of sight.  The only disadvantage of making a permanent change is, without selling Euros and changing back into dollars, there is no chance of "realizing the profit".  

Hi lads - I just printed the Petrov article and will let you know my thoughts soon.  

IRAN OIL BOURSE: ULTIMATE "NUCLEAR" WEAPON OR CONSPIRACY ON STEROIDS?

The Petrov article is an excellent platform for discussing the Iran Bourse - both because it is the most careful documentation of the argument and because the author makes no bones about his claim that it is among the primary threats to US power. Petrov calls the IOB the ultimate "nuclear" weapon, says it will "precipitate the demise of the dollar" and cause the US to take drastic actions that could include sabotage, launching coups, unilateral nuclear strikes and unilateral total war.

It not going to surprised anyone that I am going to escalate my own argument by calling the IOB the greatest conspiracy theory of the year. Below is an atttempt to deal with the issue at the level of first pricipals, since an fairly elaborate structure has been build on what I feel is a shaky foundation.

Petrov's article contains in near equal measure bold assertions that I disagree with, underlying economic concepts that I do agree with, and utter speculation about the future, which I'll leave alone.

Because the "bold assertions" recur and underpin the ongoing argument, let me start my stating my interpretation of the foundation of the "IOB as kryptonite" argument and where I differ. Fundamentally, whether you can accept the IOB premise seems to depend on whether you can accept the three claims below:

1. The foundation of US economic growth and strength is "extraction" or taxation of others, rather than creating value.

The belief that the US has a productive economy that has been growing near 3% a year because of high levels of productivity is fairly well documented. Greenspan and the US Fed focus intensely on measuring the growth in the productivity rate in the US economy because this is the key factor underlying the continuing strength of the economy. There is no tracking of "extraction rates", "taxation of economically subject nations" or trends in theft.

The extraction claim seem only to be supported by a circular argument that the US economy is based on taxing others, which is proven by the claim that the dollar as trade currency enforces it, which is in turned proven by the extraction argument. But maybe I am wrong and someone provide a factual basis for the claim that US economic strength is based on extraction of value from others by force. I am waiting.

2. The US dollar price is not only a requirement that currency be paid in dollars, but that this requirement is the primary reason why countries hold dollars

As discussed before the dollar price of oil is just a price tag. If an EU country wants to buy Iranian oil and Iran wants to hold Euros, they currently have two ways to make this happen:

a. First the EU country exchanges Euros for dollars, then transfer dollars to Iran for oil, finally Iran exchanges back into dollars. This can essentially occur instantaneously, so the time that the assets are held in dollars is so brief as to be meaningless. The beneficiaries are currency exchanges who gain a commission on both side of the deal - although the Euro/$ bid-ask spread is very small.

b. Just make the transfer in Euros at the rate based the Euro dollar exchange rate. If this is really done - as I suspect - this argument alone proves the Petrov point is wrong.

Both of these methods are no different than if I sold you a car, which I had priced at $1000. If you had Euros, you could convert to them to dollars five minutes before we met, then hand them over. I could then convert into Euros five minutes later if I wanted. In this case, it would be easier for me to just accept your Euros at the exchange rate times the price.

The IOB arguments seems to claim that the dollar police would come and hit me on the head, or blow up the cars, but again, I feel this is utter speculation. Since this is such a crucial assumption of the IOB argument, I think someone needs to document how these transactions take place. If the second method I describe above can be done, what is the use of the IOB. If it can not be done - why not?

A counter argument to this could be that by converting at the time of the transaction - rather than holding dollars - the buyer bears currency risk. But this is not really accurate. First, the same risk would exist if the transaction were conducted over an exchange such as the IOB. Second, the oil price fluctuations take into account the trade weighted average of the currencies it is procured in. There is no advantage that can accrue based on the currency oil is purchased in that can not be gained by mere speculative holdings of the same currencies.

I think it has been clearly established that there can only be one price for oil and that the IOB can only translate that price into Euros. If there are two different prices, everyone would only buy from the cheaper provider until prices equalized. If anyone disagree with this let me know.

3. Role of the US dollar is key component of US strength and the ability of the US to protect itself is economic distress by inflation.

I have no dispute with this line of argument. In fact I have used it myself in showing that the US is far less at risk from its overseas debt that it appears. I do think that if foreign economies stop sell or stop buying US dollar assets, the US can and will inflate itself out of the problem. It is not nice and does hurt the US too. But is a powerful tool and an economic reality.

However, my claim, which I have laid out in my entertaining earlier discussion with lads on the same topic (http://www.theoildrum.com/story/2005/12/27/232238/03 [scroll down]) is that this has nothing (or very little) to with prices tags or the currency used in transactions. The foundation for the predominance of the dollar is the long term holdings of dollar denominated assets, which is done voluntarily as part of a strategy of managing returns and exchange rates.

CONCLUSION:

My impression is that Petrov and his conspirators have started with a conviction that the US is an empire based on extraction of resources from others enforced by military might. The IOB argument is an attempt to reverse engineer reality to explain how it all works.

He ignores two key facts:
1.    The US economy creates value rather than steal it
2.    Other economies voluntarily hold US dollars because they also benefit

I contend that the position that one takes on these two points determines whether they will see the IOB as kryptonite or conspiracy.

Finally, one point that I find very strange. Iran has a real weapon that can harm or destroy the world economy: energy. Why try to trace such as convoluted path trying to believe they have a different one?

Hi lads,

I realized that I did not address this point: "if a country wants to dump dollars, it'll buy another foreign currency and not trade it to its own. That way an unwanted appreciation of self currency is avoided."

I do not think this is accurate. Say, country A sells country B's currency and buys country C's. It currency will go up against B and down against C. You could say that there is no net appreciation of the currency (ie. against B + C), however this is not relevant in most cases.

Turning to the real world, if China is country A, the US is B and Europe is C. You may be able to make the argument that China's currency is stable against the US and Europe. But there is no doubt that the Yuan will appreciate against the dollar. Since China's primary customer is the US consumer, the dollar exchange rate is paramount.

Whether the transaction is done by going from Dollars to Yuan to Euros or just from dollars to Euro, doesn't make much difference.

On another point, I think Petrov's treatment of the US exit from the gold standard is flawed and self-serving. The classical gold standard ended with WWI. The US returned to the gold standard in 1919 with GB, Switzerland, France and Scandinavian countries restoring it by 1928. However this was a facade version of the standard, which collapsed in 1931. After WWII Bretton Woods was convened to create exchange rate stability. It created a "Gold-exchange standard" in which the US dollar was marked to gold and all other currencies to the dollar. This was fated to fail as claimed by Robert Triffin's "Triffin Paradox", which said that this would force the US to run a balance of payments deficit.

It seems he was right and the Bretton Woods system struggled with France trying to cash out in the early sixties, the US and IMF making a series of adjustments and finally the US expansionary monetary policy, which made the whole thing untenable. Nixon did end the standard in 1971. This did benefit the US by reducing its obligation. However, Petrov's comparison with bankruptcy is overstated. A "haircut" or debt reduction would be more accurate.

I do agree that the current US monetary position resembles that of 1971 and that a comparison of the current prospects of inflating out of debt with the 1971 refusal to honor the gold standard is apt. However, the background is far more complex and the actors involved far more broad-based than Petrov would have you believe.

My source for this is a textbook International Financial Management, Eun/Resnick, McGraw Hill. However it is fairly standard stuff. You can also see:
http://en.wikipedia.org/wiki/Bretton_Woods_system