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A Fist Against the Dollar

Why are Ahmadinejad and Chavez laughing about crude oil & the US Dollar...?

brother countries, united like a single fist," declared Venezuelan kingpin Hugo Chavez after meeting Mahmoud Ahmadinejad, president of Iran, in Tehran on Nov 19th.

   "We have common viewpoints and we will stand by each other until we capture the high peaks. God is with us and victory is awaiting us," added Ahmadinejad, vowing to defeat US imperialism together and pointing to the fall of the US Dollar as the prelude to the end of America's global dominance.

"Don't you see how the Dollar has been in free-fall without a parachute? The US prints Dollar bills with no real economic foundation. Soon we will not talk about dollars, because the empire of the Dollar is crashing. The day will arrive not only in OPEC, but also in Latin America, when we will be liberated from the Dollar.

"With the fall of the US Dollar, US imperialism will fall as soon as possible," Chavez declared.

Why are Ahmadinejad and Chavez laughing? Oil prices are up 56% this year after nearly reaching $100 per barrel. At the same time, the US Dollar is mired at a 20-year low, with the US economy teetering on the verge of a recession.

   The US Dollar has fallen over 50% versus the Euro since 2002, and oil prices are nearly five times higher over the same time period. Increasingly, the US dollar's reserve currency status is looking very fragile. Perhaps, all that's left supporting the greenback is America's military might.

   "They get our oil and give us a worthless piece of paper," Ahmadinejad told OPEC ministers in the Saudi capital of Riyadh, insulting the US Dollar. But the more the US Dollar slides, the less foreign investments in the US capital markets are worth, and the more likely that foreigners could withdraw en masse.

   If that were to happen, the greenback would collapse.

   "The Dollar is losing its status as the world currency," warned Chinese central bank director Xu Jian on Nov 7th. "We will favor stronger currencies over weaker ones, and will readjust accordingly," added Cheng Siwei, vice chairman of China's National People's Congress, signaling plans to diversify Beijing's $1.43 trillion of foreign exchange reserves.

   Over the past six months, China, Japan, South Korea, and Taiwan have been net sellers of $65 billion of US Treasuries. However, the Arab Oil kingdoms have picked up the slack, boosting their holdings of US Treasuries through their agents in London and providing the Dollar with vital life support.

   Holdings of US Treasuries from the United Kingdom have soared by $205 billion from a year ago, allowing Asian central banks to scale down their exposure to US bonds in an orderly fashion.

   The Arab Oil kingdoms are plowing petro-dollars into US Treasuries, but they are also facing the same quagmire that's entrapping China – an inevitable devaluation of their pegged currencies alongside the US Dollar.

   Earlier this week, the Dubai-based Arabian Business magazine fed speculation of a UAE dirham revaluation of 3-5% as early as this weekend, pushing the Saudi Riyal to a 21-year high and the Qatar Riyal to a five-year high against the dollar, on ideas of a coordinated currency shift.

   Now Washington is asking the Saudi king for more big favors: Maintain the Saudi Riyal peg to the Dollar at all costs, and start pumping more oil this winter, to keep prices from climbing above $100 per barrel.

   But keeping the Dollar peg intact threatens the Saudi kingdom with hyper inflation and social unrest. Pumping more oil endangers budding relations with Iran, and could trigger a sharp downturn in the Saudi stock market, which is just starting to recover from a brutal 60% correction.

   Iranian president Ahmadinejad would love to see Saudi king Abdullah bin Abdulaziz Al Saud pull the plug on the 21-year old US-Dollar peg to the Saudi Riyal. Tehran has cut all ties with the Dollar when it comes to oil transactions.

   "This is an economic decision and we've been proven right. Over time the Dollar has got weaker and weaker," explains Hojjatollah Ghanimifard, director of the National Iranian Oil Company.

   "Less than 20% of Iran's oil export earnings are in Yen and the rest in Euros," he said. Tehran is fetching $90 a barrel on oil sales of 2.4 million barrels per day.

   Such a stunning move by King Abdullah to price Saudi oil in Euros or a basket of foreign currencies would knock the US Dollar into a tailspin. "There will be journalists who will seize on this point and we don't want the Dollar to collapse instead of doing something good for OPEC," whispered Saudi Prince Faisal al-Saud, during a key closed meeting, when microphones were not cut off.

The Fed Monetizes Record High Oil Prices

   Ahamdinejad's assertion that foreign central banks are printing worthless paper currency in exchange for OPEC's oil was fully understood by those political leaders.

   Between them they control 75% of the world's proven oil reserves.

   The Federal Reserve has allowed the MZM money supply to expand by $850 billion this year, up 13% from a year ago. The broader US M3 money supply is 15.8% higher, its fastest rate in history, monetizing the surge in crude oil and the Gold Price, key hedges against inflation.

   Explaining the Fed's disregard for sharply higher food and energy prices on October 20th, Federal Reserve governor Frederic Mishkin said, "Changes in price indexes without food and energy provide a clearer picture of underlying inflation pressures. If the monetary authorities react to headline inflation numbers, they run the risk of responding to merely temporary fluctuations."

   At the same time, Mishkin said it was the Fed's job to "counteract negative shocks to the economy" from high oil prices, suggesting a further expansion of the money supply.

   "Our emphasis over the years has been more on core inflation, which strips out food and energy, because we think that's a better predictor of future total inflation than today's total inflation has been," said Fed governor Donald Kohn on Nov 28th.

   Traders interpreted Kohn's disregard for commodity inflation, as a signal that the Fed would continue to lower the fed funds rate next month to bail out Wall Street bankers and brokers, and to cushion the housing market.

   But on Nov 16th, the United Nations Food and Agricultural Organization (FAO) reported that at $100 a barrel, the price of oil has sent the cost of food imports skyrocketing this year.

   What's more, worldwide food reserves are at their lowest in 35-years, so prices are likely to stay high for the foreseeable future.

   "Past shocks have quickly dissipated, but that's not likely to be the case this time. Supply and demand have become unbalanced, and can't be fixed quickly," said FAO analyst Ali Ghurkan.

   The world's food import bill will rise 21% to $745 billion in 2007. In developing countries, costs will go up by 25% to nearly $233 billion, due to stronger demand for bio-fuel crops, extreme weather and growing demand from countries like India and China.

   As the famous economist John Maynard Keynes used to say, "By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debase the currency.

   "The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

ECB Also Fuels High Oil Prices

   The European Central Bank has also been a big contributor to the global inflation problem, by clandestinely monetizing the price of crude oil to record highs.

   Under Jean "Tricky" Trichet, the ECB has expanded the Euro M3 money supply at a 12.3% annualized rate, far above the central bank's original target of 4.5% growth, while giving empty lip service to "vigilance" against inflation.

   But now the ECB's strategy is backfiring. Food-price inflation in the 13-nation Euro region accelerated to +3.8% in October, the highest rate since March 2002. Fuel was +9% higher in the past year. It's easy to see how far EuroStat has to doctor the Eurozone's inflation rate.

   Crude oil has risen 60% in the last 12-months and the price of wheat has increased 43% this year. The cost of shipping dry goods across the sea, as measured by the Baltic Dry Index is up 150% from a year ago.

   But on Nov 15th, with crude oil bumping up against $100 per barrel, Bank of Spain chief Miguel Angel Fernandez Ordonez broke ranks with Trichet and his fiery band of inflationists.

   "The persistence of energy and food price increases entails the serious risk that inflation expectations could become unhinged. As a result, our credibility as central bankers could be significantly damaged," he warned.

Saudi Money Supply Out of Control

   The Fed's daily money injections and expectations of more rate cuts, are threatening to transmit hyper-inflation to the Saudi kingdom.

   The Bernanke Fed is expanding the US M3 money supply so fast, it's inviting speculators to sell the Dollar for Saudi Riyals. To counter the Dollar's weakness, the Saudi Arabian Monetary Authority (SAMA) is expanding the Saudi M3 money supply at a 19.5% annual growth rate, engaging in a round of competitive currency devaluations with the Fed to keep the 21-year old Dollar peg intact.

   Last week, the Saudi Arabian Monetary Agency (SAMA), reduced its reverse repo rate by 50 basis points to 4.25%, and the UAE's central bank cut rates by as much as 20 basis points to relieve pressure on the weak Dollar.

   But the Fed's Daily Injections of Liquidity into the banking system are threatening the Saudi kingdom. With consumer inflation raging ahead at 5%, a 10-year high, an easing of SAMA policy could be a catalyst for hyper-inflation and social unrest within the kingdom.

   And because the Saudi Riyal is pegged to the US Dollar, the Euro is 50% higher from five years ago to a record 5.5 Saudi Riyals, increasing the costs of import prices from Europe. More Federal Reserve rate cuts designed to inflate the US money supply could put unbearable pressure on the Gulf currency pegs.

   Despite the enormous pressure to ditch the Dollar peg, King Abdullah is sticking with the greenback. The Saudi royal family has a secret agreement with Washington, dating back to the early days of Saudi oil, which barters US military protection for the desert kingdom in exchange for the Saudis making sure that crude oil stays priced in US Dollars.

   The US military umbrella also extends to the tiny Persian Gulf satellites. That forces oil importers to buy roughly $1.5 billion per day of US Dollars in exchange for the oil that OPEC sells on world markets.

   Behind the smiles and handshakes in Riyadh last week, Saudi king Abdullah is very worried about Iran's growing military might. He fears Tehran could stir up the kingdom's own Shiite minority, suspected as a fifth column by Saudi leaders.

   Saudi Shiites represent 15% of the population and live in the oil-rich Eastern Province, adjacent to Kuwait and Bahrain, which both have sizable Shiite populations.

   The Saudi royal family is also worried about Iran's drive for nuclear invincibility. On Nov 15th, the UN's nuclear watchdog confirmed that Iran has 3,000 working centrifuges in its nuclear facilities, a ten-fold increase from just a year ago.

   If those 3,000 centrifuges can be made to work efficiently, Iran could manufacture a nuclear bomb in 12-18 months. Iran said on Nov 27th it has a new missile, named Ashoura, with a range of 1,250 miles. It will enable Iran to aim at targets in Europe.

Will Venezuela's Chavez Dump the Dollar?

   On Nov 27th, Venezuela Energy Minister Rafael Ramirez stepped up his call for OPEC member states to bill their oil sales in currencies other than the weak US Dollar.

   "The oil price is at $100 a barrel, but what Dollar are we talking about? It's a Dollar that makes you laugh. The Dollar has devalued and it is distorting the oil market because there is a financial crisis knocking on the US door," Ramirez said. He also pointed to US economic sanctions on Iran that helped push crude toward $100 a barrel.

   Until now, Chavez's outlandish comments have been brushed off as the ranting of a raving madman, or a tin-horn crack-pot.

   But Chavez is one of the most powerful political figures in the world today. He controls the Orinoco oil fields, recognized as the world's single largest known oil deposits, and with the proper development could help Venezuela surpass Saudi Arabia with the most oil reserves. Last June, Chavez ousted US oil giants Exxon Mobil and Conoco Phillips from the Orinoco Belt to consolidate his control.

   If Chavez gathers the courage to demand non-Dollar payments for Venezuelan oil, he could knock the Dollar sharply lower, overriding Riyadh's artificial support. Venezuela exports 1.5 million barrels per day (bpd) to the United States. Its total exports are nearer 2.6 million bpd, fetching close to $7 billion per month.

   "We better understand the vulnerabilities to our economy and our lives, when we're dependent on Iranian mullahs and whackos in Venezuela," warned Arizona Senator John McCain on January 22, 2007.

   State-run Petroleos de Venezuela is sending more tankers of oil and fuel to India and China this year, buyers who are up to seven times more distant than the US, to reduce Chavez's dependence on his US export market.

   "The US depends on us, not we on them," Chavez said on May 16th when he predicted oil prices would soar to $100 a barrel if he chose to send its oil to China, Europe and other countries instead of the US.

   Chavez has boosted oil sales to China and India to 360,000 bpd this year, and is shouldering the higher tanker carrier rates.

   Global tanker rates to transport crude oil were stuck at four-year lows this past summer, but have now doubled in the past two weeks. That could cost Chavez an extra $6 per barrel to ship his oil to the Far East. So far, however, soaring global oil prices have made up for lost revenue.

   So what's preventing Chavez from switching to non-Dollar currencies for Venezuelan oil right now? The maverick Venezuelan leader has often accused President Bush of plotting to invade his oil-rich country to bring down his regime. Switching oil sales away from the Dollar could mean Chavez would suffer the same fate as the late Saddam Hussein.

   Last year, Chavez signed a $1 billion arms deal with Russian kingpin Vladimir Putin, but 30 Russian fighter jets and a few hundred thousand rifles are not enough to wage a war against the world's leading military power.

Focus Turns to OPEC Meeting in Abu Dhabi on Dec 5th

   Already the Western media is fanning speculation of a boost to Saudi oil output at the upcoming OPEC meeting in Abu Dhabi, to placate its military patron in Washington and cool oil prices.

   Within OPEC, Saudi Arabia is the only producer with any capacity to pump more oil. Saudi oil chief Ali al-Naimi indicated the kingdom had spare oil capacity of 2.3 million bpd. Total OPEC spare capacity is 3 million bpd.

   On Nov 21st, former Saudi oil minister Ahmed Zaki Yamani engaged in psychological warfare with crude oil traders, attempting to "jawbone" oil prices lower.

   "If there are no disasters, then oil prices could fall to $75 per barrel after the winter," he said. Already, crude oil has tumbled to $91.50 per barrel on expectations that Riyadh will boost its oil output by 500,000 bpd. (How myopic have equity traders become, now that $91 for oil is considered cheap, after seeing $99 last week?)

   "We observe with great concern the recent escalation of oil prices. But we believe that the world market is well supplied and petroleum inventories are comfortable," said Saudi oil minister Ali al-Naimi on Nov 28th. Asked if OPEC would agree to a second output increase on Dec 5, Naimi was non-committal:

   "We need to look at the data, at the information, and then we will decide."

   But on Nov 27th, Qatar's oil minister Abdullah al-Attiyah downplayed speculation of a boost in OPEC oil output next month. "My personal belief is that for the moment there is no need to increase production. The market is saturated," he said.

   Qatar is one of OPEC's smallest producers with oil output of around 830,000 bpd, but its final decisions are usually closely aligned with Saudi Arabia. And "please don't blame us for $93 oil," said Qatari Oil minister Abdullah al-Attiyah on Oct 30th.

   "The market is increasingly driven by forces beyond OPEC's control, by geopolitical events and the growing influence of financial investors," agreed UAE oil chief Mohammed bin Dhaen al-Hamli.

   In other words, OPEC blames foreign central banks for printing too much money, which in turn, encourages speculation in the oil market.

   Riyadh's ability to keep the crude oil market under wraps by pumping more oil might draw to an end by late 2008. The International Energy Agency is forecasting that global demand will climb by 2.1 million bpd to 88 million bpd next year. Global supply however, is forecast to rise a scant 200,000 bpd to 85.6 million bpd, leaving a growing shortfall that would exhaust all of Saudi's spare capacity.

   In the short term, the direction of oil prices – just like Gold Prices – might depend upon the Federal Reserve.

   "Nobody should ask OPEC to do something to lower oil prices, because even if OPEC introduces another 500,000 barrels of oil next month, the price is not going to change unless the Dollar corrects itself," said Iranian Oil Company chief Hojatollah Ghanimifard.

   "The US Treasury should take measures to strengthen its currency if it doesn't want oil prices to continue rising."

   No matter how high commodities zoom upward, however, the European Central Bank is also expected to continue its super-easy money policy, now fueling Eurozone inflation.

   To brainwash the public, the ECB's Vitor Constancio described the historic rise in food and energy prices as "A temporary phenomena that will dissipate in March next year. We cannot interpret this inflation rise as something permanent.

   "We are not faced with a situation where the process of inflation is out of control in Europe."

   Clearly, European central bankers and the US Treasury expect the Saudi royal family to cap global oil prices by boosting output next month. That would allow the ECB to avoid a rate hike to control inflation, and would permit the Fed to continue to inject more dollars into the hands of Wall Street dealers. But a move by the Saudis to knock oil prices lower could also inflict damage on its own shaky stock market, whose spirits have been energized by higher oil prices.

   On Sept 25th, Saudi Arabia lifted remaining restrictions on citizens from Kuwait, the United Arab Emirates, Qatar, Oman and Bahrain, for trading in the biggest Arab stock exchange, unleashing the Saudi All Share Index from its two year slump. But the rally could fizzle out, if King Abdullah knocks oil prices sharply lower.

   Since an estimated 7,000 princes in Saudi Arabia own 70% of the stock market, there's a good chance that King Abdullah won't hurt the royal family.

   Whether the historic rise in crude oil towards $100 per barrel heralds the arrival of "Peak Oil" or is just a speculative bubble that will deflate are just some of the tough questions in today's brave new world of investing.

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GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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