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Geopolitical Risk # 1: Maintaining the Reserve Currency Status of the U.S. Dollar In the summer of 2005, the Bank of International Settlement warned investors worldwide that, “the reduction of current account imbalances, which have widened further since the beginning of the year, remains a major global challenge.” 1 Though the U.S. and China are not mentioned directly, with the greatest trade deficit and surplus (respectively), our two nations are large contributors to this problem. Richard Duncan, former consultant to the International Monetary Fund and a specialist with the World Bank, is a little more direct. He states, “Current account deficits, like economic bubbles, are inherently unsustainable. The collapse in the value of the [U.S.] dollar is a matter of when, rather than if.” 2 And, these concerns are largely warranted. On Tuesday, March 14th, the Commerce Department reported that the United States’ hit the highest current account deficit in history, at $804 billion for the year 2005. This is the selfsame deficit that has widened over $136 billion, or 20 percent, since 2004. 3 From the earlier mentioned expenditures on defense, clearly the size of military spending contributes significantly to our current account deficit. “Favorable liquidity” is a related term that is thrown around quite a bit in the investment business. Never mind that this is a euphemism for debt. The term is usually followed by some pundit’s commentary on how this is a positive sign for the markets. At the core of this assumption lies the belief that the Federal Reserve has somehow attained the status of omnipotence. Not realizing the exponential growth in the amount of debt America has subjected itself to lately, many Americans have become overconfident and believe that it doesn’t matter how much debt we take on because foreign central banks will always buy our debt. Yet, time and again, history has proven that this is not the case. Again, as Dr. Krassimir Petrov points out: “In 1971, as it became clearer that the U.S. government would not be able to buy back its dollars in gold, it made in 1972-73 an iron-clad arrangement with Saudi Arabia to support the power of the House of Saud in exchange for accepting only U.S. dollars for its oil. The rest of OPEC was to follow suite and also accept only dollars. Because the world had to buy oil from the Arab oil countries, it had the reason to hold dollars as payment for oil. Because the world needed ever increasing quantities of oil at ever increasing oil prices, the world’s demand for dollars could only increase.” 4 Some have argued that pricing oil in dollars has not helped the dollar retain the status of reserve currency and that pricing oil in Euros would have no adverse affect on the dollar. Yet, Coilin Nunan has well observed that countries’ central banks keep foreign exchange reserves to guard against sudden devaluations in their own currencies. In deciding the currency in which to keep foreign reserves, central banks must decide against which currency a devaluation of their own currency would be most damaging. “For all of the rich countries in the world, a sudden devaluation against the dollar has the potential to be far more damaging than a sudden devaluation against the euro, the yen, the yuan, the rubble, etc. This is because most of the goods and services traded internationally are priced and paid for in dollars and, virtually all commodity trade, including the trade of oil which is by far the most important good traded internationally, is denominated in dollars. Since virtually all of the really important imports are priced and paid for in dollars, it makes complete economic sense for rich central banks to keep most of their reserves in dollars. If the denomination of these important imports, in particular oil, were to move away from the dollar, then rich countries would move their reserves into other currencies and consequently the dollar would lose a lot of its importance.” 5 If the world is only buying our dollars because oil is priced in dollars, yet in the name of “favorable liquidity” U.S. debts grow to the stratosphere (with an attendant devaluation of the dollar), then the U.S. should keep a close eye on the currencies in which national level oil contracts are being priced. In the words of Congressman Ron Paul, “If oil markets replace dollars with Euros, it would in time curtail our ability to continue to print, without restraint, the world’s reserve currency.” 6 In November of 2000, Saddam Hussein did just that. He began demanding that payment for Iraqi oil be paid in Euros. Firms from many countries, including some U.S. conglomerates, began paying for Iraq’s oil in Euros. 7 Again, Congressman Paul comments: “There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in Euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war. Within a very short period after the military victory, all Iraqi oil sales were carried out in dollars. The Euro was abandoned.” 8 Though I am sure many of you are familiar with the following, a brief synopsis of the events surrounding the invasion of Iraq bears repeating. This second look at the U.S. invasion of Iraq quickly reveals why Russian and China disagree with the U.S. regarding U.N. Security Council actions to be taken against Iran. Then, as now, Russia and China had important conflicts of interest. At the time of the U.S. offensive on Iraq: “Russia’s Lukoil and two Russian government companies had a 23-year contract to develop Iraq’s West Qurna oilfield. China also was against the war. Its China National Petroleum Company held a potentially huge oil contract in western Iraq. France too held rights to exploit Iraq oil under the Saddam regime. All three powers knew that a unilateral U.S. war could end their Iraq dreams for good.” 9 Further evidence of Russia, China, France, and other countries’ desires to obtain Iraqi oil can be found by reviewing the Cheney Energy Task Force document titled “Foreign Suitors for Iraqi Oilfield Contracts.” 10 This document, available at judicialwatch.org, makes it apparent that U.S. knew about these projects when we invaded Iraq. It may also be worth noting that the U.S. Department of Energy’s Energy Information Administration comments that as of December 2005, Iraq is estimated to hold the third largest proven oil reserves in the world, at 115 billion barrels. However, estimates vary widely as much of the country has not been explored. 11 After Saddam was toppled, these contracts with Russian, Chinese, and French firms appear to have been nullified. 12 Needless to say, geopolitical tension with these three U.N. Security Council members has mounted. This leads us to our point. Even though the oil itself is still priced in dollars, in 2003, Iran began demanding their oil payments in Euros instead of dollars. 13 Oil, reserve currency pressures, unsustainable U.S. military growth, and extreme Islam do not mix. With the demand for oil continuing to grow, Fed Chairman Bernanke stoking the printing presses, U.S. military costs mounting and extreme Islam raging, we must remain watchful as this complicated concoction moves ever closer to a clash. As the pressure keeps building, at some point, the markets will be forced to reflect this fact. Geopolitical Risk # 2: Oil In many countries, the peak days of oil production are over yet demand continues to increase. Dr. Robert Hirsch, Senior Energy Program Advisor for Science Applications International Corporation (SAIC), gives a general description of the dilemma. “The image is one of a world moving from a long period in which reserves additions were much greater than consumption, to an era in which annual additions are falling increasingly short of annual consumption. A related fact is that oil production is in decline in 33 of the world’s 48 largest oil-producing countries.” 14 The U.S. intelligence community has become focused on this topic. In 1996, John Gannon, deputy director of the CIA, stated, “We need a substantial quantity of imported oil to sustain our economy. [As such] The U.S. will need to keep close watch on events and remain engaged in the Persian Gulf to safeguard the flow of vital oil supplies. We have to recognize that our nation will not be secure if global energy supplies are not secure.” 15 The U.S. military has also taken note of this concern. In a 1999 report before the Senate Committee on Armed Services, General Anthony C. Zinni, then commander in chief of the U.S. Central Command (CENTCOM), told Congress, “America’s vital interests in [the Gulf] are long-standing. With over 65 percent of the world’s oil reserves located within the Gulf States, we must have free access to the region’s resources.” 16 If the U.S. sees oil as vital to our national security, it makes sense that other industrial nations would as well. When we examine what has been happening in the largest oil fields in the U.S., Russia, and China, we see more clearly why the nullification of the oil contracts Iraq had with U.N. Security Council nations is seen as a hostile action. When gas prices climb, many in the U.S. talk of looking to Alaska for more oil. In his book, Twilight in the Desert, Matthew Simmons speaks to the fates of the super-giant oilfields outside of Saudi Arabia. Simmons gives an overview of Alaska’s Prudhoe Bay. The field produced 1.5 to 1.8 million barrels a day during the 1980’s until it peaked in late 1989. By 2004, including an additional five to seven nearby satellite fields, output had fallen to 350,000 to 450,000 barrels per day. 17 The Samotlor Field, in Russia, tells a similar story. An aggressive water injection program pushed the Samoltor’s production rate far past the originally planned ceiling of 1.5 million barrels a day. Samotlor peaked at 3.5 million barrels a day, only to watch the production fall to 300,000 barrels per day by 1999. 18 The Daqing Field, China’s largest, sustained oil production above a million barrels a day for over 35 years, though their water cut, the ratio of water produced from well, 19 has risen steadily and today is reported to be over 90 percent. In early 2004, even though output was still at 950,000 barrels a day, China’s energy planners began publicly discussing the likelihood that Daqing’s output would be down by 40 percent by 2006 or 2007. 20 William Engdahl takes note of China’s increasing need for oil. “China by then [2002] was well on its way to replace Japan as the world’s second largest oil importer after the United States. Within ten years, at present growth rates, it would easily become the world’s largest consumer of oil, almost all imported.” 21 (Emphasis mine)
So, where are the largest oil fields in the world? You guessed it – the Middle East, and particularly the coastal areas of the Persian Gulf. It is no coincidence that we maintain such a strong military presence in the region. The chart on the left is oil, and the chart on the right shows various U.S. military bases. The Middle East looks like it could draw the financial, military and political focus of the world for sometime to come. Now, let’s turn our attention to Iran’s nuclear capabilities and the U.N. Security Council. Sources
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