The War for the Dollar is Over Part II: The Fly or the Windshield?


    by Tom Luongo, Tom Luongo:

    In part I of this series I told you the war over the US dollar was over because the bane of domestic monetary policy, Eurodollar futures, lost the battle with SOFR, the new standard for pricing dollars.

    The ignominious end of the Eurodollar system is a study in the evolution of markets, as a new system replaces an old one. Old systems don’t die overnight. We don’t flip a switch and wake up in a new reality, unless we are protagonists in a Philip K. Dick novel.

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    More than a decade ago I looked at the responses to President Obama cutting Iran out of the SWIFT system as the beginning of the end of the petrodollar system. The goal was to take Iran out of the global oil markets by shutting Iran out from the dominant dollar payment system.

    Out of necessity Iran opened up trade with its major export partners, most notably India, in something other than dollars. India and Iran started up a ‘goods for oil’ trade, or as Bloomberg called it at the time, “Junk for Oil.”

    The stick of sanctions created a new market for pricing Iranian oil and a way around the monopoly of US dollar oil trading. India, struggling with massive current account deficits because of their high energy import bill, welcomed the trade as a way to lessen the pressure on the rupee.

    Iran needed goods. They worked out some barter trade and the first shallow cuts into the petrodollar system were made.

    Turkey eventually joined the fray, seeing the opportunity to act as a middle man by accepting gold into its banks from Iran’s customers and settling up with Iran in dollars or whatever.

    Turkey was the first country to make gold a 100% reserve asset in defiance of Basel I capital rules to facilitate this trade. Turkey’s gold ‘reserves’ skyrocketed because of this.

    More than 10 years later we’re now looking at the lynchpin of the petrodollar, Saudi Arabia, seriously considering taking other currencies for their oil. The petrodollar was never going to die overnight, it was always going to die as the cost of doing business in dollars rose to make using other currencies a better path to buying/selling oil.

    Every time the US went to the sanctions well to coerce conformity, the more “star systems slipped through its fingers,” to quote Princess Leia. While we joke today about never ‘going full retard,’ this is just another way of saying that you should never threaten to nuke someone either.

    Trump went sanctions nuclear on Iran in 2018. He failed.

    “Biden” and Davos went nuclear on Russia in 2022, going further than even Trump. And they failed even harder. All they did was raise the cost of using dollars in the minds of the dollar’s best customers.

    When the cost/benefit framework flips, behavior changes accordingly.

    In the world of money, since we don’t have anything close to resembling real capital markets, rather politicized ones, policy is the thing that alters that cost/benefit structure the most. This means while analyzing the market reaction to day-to-day data the listening to the tea-leaf reading by commentators becomes an exercise in chasing your tail through a wilderness of rhetorical mirrors if you don’t include policy changes.

    So, with that in mind we have to analyze structural changes to markets from a policy perspective to see what the future really looks like. It’s not that the markets don’t have a say in the matter, it’s that if you analyze the policy through the lens of capital flowing to where it is treated best, then the future outcome is pretty predictable if there isn’t a competing policy put in place to redirect that capital flow later.

    In this sense, financial analysis in politicized markets is better described by court politics than spreadsheet output cells.

    People want oil. They will buy it regardless of what Davos or “Biden” or anyone else says about this. Until you replace oil itself, no amount of policy changes will fundamentally change the market for oil unless you destroy the supply chain supporting the oil industry.

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