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The Dollar Shoots Itself

Unwittingly, the United States is aiding the dedollarization of the world, most notably through the economic sanctions it organized to discourage Iran from developing nuclear weapons. The sanctioning countries agreed, among other things, not to import oil from Iran. Although a November 2013 agreement brokered by Putin suspends some elements of the sanctions, that primary one remains active.

The U.S. government prefers sanctions over a military attack for a simple reason: Iran would not be the kind of pushover Iraq was. U.S. naval vessels attacking Iran from the Gulf would be met with a swarm of small suicide craft. And Iran could easily attack the oil tankers (big, slow targets) passing between Saudi Arabia and Bahrain and the Strait of Hormuz, which would choke off 20 percent of the world's oil supply.

And then there's Putin. Russia is not likely to sit on its hands while the United States bombs one of its allies. So, Johnny, don't get your gun.

When the sanctions were laid, U.S. allies, including much of Europe and parts of Asia, fell into step quickly, excluding or reducing imports of Iranian oil. Iran's oil exports initially fell by half, but Iran didn't roll over.

Oil is highly fungible, which means one barrel of crude may be interchangeable with another. Once it leaves its home country, it's difficult to determine where a barrel of oil originated, if its handlers desire to make it so. And it's not just barrels that are hard to track. Even though oil is carried on ships so large they are dubbed supertankers, it is surprisingly difficult to keep tabs on every tanker or its cargo.

Under international law, a cargo ship is required to carry a satellite tracking device, but the ship's master has discretion to turn it off for safety reasons if permission is given from the ship's home country. Iranian captains have been exercising that discretion, and now most of the country's 39 tankers are sailing "off radar." Only seven of Iran's very large crude carriers (VLCCs) are still operating their onboard transponders, while only two of the country's nine smaller Suezmax1 tankers are trackable.

So millions of barrels of Iranian oil held in storage in Iranian tankers have been "disappearing." Officially, there is just a shrugging of shoulders. No one admits to knowing where the oil goes.

Iran's National Iranian Tanker Company (NITC) has begun taking delivery of 12 new supertankers built in China, which will add to its capacity for whisper shipping its oil.

Iran has proven that sanctions can be evaded, but all the tricks and maneuvers come at a cost.

Added freight costs for each voyage come to nearly $5 million, or $2.50 to $4.00 per barrel, depending on the size of the ship. Iran is also shelling out millions of additional dollars to insure each shipment, because most of the insurance industry operates from sanction-compliant.

And since business is business, buyers are demanding easy credit terms from the National Iranian Oil Company (NIOC). The buyer may get as long as six months to pay for each 2-milfion-barrel cargo, a grace period that costs Tehran another $5 to $8 per barrel.

All told, the added freight costs, insurance, and generous credit terms can wipe out 10 percent to 12 percent of the value of each supertanker load. It has been a serious burden, but it hasn't been a crushing one.

The sanctions' prohibition on accepting shipments of Iranian oil has a counterpart—a blockade on payments to Iran. In particular, the sanctions forced the Society for Worldwide Interbank Financial Telecommunication (SWIFT)2 to refuse wire transfers to or from Iranian banks. That closed the conventional avenue for settling transactions between anyone outside Iran and anyone inside Iran, which would have been painfully effective if every country actually supported the sanctions. But that hasn't been the case.

A good number of countries have gotten past needing to kowtow to the United States. Some explicitly objected to U.S. sanctions on Iran and refused to cooperate. Others are more politic, choosing instead to trade with Iran through avenues that sidestep the sanctions, such as routing goods and money through third countries. (China has made a business out of helping.) Others simply ignore the sanctions but without saying so.

For still others, circumstances trump any impulse to cooperate with the United States. They depend on Iran for so much of their oil that complying with sanctions would be too painful to consider. India is a major user of Iranian oil, China is another, and South Korea is a third. They are not going to trade their own economic health for a pat on the back from the United States.

Trading with Iran without openly mocking the sanctions has become an art, largely developed by the Iranians themselves. When you ban people from SWIFT, they don't pound sand; they devise alternatives.

Iran is selling oil to India for gold and rupees. There also is a deal with China that swaps oil for a Walmart's worth of Chinese products. And South Korea, as well as China, is quietly paying for oil with its own currency.

One trick required the cooperation of Turkey, whose state-owned Halkbank ran oil payments through a so-called golden loophole. Between March 2012 and July 2013, the Turks shipped $13 billion of gold to Tehran directly or through the UAE. In return, the Turks received Iranian natural gas and oil. But because sanctions barred paying for the petroleum in dollars or euros, the Turks paid in Turkish lira, which the Iranians used to buy the gold that was already sitting in Tehran. Thus Iran got more gold and Turkey could say it was sending cash to private citizens, thus not violating sanctions.

President Obama closed the golden loophole in January 2013, classifying any such transactions after that date as a violation of sanctions.

Barter may be the next work-around. Iran and Russia are negotiating an oil-for-goods swap worth $1.5 billion per month to boost Iranian oil exports. Russia would accept up to one-half million barrels per day in exchange for Russian goods. Since Russia doesn't need the oil, it would resell it on the world market for rubles.

The U.S. government has demanded that Russia back away from its proposal and has threatened tighter enforcement of the prohibition on Iranian oil. What that might entail is open to conjecture. Would the United States seize vessels carrying Iranian oil purchased by Russia? That would surely push strained U.S.-Russian relations past the breaking point, with potentially horrific consequences.

All in all, non-dollar-denominated trade with a long list of friendly nations has been keeping Iran's finances afloat. Sanctions predicated on Iran's need to use the U.S. dollar in fact leave loopholes wide enough for VLCCs to sail right through.

And that's the irony. The sanctions are teaching Iran and its oil customers how to live without dollars. Other countries are watching and learning.

It's a classic self-inflicted foot wound: Sanctions intended as an exercise of U.S. supremacy are in fact showing the world how to neutralize the primary tool of U.S. economic control. Those unhappy with U.S. over involvement in world affairs are inspired to discover ways to escape dependence on the dollar.

The United States intended to demonstrate to the world that it still carried the biggest stick. Instead, it has shown that getting whacked with the stick needn't hurt that much.

U.S. sanctions against Russia for its involvement in Ukraine are having the same perverse effect on the dollar as sanctions against Iran.

In March 2014, furious over the blocking of a remittance from the Russian embassy in Kazakhstan to Sogaz Insurance Group via JPMorgan in New York, Putin ordered the Russian central bank to proceed immediately with Project Double Eagle.

Double Eagle will build a new "national payment settlement system" that will be a Russian alternative to SWIFT. It would enable trade partners to price oil in gold, which Russia has been stockpiling. That will allow users to move away from the dollar (and the euro), and conduct their business in something physical and more substantial than fiat money. The BRICS countries are cheering it on.

Russia's Ministry of Foreign Affairs calls SWIFT the "glue" that binds the global monetary system to the dollar, which it is. The ministry boasts (and it just might be right) that the Russian alternative will "destroy [SWIFT] in a fortnight." It also claims that the other BRICS countries are ready to join the new exchange as soon as it comes online.

As an angry Valentina Matviyenko, the speaker of Russia's upper house of parliament, colorfully put it, "Some hotheaded decision makers have already forgotten that the global economic crisis of 2008—which is still taking its toll on the world—started with a collapse of certain credit institutions in the United States, Great Britain, and other countries. This is why we believe that any hostile financial actions [toward Russia] are a double-edged sword and even the slightest error will send the boomerang back to the aborigines."

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