Iranian Missiles Target the Petrodollar

This post Iranian Missiles Target the Petrodollar appeared first on Daily Reckoning.

Back in December, I wrote a newsletter about lessons from the war in Ukraine.

The conclusion was:

“This is the age of asymmetric warfare. Pinpoint long-range weapons systems have eliminated the advantage of large troop concentrations and capital ships like aircraft carriers.

For a long time, only superpowers like America and Russia had access to these types of systems. Now they have proliferated throughout the world. The implications have yet to be fully realized.”

This lesson is coming into sharper focus due to the war with Iran. So far, the U.S. has kept its Navy ships far from the country. Yes, they are still launching strikes from the 1 carrier in the area, but from a safe distance. This limits aircraft time over target.

The threat of anti-ship missiles and sea and air drones has kept U.S. Navy ships mostly out of the Persian Gulf. We also saw this during America’s brief skirmish with Yemen’s Houthis. With the threat of anti-ship missiles, they were mostly able to scare off even mighty U.S. aircraft carriers.

Now Iran is using the threat of sea drones and anti-ship missiles to keep the Strait of Hormuz closed.

Iran is allowing some ships through, but none owned by the U.S., Israel, or certain other countries.

Tankers that are allowed to pass are apparently paying a toll of around $2 million. But they’re not paying in dollars. The toll is being paid in Chinese yuan. Fortune:

The secretary-general of a bloc of Gulf Arab countries said that Iran is charging fees for ships to safely transit the Strait of Hormuz. Industry experts say some ships are paying in Chinese yuan to pass through the Strait of Hormuz, where 20% of all traded oil and natural gas is transported in peacetime.

For Iran, using Chinese currency is preferable because it cannot be seized by America or NATO countries. And it’s a small blow against U.S. dollar hegemony.

This is not a small thing. For the first time in a long time, a foreign enemy is denying us and our allies resources. And forcing other parties to switch from U.S. dollars to Chinese yuan.

We are accustomed to being the one who sanctions.

The Petrodollar Remains (For Now)

For those who need a quick reminder, the petrodollar system has been in place since the 1970s. The agreement was simple.

Oil producers in the Middle East would only sell their oil for dollars. This drove up demand for dollars, and helped cushion the shock after leaving the gold standard. It was also understood that these countries would invest their oil profits in U.S. stocks and bonds.

In exchange, we would protect these oil producing countries from attack. Our distinguished colleague Jim Rickards actually helped forge the petrodollar system. It was a brilliant solution to reverse a falling dollar.

The petrodollar system allowed the U.S. dollar to remain a strong world reserve currency, even after we ended the gold standard.

The problem right now is that Iran is attacking all our military bases in the area. The New York Times just reported that, “Many of the 13 military bases in the region used by American troops are all but uninhabitable”.

NYT reporters say that U.S. troops have abandoned many of these bases for local hotels and office buildings, and are “working remote”. Many of us have known this for weeks, but it’s nice to see it finally acknowledged by “the paper of record” (ha!).

Iran has also targeted Gulf countries’ oil infrastructure, which has become a key point of leverage.

This could present a problem for the petrodollar system. If we can’t properly protect our Gulf allies from attack, they may be tempted to strike a deal with Iran. And Iran, of course, is allied with China and Russia.

Eventually, these Gulf countries could switch from selling oil in dollars to yuan and other currencies. This would be a major blow to the petrodollar.

For now, the dollar is fine, and even getting stronger. Most countries still use dollars to purchase oil, and oil is far more expensive than it was. So currently we’re actually seeing a dollar shortage.

But unless this war ends soon, the threat to the petrodollar system could become very real. And that could mean a significant fall in the value of the dollar over time. Which would mean inflation and disruption to U.S. markets.

Iran: A Difficult Challenge

Today the U.S. maintains large military bases in Saudi Arabia, Bahrain, Iraq, Kuwait, the UAE, Oman, Turkey, and Pakistan.

The old joke is “why’d they put their country so close to all our military bases?!”

Iran has always been a dream target for regime change. The ultimate hope of neocons and neolibs for decades.

It sits north of the most important sea route in the world, the Persian Gulf and the Strait of Hormuz. It has the largest natural gas reserves in the world, and among the largest oil reserves.

The problem, of course, is that Iran is built like a fortress. It is surrounded by high mountains and has a population of 90 million highly-educated people. This is why Persian culture has survived for thousands of years, while countries around them are frequently toppled.

And today Iran is extra tricky to target due to advances in missile and drone technology. Sure, we can launch missiles and bomb them almost at will, but their military assets are spread out across thousands of locations across the country. Under 300 feet of granite and reinforced concrete, in some cases.

Anti-ship missiles in a “missile city” located under a mountain on Iran’s coast.

Underground missile launch system in Iran

Satellite view of one of Iran’s launch facilities on top of a mountain. Source: Maxar via Fox News

These underground “missile cities” have been hit by bunker buster bombs repeatedly so far in the war, but are still firing. Sure, we can block the entrances temporarily, but then Iran digs out and starts firing again.

I get the feeling that people, including politicians, are still underestimating Iran’s capabilities. And that is a bad thing to do during a war.

Honestly, at this point I don’t see either side backing down anytime soon. I suspect Iran can keep the Strait of Hormuz closed for months or a year if they want to.

And sure, we could hit all of Iran’s energy sites, but they would strike facilities that provide 20%+ of all global oil and gas. We covered this in-depth in Escalation Ladders, so check that out if you haven’t yet.

It’s an ugly situation. And I don’t see any easy way out of it. Trump and Iran are so far apart on negotiations, it’s hard to imagine either compromising. It may have to get significantly worse before one side caves.

Militarily, there are only bad and worse options going forward. A ground invasion might happen, but will not go well. Honestly I don’t even know how they’d insert the troops. V-22 Osprey from Kuwait, perhaps? It wouldn’t be easy to get many in. Amphibious landing? Call me skeptical.

Destroying Kharg island, Iran’s primary oil export facility, is entirely possible but would trigger massive retaliation.

There is an ever-increasing risk that 20%+ of the world’s oil and LNG production goes offline for years.

And that would be a catastrophic outcome. Hopefully some kind of deal can be struck soon.

Otherwise, we continue to climb the escalation ladder, and eventually could end up at the last rung – the nuclear one. And I don’t think anybody wants that outcome.

Update: As I was finishing this article, we learned that Israel has struck 3 Iranian steel plants, a nuclear facility, and other infrastructure. It appears the ceasefire on non-military infrastructure is over. Iran has vowed to retaliate.

We’re climbing that ladder. I’m sure we’ll have developments over the weekend, and will have more Monday.

The post Iranian Missiles Target the Petrodollar appeared first on Daily Reckoning.

This story originally appeared in the Daily Reckoning . The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.