Are Exchange Controls Coming?
Julian D.W. Phillips
Russian President Vladimir Putin has accelerated the plan to make the Russian ruble a completely convertible currency and to trade Russian oil and gas for Rubles. After the creation of the Iranian Euro-based Oil Bourse, this Russian act is the second momentous step taken by foreign financial powers to undermine the strength of the American dollar. As nations will no longer need U.S. dollars to buy oil, they will have less incentive to buy U.S. treasury notes that fund American trade deficits and deficit spending. The consequent rise in interest rates to retain investors will cause massive inflation in the U.S. and lead to instability.
Russian President Vladimir Putin called for work on making the national currency convertible to be completed, oil and gas to be traded in Rubles on a domestic exchange, and an innovation-based economy.
In his annual state of the nation address before both houses of parliament, ministers and reporters, Putin said work on making the national currency fully convertible should be completed by July 1, almost six months ahead of the original January 1, 2007 deadline.
The president called for the establishment of a Ruble-denominated oil and natural gas stock exchange in Russia. "The Ruble must become a more widespread means of international transactions. To this end, we need to open a stock exchange in Russia to trade in oil, gas, and other goods to be paid for in Rubles," he said. Putin said this would be impossible without economic growth of over 7%, which, he said had been achieved in the past three years.
This is the second most significant step in removing the U.S. dollar from the throne of sole global reserve and trading currency! Should any more oil producers take this step, it will precede a U.S.dollar crisis and create massive potential instability in the globe's foreign exchanges.
Once Russia has completed these steps [July onwards], we expect to see the greatest bulk of Russia's oil sold for Rubles.
Following China's valuation of its currency against a basket of currencies of the countries with which it trades and the proposal by Iran of a multi-currency Oil Bourse in Tehran, other than the U.S. dollar as well, this move by Russia tolls the bell on oil being exclusively priced in the U.S.dollar.
With the oil comprising a huge portion of global trade, as part of the 86% of global trade denominated in the U.S.dollar, the impact of this change will be heavy on the value placed on the dollar.
So far, as the oil price rose, the demand for the U.S. dollar grew heavily, in line with the rising price, giving it the stability it has maintained over the last few years, despite the series of record Trade Deficits. The fact that this has been in effect a devaluation of the dollar in terms of oil, is not yet deemed of consequence.
But the rest of the globe doing trade with the U.S. is under no illusions that the sheer volume of dollars being printed to pay the bill for this Trade deficit has forced them to accept a suspect currency. They must, of necessity, hold these surpluses in U.S. assets. Most have found their way into highly liquid U.S. Treasury Bonds and Bills. Now is the time to attempt to slow the acquisition of new dollars into their reserves. Clearly, a lowering of the demand for the U.S.dollar in international trade will lower the demand for the dollar and U.S. Treasury Bonds and Bills. As the dollar' role shrinks, so will the globe's ability to absorb, not just the Trade deficit of the U.S. but also the growing volume of dollars surplus to requirements.
Let's make clear what this could mean eventually, with Russia supplying oil to the U.S., the U.S. will have to buy Rubles to pay for it, just like other nations.
Many are the dollars held in reserves to buy oil with and many are the countries who need to change their currencies to the dollar to pay for their oil with currently. Where they can use their own or have to buy Rubles, the demand for the dollar will drop and significantly. This will lead to a steady sale of dollar assets, then the dollars themselves with which to buy these Rubles [and Euros].
This will precipitate, in time, upward pressure on interest rates. We would expect this to start in the markets through sales at the long end of the Treasury Bonds, then as these are sold off, move down to the short end of the market until foreign investments are concentrated at the short-end [T-Bill] and at worst, held in "call" money. The liquidation of these assets and subsequent purchases of foreign currencies will pull the dollar down and cause a heavy outflow of foreign capital.
Before this happened, we would expect the Fed... to heavily intervene in the foreign exchanges to defend the exchange rate of the dollar. The Fed has already made preparations for such a defense. Should this prove insufficient, and we have no doubt they will, we expect the Fed to try to stem the capital outflow from the country with Exchange Controls from initially gentle to eventually harsh levels. [The writer has many years of experience in Exchange Controls in different countries].
Many of you readers may feel these prospects are impossible, but history has precedents. At the turn of the century, the British Empire was in its heyday. Seventy years later it had to impose Exchange Controls of its own to prevent the sudden exit of foreign investments from its shores.
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