James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.
In March, 2009, I joined a group of sixty officials from the armed forces, intelligence community, U.S. Treasury, think tanks and Wall Street at a top-secret weapons laboratory near Washington, D.C., to conduct the first ever war game in which the weapons were not missiles and bombs but stocks, bonds, and currencies.
The Pentagon wanted to understand how adversaries could inflict harm on the United States and expand their own power using financial weapons. My mission was to play for the China team, although I had recruited allies on the Russian and Swiss teams also. Over two days of moves and countermoves the Chinese and Russians played a gambit in which a new gold-backed currency created by them would replace the dollar as the medium of exchange for Russian natural resources and Chinese manufactured goods. Many of the established academic economists in the war room were appalled at the audacity of the move to gold and some ridiculed it openly. That was then.
As a global-macro analyst, I am frequently asked if war with Iran will come and, if so, when. My answer is the war has already begun. It's not a shooting war—yet. What the United States and Israel are now waging with Iran is what experts call unrestricted warfare. This is warfare that consists of sabotage, assassination, special operations, psychological operations, attacks on critical infrastructure, cyber warfare, and—the most recent addition to the arsenal—financial warfare.
The United States has applied financial and economic sanctions to Iran for over 30 years—sanctions are nothing new. But a few weeks ago President Obama moved to choke off Iran's oxygen supply by imposing sanctions on the central bank of Iran. International banks were told if they did business with Iran's central bank, they would be barred from doing business in the global dollar payments system controlled by the United States. Of course, the banks complied.
The result was an immediate isolation of Iran from the dollar system and an acute shortage of dollars in Iran. The Iranian currency, the rial, crashed in value 40 percent against the dollar in a few days. Since many goods in Iran are imported, local prices doubled as merchants demanded more rials in order to acquire whatever dollars might be available on the black market to buy imported goods. Iranian banks responded by raising local interest rates to over 20 percent in order to keep rials from flooding out of the Iranian banking system.
In a matter of days, the United States had isolated Iran from the world banking system, destroyed the exchange value of Iran's currency, injected hyperinflation into the local economy and caused a stratospheric increase in interest rates. That this happened just weeks ahead of Iranian elections at a time when the United States is promoting regime change in Iran is no coincidence.
What came next was surprising to many but not to those who gathered at the financial war game in 2009. India is one of the largest buyers of Iranian oil, which it needs to fuel its own economic growth. Reports from Israel indicated that India and Iran have worked out an "oil-for-gold" swap in which India would pay for Iranian oil exports with gold. At today's prices, the swap would equate to 17 barrels of oil per ounce of gold. Other reports suggested that China would also continue its Iranian oil imports but would work on alternative non-dollar payment mechanisms possibly including gold but also making use of Chinese, Russian, Central Asian and other non-Western banking systems, currencies and commodities.
In these and other developments we may be witnessing the end of the dollar standard that has prevailed since the collapse of the gold standard in 1971. Any monetary standard—be it gold or dollars—only works so long as the participants trust that the leading parties will maintain the value of the unit on which the standard is based. A strong dollar can be the basis for a global dollar standard. When the U.S. Federal Reserve debases the dollar—as it has over the past three years with $2 trillion created from thin air—it comes as no surprise that global and regional powers such as Russia, China, India, and Iran take steps, however fitfully, to exit the dollar system once and for all.
What began as an exercise in financial warfare against Iran using dollars as a weapon may end in a dollar defeat because the Fed has abused the trust placed in it by dollar holders everywhere. It is ironic that the U.S. national security community has come to appreciate the role of finance as warfare at exactly the time the Fed has allowed the dollar weapon to degrade due to debasement and derogation of trust. A strong national security posture cannot be pursued with a weak currency. Let's hope someone reminds the Fed before it's too late.