E-Paper
Iran’s Hormuz strategy is a challenge to the US’s economic future
This article is authored by Sanjay Turi and Praveen Sothwal.
The US attack on Venezuela, followed by an attack on Iran and Cuba, possibly going to be the next, is not merely a coincidence but a well-calculated strategic move to deal with the issue of the declining importance of the dollar worldwide. As the American economy is closely linked to the petrodollar system, the US’s attacks on these countries to acquire crude resources are well understood as part of its concern for protecting its petrodollar-driven economy.
The dollar serves as the world’s reserve currency, with over 57% of global foreign exchange reserves held by central banks and nearly 90% of global forex transactions taking place in US dollars. History is witness to the fact that whosoever challenged the dollar in the past, be it Saddam Hussein, Muammar Gaddafi, or, recently, Nicolas Maduro, have had to pay a heavy price. Given that the petrodollar system is the backbone of the US economic dominance, which is surprisingly challenged by Iran during this war, the Iranian ground invasion plan is inevitable sooner or later. This invasion can be averted only if Iran goes for a ‘compromise’.
Hence, this fear of losing dollar dominance is probably preventing the US from exiting this war early. As the US’s early exit without any solution will give an edge to Iran over the US in dictating the global oil prices, this war is possibly not going to end very soon. The paradox of this war is that neither Iran can be defeated easily, as it has decentralised its central command in 31 provinces, nor will the US make an early exit from this war without reaching its objectives. Hence, it is very obvious that the war will be prolonged. Both Iran and the US have recently put forward a ceasefire proposal; the conditions demanded by both sides are not acceptable to anyone. While Iran wants a permanent and sustainable solution from this deal to prevent any future action by the US, the American side indirectly wants regime change and total control over Iran as well as the Strait of Hormuz. Given the trust deficit, no party is likely to accept the ceasefire conditions at all, as both sides continue to internally mobilise their troops, preparing for the next phase of this war. While the US is planning to order an additional 10,000 paratroopers for ground operations in Iran, the crumbling regime of Iran is additionally mobilising to include more than one million fighters in the Iranian army.
The Federal Reserve has recently issued a Federal Open Market Committee statement saying that it would maintain an interest rate between 3.5% and 3.75%, while there is speculation that the Federal Reserve would be increasing this rate in the upcoming months, aiming to attract the global investors to invest in the US bond market.
It can be argued that the dollar dominance, petrodollar mechanics, and the depth and liquidity of the US financial market are all interlinked. Oil is considered one of the most significant goods required for every single country to run. Meaning, the world needs oil to run, which is actually and generally traded in dollars (petrodollar). For that matter, every country accumulates dollars in the form of forex, which is again directly linked to a country’s overall depth and financial liquidity, through which the money supply dynamic (core purpose of an economy) is regulated. That is how the dollar’s dominance in practice relies heavily on petrodollar mechanics, and that is also how, for the US, the significance of the Strait of Hormuz came to prominence. As the Iran war is more of a geoeconomic and less of a geopolitical war, the significance of the Strait of Hormuz for the US is gaining more prominence after Iran hinted at replacing the petrodollar with the petroyuan, announcing that it will allow only those countries to pass through the Strait of Hormuz which will be conducting only yuan-denominated transactions. This announcement has completely surprised the US, challenging the decades-old petrodollar system in the international crude market. As the petrodollar system is the foundation of the US economy, this decision by Iran has shaken it from within, which is well reflected in the Federal Reserve’s recent decision not to cut interest rates, so that it could attract a larger number of investors to US bonds and securities. The purpose of these steps is obviously to absorb the shocks coming from the supply chain disruptions, primarily to prevent panic selling of US bonds and securities. If this is not handled with sensitivity, this may trigger a dumping of US securities, which may result in a disaster for the US economy.
Although the world is facing skyrocketing crude prices, supply chain disruption and negative sentiments towards the dollar, the US central bank is reportedly still seeing a relatively higher inflow of money into the US bond market after the FOMC statement. As the gold market seems to be entering a bearish trend, the falling prices of gold suggest that investors are possibly diverting their money from gold to US bonds as a safe haven and better returns. Though increasing interest rates is not sustainable for the US economy in the long run, given the US’s massive national debt of more than $39 trillion, the Federal Reserve has no other option but to either raise or maintain interest rates to address the problems arising from West Asia. Nonetheless, apart from the $2 trillion budget deficit, more than $9 trillion of US debt is additionally set to mature in 2026, requiring a massive refinancing by the end of this year. Therefore, failing to comply with the conditions for interest payments on time will undermine investors’ trust in US bonds, which may pave the way for financial catastrophe, as it already did in 1971-1973 (the collapse of the Bretton Woods System). It appears that Trump has realised that he has possibly made a mistake by attacking Iran; however, the early exit from this war is not only likely to hurt the US economy but also the US’s global image as a hegemonic power.
Given that some central banks around the world have significantly reduced their US security holdings, if Iran, with the help of China, Russia and other significant players, succeeds in replacing the petrodollar with the petroyuan, a domino effect can be seen in the selling of US treasury globally, leading to the collapse of the dollar as the core global financial system. However, it is not that easy to do so. Historically observing, the US economy surpassed the UK’s in 1916; it took the dollar more than 28 years to become the global reserve currency in 1944, given that the world went through several ups and downs (World War I & II and the Great Depression) during this period. Therefore, it would not be wrong to say that the world's reserve currency does not change overnight. However, it is very much possible in the long-run. The Trump administration’s recent policy of tariff impositions and the ongoing crisis in West Asia may soon trigger a move towards the dollar being replaced by the yuan. Iran, by allowing passage through the Strait of Hormuz only to those countries making transactions in yuan, is possibly trying to break the Gulf’s petrodollar agreement and move towards allowing crude oil trade in Chinese Yuan. If this successfully happens, countries holding US bonds and securities may dump the dollar and switch to other options available.
Because bond yield and bond prices have an inverse relationship, dumping of US bonds and securities may also lead to significantly higher interest rates on US bonds. Hence, for the US, it can be said that the recent attack on Iran is more suited to phrases like ‘digging one’s own grave’. However, it is also widely said that when America sneezes, the world catches a cold. This saying is not just an exaggeration. It is not to be forgotten that today, over 57% of global forex reserves and nearly 90% of all global foreign exchange transactions are conducted in US dollars. Now, the question arises: to what extent is the world ready to treat a cold, which is most likely to develop into a long-term, intractable disease?
In this context, it is not unreasonable to assume that the world is not very far from another global financial crisis. Now, another question arises: can the US really afford to exit the Iran war in the meantime? The answer is no. Though President Trump consistently reiterates that he will end the war soon, the geo-economic compulsion of the US will not allow it to exit this war too early without achieving its objectives. The recent speculation of the US planning to go for a ground invasion plan into Iran is not just a prediction, rather it is inevitable sooner or later. In fact, from an American economic perspective, it may have become necessary for the US, knowingly or unknowingly, to protect its own economy from collapsing. As the world’s economies are well integrated with the US economy, its potential collapse could trigger a global financial crisis.
(The views expressed are personal)
This article is authored by Sanjay Turi and Praveen Sothwal, doctoral candidates, Centre for West Asian Studies (CWAS), School of International Studies (SIS), Jawaharlal Nehru University, New Delhi.
