This article is a re-issue of an article produced for the Gold Forecaster newsletter recently.
In the last few weeks the story of Iraq has faded from the headlines to be replaced by the story on the Ukraine, Gaza and on the business front the tumble of the Dow on the New York Stock Exchange.
But right now in the world we are watching many structural changes taking place quietly but completely. One is the shift of wealth and power to the east, the rise of the Yuan and its use in a growing number of global transactions in the place of the U.S. dollar. At the moment Russia is turning its economic head towards China and the developed world doing its best to do so too. And still the east is gaining ground and its share of global cash flow has doubled from 20% to 40% since the beginning of the century. This is set to continue strongly.
These developments are sending warning signals to us not just that the developed world's share is waning, but the grip on the world's currencies by the U.S. dollar has to weaken over time. Not only is the threat to the dollar's hegemony growing from the Yuan, but key to that role, its dominance over the oil price, is in danger.
Of comfort to the U.S. is its rapid rise to oil self-sufficiency, shrinking the threat from the future oil market to the dollar oil price. But this is extremely critical to the U.S. because it has to retain dollar hegemony primarily because it runs a constant Trade deficit. If it is required to pay for goods in currencies other than the dollar it is in trouble. The dollar's role as the sole global reserve currency will happen, but of more importance will be the loss of its power over global financial markets. As it is the U.S. dollar has lost its power over China. With $4 trillion in its reserves and its growing ability to trade in the Yuan and not the dollar it seems secure from any U.S. action to curb its financial power in the world. The only recourse the U.S. has over China will be over that $4 trillion and we wonder if its actions to prevent BNP Parisbas using the U.S. dollar could possibly be considered by the U.S. under some circumstances?
Apart from that, the U.S. considers the Middle East oil supplies as part of its 'vital interests' in terms of its global power and the power of the dollar. Ask yourself, if most nations were able to pay O.P.E.C. in any currency, what importance would the U.S. dollar hold. Its critical use would be limited to trade with the U.S. The liquidity of the U.S. dollar market does prevent the easy use of 'softer' currencies but the liquidity of the euro, sterling, the Swiss Franc and then Yen, together with the arrival of the Yuan on the global scene would provide sufficient liquidity in place of the dollar. Then where would all those excess dollars go and what would be their value?
So it is in this context that the importance of the situation in Iraq now becomes of disproportionate importance to the monetary world.
In trying to extrapolate what will happen there we have to look at the Middle East with eyes that are neither geographical nor political. We have to look at the religious battles going on there and see where they are going to see what will happen to the oil price and in what currency it will be traded.
As a glimpse of the importance of these issues, the seizure of an oil tanker sent to the U.S. for the sale of oil by the Kurds of Iraq, by the U.S. last week has caught our attention.
The changing Iraq
With the declaration of a new country straddling the borders of Syria in the west and Iraq in the east, the scene is set for the full disintegration of Iraq into three countries along sectarian lines. We now look at what countries lie ahead in the region;
Each of the borders to these countries will be embroiled in war against each other. The sectarian issues have overwhelmed any political issues, which are being swamped in the process.
Even the U.S. has lost its influence with the exception of supplying arms to the government it instituted before it left. This government's history of corruption and prejudice against Sunnis is where the war will become centered.
We see the most northerly 'country' being Kurdistan [in cream on the, map], unlikely to want to give up its autonomy rapidly becoming sovereignty and so consolidating its hold on the oilfields of Kirkuk.
The Islamic State
The second 'country' is the new 'caliphate' under the Sunnis [in light brown on the map], again, because of bitter experience of its treatment under an integrated government in Bagdad, unlikely to want to merge into a future integrated government even if moderate
Sunnis win out over ISIS [most unlikely].
The Shia State of Iraq
The third 'country' will be in the south [in the darker green] under the Shi'ites, in command of the bulk of the nation's oil [3m barrels per day] and export terminal at Basra.
While we see this as the outcome, the cost to the country is likely to be extraordinarily high as the polarization of the two sides of Islam, which will, no doubt, come, will leave the rest of Iraq facing religious 'cleansing' because of the many remaining mixed areas of the country, including Baghdad [in light green on the map], where blood baths have and will surely ensue as different groups tried to establish their dominance in these 'undefined' areas, as you can see on the map here and chase those not of their religion out of those areas.
With Iran, their historic enemy, now lining up drones and other military supplies to help the government of Prime Minister Nuri Kamal al-Maliki retake the north and protect the south, many Sunnis are becoming become further alienated from the state. But we do not see the current 'support' of the American instituted government in Bagdad, by Iran, as being committed to that government, but certainly committed to the Shi'ites in the country. This is not about secular government, or simple geography, it is about religion and oil.
The rapid invasion of Iraq by the Islamic State in Iraq and Syria, which supplied the shock troops of the assault on Mosul, has made vigorous efforts to inculcate a new identity for those living within its growing transnational sphere, setting up Shariah courts and publicizing videos in which its fighters burn their passports. Recently, the group issued an eight-page report denouncing the Middle Eastern border system as a colonialist imposition, and included photographs of its fighters destroying what it called "crusader partitions" between Iraq and Syria.
Across the border in Syria, a Kurdish region in the country's north is also effectively independent of Damascus, with its own military and provisional government. And Turkey, which in the past strongly opposed an independent Kurdish state on its border, now sees the Kurds as a stable buffer between itself and the extremists of ISIS.
In Iraq, it has long been assumed that the Shi'ite heartland of southern Iraq, where the major oil fields are, would give the Shi'ites a tremendous advantage, leaving the Sunnis with only the vast landlocked deserts to the north and west. But northern Iraq also controls both of the country's major rivers, the Tigris and Euphrates, which flow southward toward Basra.
The prospect of a more formal partition in Iraq or Syria would also lead to mass migrations and further turmoil, judging by some recent examples of state partition, like the division of Sudan in 2011, or that of India and Pakistan in 1947. Those breakups were the result of long struggles and led to terrible violence.
Prospects for gold and oil
While exports from the terminal at Basra are trying hard to make up for lost exports in the north and the oil price has only hit $115, should the conflict see ISIS try to attack the south-west of Iraq and Bagdad, we do see speculators pushing oil prices up to $140.
We also see Iran taking far more aggressive actions by sending in troops overtly or covertly [which they are doing now] to secure the Shia 'country'. If the current government collapses [looking very likely right now], we see Iran's moves to protect the Shi'ites as certainly including controlling Basra.
They would, we feel try to pacify the U.S. and the oil world by maintaining the current production levels. A failure to work with Iran, no matter the political compromise involved, would see oil prices move up over $140 to the detriment of every economy on this globe!
But would Iran be paid in dollars? Or as we see Iran, currently under the control of the U.S. vis-a-vis its oil exports [until the nuclear issue is resolved], having these controls lifted.
Already it supplies China and will have the option of doing so with Iraqi oil too. With the punishment of BNP Parisbas in mind, we would expect Iran to be happy to receive Yuan [Renimbi] in payment of its oil. This would weaken dollar hegemony and blaze a trail for other nations to move away from the dollar [as it is now more overtly political]. This will directly impact the global monetary system and dollar hegemony.
As to gold, three factors emerge:
The forecasts of the WGC OMFIF report come onto center stage.
The actions of the Iraqi government in buying 90 tonnes of gold can now be seen in context as its currency begins to lose all credibility, as ISIS robs the banks it invades taking the management of that currency to untenable levels.
With the Middle East responsible for 20% of the world's physical gold demand last year, we expect their demand to jump not simply at retail levels but at central bank levels. Whenever war comes into the picture, one of the first casualties is the local currency. The Ukraine is a recent example of this. Even though the country is not at full scale war levels, their currency has fallen 45% this year already.
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