Iran's plan to weaken the dollar will fail
Tehran lacks the freedom and transparency needed for a successful oil exchange.
JERSEY CITY, N.J.
If, as is widely believed, the original tales of the 1001 Arabian Nights came out of Persia, then Iran, Persia's modern successor, has just given the world yet another great fantasy: the Iranian oil bourse.
Surely Tehran lost touch with reality when it developed its plan to use a new, euro-based oil exchange, on Kish Island in the Persian Gulf, to dethrone the greenback from its position as the world's reigning reserve currency. Such a project is neither likely to attract much business nor to have Tehran's desired effect on the dollar or the United States.
Tehran's plan of attack has the virtue of economic logic at least. Iran's planners recognize that the heavy use of the dollar in international trade sustains its foreign exchange value by forcing people to hold greater dollar balances than they otherwise would. The dollar's consequent strength encourages its use in other transactions, which requires still greater dollar holdings in a dollar-boosting cycle. Iran's planners hope that their euro-based exchange will disrupt this pattern. By forcing oil traders to hold euro balances instead of dollar balances, Tehran expects the oil bourse to induce dollar selling and consequently force a drop in value. Those foreign exchange losses will draw still more trading away from the dollar, further weakening it, until, ultimately, it loses its world-leading position. Iran's planners expect to do the US great harm in this way.
This economic logic, though reasonable from a theoretical standpoint, misses some very practical hurdles to success. Tehran's exchange simply is not attractive compared with the exchanges in London and New York, where dealers and traders are prospering amid their well-developed networks. On distant Kish Island, they would: (1) lack trained locals to work in their operations, (2) have to deal with a notoriously corrupt bureaucracy, (3) lose contact with a transparent financial, regulatory, or banking system, (4) lack the necessary technological infrastructure, and (5) sever most links to the globe's electronic commercial structures on which trading relies.
Because Iran is not even a member of the World Trade Organization, dealers who move to Kish Island would also miss the kind of legal structures on which they rely to facilitate trading and secure the contracts that support it. Furthermore, a firm's move to Kish would subject any staff assigned there to Islamic sharia law. Western oil company employees tolerate that burden because they must go where the oil is. The same is not true of futures traders.
Against this list of drawbacks, it is difficult to see how such an exchange could even get started. Tehran is unconvincing with its argument that proximity to the Middle East oil fields can overcome other reservations, especially in today's electronic, information-laden world. Neither can Tehran use its oil production, as it has hinted, to force traders and dealers to its exchange. As long as Iran sells its oil onto world markets, it has no control over where it gets traded. And Iran, whatever its political agenda, simply does not have the economic and financial wherewithal to hold back its oil altogether. Petroleum amounts to 80 percent of all Iranian exports, 45 percent of the country's GDP, and 60 percent of the government's revenues. With the economy there already rickety, any shortfall in oil sales would tempt financial, economic, and consequently political suicide for Iran's current regime.
Iran's proposed bourse would also face serious diplomatic and religious problems. To work, the exchange would require a free flow of funds and oil, but Iran's membership in OPEC subjects it to strict production and sales quotas. It is not at all clear how Tehran plans to reconcile one requirement with the other. Most fundamental of all, at least for many Iranians, is the likely violation of Islamic law. The Koran forbids either paying or receiving interest; futures contracts always carry an implicit interest for the time value of money. On this basis, the bourse could pose more of a problem for relations between Iran's government and its people than for the dollar.
Even if by some miracle of legal maneuvering and commercial seduction, Tehran established its euro-based oil bourse, trading there would likely fail to move the dollar from its dominant position. Even a wildly successful Iranian exchange would have only a short-lived currency effect. Once traders and dealers had adjusted their transactions balances to accommodate the euro-based trading, they would have no reason for further dollar sales or euro purchases. Currency values would then stabilize at a new level.
Clearly, Tehran has failed to think through its bourse project thoroughly. For the time being then, such talk of dollar destruction from Tehran resembles hopes and dreams more than practice and probability. To steal a phrase from that inspired Middle Eastern thinker, Fouad Ajami, the Iranian oil bourse would seem then to fit best with the many other Middle Eastern "dream palaces."
• Milton Ezrati is the senior economic strategist for Lord Abbett, a money management company.