Saturday, December 10, 2005

A Peak Behind the Curtain

Exactly one month ago, the US Federal Reserve issued a simple press release that they will cease reporting M3 as of March 23, 2006. Three whole sentences (read it...). It received zero coverage by the mainstream media. A Fed spokesman said that ''M3 does not appear to convey any additional information about economic activity that is not already embodied in M2."

If M2 and M3 make you think of British motorways or BMWs, read this primer on money supply. I think that this is CRITICAL, because it is the structural backbone to modern geopolitics.

In short, M0 is the value of all US currency that exists in actual bank notes and coins. M1 is M0+checking accounts. M2 is M1+money market accounts and CD's under $100k. M3 is M2+all larger holdings in the dollar (Eurodollar reserves, larger instruments and most non-European nations' reserve holdings). The key point here is that which will be lost when the Fed stops reporting M3, but continues to report M2 and M1: we will lose transparency on the value of reserve holdings in dollars by other nations and major financial institutions.

And, of course, the timing of the discontinuation of M3 data just happens to coincide with the opening of Iran's euro-denominated oil bourse. Funny how that hasn't exactly been reported at all by ABC, CBS, NBC, CNN, Fox or the other "Main Stream Media" sources.

So what will happen when Iran opens its bourse? They won't just sell Iranian oil (although that alone is a sizeable chunk of world production, roughly 4 million barrels per day, or about 5% of global production). Instead, they will create an entirely alternate derivative market to the exclusively dollar-denominated sale of oil derivatives at the International Petroleum Exchange (London) and the New York Mercantile Exchange. The way this works is that NYMEX crude futures are for "West Texas Intermediate" crude, theoretically "deliverable to Cushing, Oklahoma." It will come as no surprise that all the oil is not actually delivered to Cushing, and that oil consumers from around the world still use these NYMEX futures to purchase and hedge on oil. By way of arbitrage, people who need crude oil don't have to actually ship it through Cushing--it doesn't even have to be West Texas Intermediate crude, for example, Nigerian "Bonny Light" or Algerian "Saharan" crudes can all be bought and sold using derivative and arbitrage mechanisms on the NYMEX. So an Brazilian refinery can purchase crude via NYMEX and may actually take delivery from a tanker direct from Nigeria. This is critical because it is exactly the same mechanism by which the new Iranian oil bourse will be a direct competitor to both the IPE and NYMEX. You can count on Venezuela's PDVSA using the Iranian bourse, for example. And naturally, it would only make sense for Euro-zone customers to purchase via Iran using their own currency. This may take some time to build momentum, but it will be a truly monumental shift in the global geopolitics.

The result of this is that countries will no longer need to use the US Dollar as their reserve currency. As reserve currency levels drop, the fundamental impact will be a drop in demand for the US dollar. This will result in a decrease in the value of the dollar, but much more importantly it will mean that there is also a decrease in people wanting to purchase US government debt--the debt that we use to carry huge and consistent budget deficits. Of course, it will still be possible to get other nations to purchase our debt instruments and finance our deficit, but the market will shift the price equilibrium for this debt upward--that is, the interest rate that we are paying on the national debt will increase significantly.

Suddenly the mysterious Fed is much less mysterious: the M3 statistic that they will stop reporting this Spring is exactly the one that would be used to identify just such a shift in the use of the US Dollar as a reserve currency. Was that the motivation for the Fed's move? It's the only one that I am aware of, but it's no more than conjecture.

Just how fast and how strong this shift from the petrodollar to the petroeuro will snowball is difficult to predict. There are plenty of people who think that it will be alternatively minor, catastrophic, or lead to the US nuking Iran in a few months. My goal here (for once) isn't to speculate, but just to shed some light on this murky topic.


Jeff Vail said...

More fuel for the fire: Ariel Sharon has aparently ordered the Israeli military to be ready to strike Iran's nuclear facilities by the end of March. Nice timing...,,2089-1920074,00.html

Peter said...

Kudos for covering this story, Jeff. I first heard about this move by the FED shortly after the press release came out and started digging around into M3. It was tough divining exactly what it meant. Even a few so-called experts didn't really know. You, on the other hand, have done an excellent job of explaining what it means and why we now have even more reason to be leery of the Fed, which is a private corporation despite the deliberately misleading name.

Anonymous said...

I've heard it said elsewhere that the impact of this oil bourse is being greatly exaggerated. The argument being that the holders of US debt will still have significant motivation to maintain their stores of dollar denominated assets and that even if the bourse is widely participated in, which may take years for the exchange to build up that kind of credibility, its effect will be negligible. This argument seems rather convincing.
What other explanantions for this shift on reporting policy by the Fed are out there? Who uses M3 data?

Thoughts? Anyone?

Nicholas Begley

ps Love the site Jeff!

Peter said...


Think about this sentence for a moment, "And, of course, the timing of the discontinuation of M3 data just happens to coincide with the opening of Iran's euro-denominated oil bourse."

The operative word here is "coincide".

That's quite the coincidence then, if it's only a coincidence.

Slick & Vaguely said...

(I'm Nicholas' from earlier)


Yeah, that would be quite a coincidence. But... I don't like leaping based on just one coincidence, even if it is somehow very convincing. What worries me is that we are missing part of the plot by just connecting these two dots without knowing more. Also, I wonder if this change in reporting protocol could really effectively conceal anything. Certainly (?) there are other economic indicators that will demonstrate this potential shift of international holdings. I don't know.
Who does?

Jayson said...

A blogger I forwarded this to commented with the following:

"I can understand why the Iranians would want to dissociate themselves from the dollar, but the euro would be a poor substitute. Denominating the price of a key industrial commodity in a currency other than that in which the products are priced would add a whole new level of currency risk. Im any case, I doubt whether the Fed is dropping M3 for any such reason."

Jeff Vail said...

"Denominating the price of a key industrial commodity in a currency other than that in which the products are priced" is exactly what the petrodollar system is all about. It only carries a significant exposure to exchange rate fluctuations if the oil-consumer doesn't use that currency as their reserve currency--which is exactly the point.

Significantly, early adopters stand to benefit as those who shift their reserves to the Euro first will see the relative value of those reserves appreciate if the Euro gains ground as a reserve against the dollar (Excess demand for Euros will increase its price). An incentive to be an early adopter creates the potential for a run on the Euro.

As I mentioned earlier, I certainly can't prove that the Fed is abandoning M3 reporting beacuse of the Iranian bourse. But I can't think of anything that makes MORE sense: if people have specific alternative motivations, please speak up...

Kevin Carson said...

Uh, didn't Saddam switch from the dollar to the euro right before, before-- Well, I forget exactly what, but I'm pretty sure something big happened right afterward.

Jeff Vail said...

Saddam switched in 2000 if I remember correctly--that didn't work out too well for him. Again, there are a lot of theories that this was the real impetus for the invasion, but the actual causation can't be proved. About the only thing that we can be sure of is that we didn't invade for the reasons that we claimed to invade. A very close friend was an intelligence officer at the Central Command headquarters in Tampa, and he very clearly and explicitly laid out the evidence that there was NOT a connection between Saddam and al-Qa'ida--if anything, that Saddam was effectively preventing al-Qa'ida from gaining inroads in Iraq. Whatever the leaders said, they definitely knew that there was no connection. "WMD" is another story for another time...

Moshe Bereznyak said...

As an Israeli, I've got quite tired of having my country, and the army where I had to serve - both serving American interests. Most of the wars we suffered were intiated by Arab regimes or groups which had previously been supported or maintained by the west.
However, Israel and the US have defferent reasons to strike on Iran. Israel has a very good reason to be afraid from Iranian weapons. America wouldn't give a damn about that, but they have oil fields to take care of there.

Anonymous said...

Please god, let the americans and israelis win and take all the oil and the gold aand whatevver and let them have the notion of superficial happiness. LET THERE BE NO MORE WARS. PERIOD. MAY BE IRANIANS SHOUD DONATE THEIR OIL FIELDS TO ISRAEL JUST LIKE VENEZUELAN PRESIDENT HUGO CHAVEZ IS DOING.
THE PROBLEM: Americans have been accustomed to cheap oil, cheap labor, cheap goods and of course cheap credit, free medicare. Any disruption of any of the above is basically met with violence.
Full Disclosure. I am a brahmin hindu from India and may be want to see a few deeply devout people of the judeochristian faith to dwell on the absolute.

Peter said...


Fix your archive links. Right now your archives are inaccessible. I wanted to reference your for argument against globalization but can't find the page.

Jason Godesky said...

Adding "" to a Google search is a good workaround.

Anonymous said...

I am posting this Jan 13 2006 from Europe.

A few points:

European Countries and countries doing most of its trade in Euros will surely like to have Oil priced in Euros, this of course will reduce the currency risk and the need to keep dollar reserves.

Many countries will have, if the IOB succeeds, a better way to settle political grievances with the USA in the monetary arena. China has significant dollar reserves. China is also an important holder of US debt and has also long term oil supply contracts with IRAN.

Iraq DID great shifting to Euros. The Euro was around .75 of a dollar back then and it is now 1.2 of a dollar. Great investment, first thing the American governor did was to go back to the dollar.

Anonymous said...

To the anonymous Brahmin:

If you consider not being nuked by Iran to be a superficial notion of happiness for the Israelis, what would be a menaingful notion of happiness? I understand that your great saint Ghandi advocated Jews walking into incinerators to protest Nazism, but let us separate the issue of American interests in maintaining oil denominated in dollars from the very explicit threats to incinerate millions of people in an unprovoked nuclear attack.

Anonymous said...

Good story: and one seemingly under-reported by mainstream media. I have a hard time figuring out why - even if an international oil bourse in Iran is just a PR stunt it should be significant and newsworthy?

Can anyone provide a link to any mainstream coverage of this?


Greg said...

With regard to anyone who thinks that the imminent Iranian Oil Bourse and its global currency ramifications aren't really significant factors for either the US/UK-run oil markets or US economic sanctity, please see the following inter-department communication from the US Treasury, circa 1978:

"...confidence in the dollar remains fragile. Recent and more frequent news reports regarding OPEC's growing disenchantment with use of [the] dollar for oil pricing further disturb the market. If OPEC changed the unit of accounting for oil pricing it ciould precipitate a major market reaction which would be in the interest neither of the Saudis, other OPEC members, nor the US."

-- Assistant US Treasury Secretary C. Fred Bergsten to Treasury Secretary W. Michael Blumenthal, in a Treasury department internal memorandum entitled, "Briefing for your Meeting with Ambassador to Saudi Arabia, John C. West", 10 March 1978, P. 1-2.

There’s also this ditty, which might in part explain why people discount to the public the issues related above between government officials:

“The Monday evening news on the networks tells people how much the Dow Jones Industrial averages went up or down that day, but not … the rates at that day’s weekly auction of U.S. Treasury bills – though the money spent to buy the Treasury bills at this one weekly auction exceeds the total trading in the Dow in the entire 31.5 hours that the market is open each week.”

-- Martin Mayer, from the book, "Stealing the Market", P. 2.

vantari said...

Have you given a thought to the fact that M3 measures monetary instruments that are not liquid, i.e. bonds and other post dated debentures. If you look at the gap that has buit up between the M1+M2 measures (liquid and convertible) to the M3 bonds, you will see the "systemic problem" that Greenspan talked about. This is excess fiat currency that has no value, since it can not be absorbed into the economy other than placing it at a future insertion date. The Fed is worried that amount of Cum = M3-(M1+M2) that has been generated since Reaganomics will be astounding. See

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