Tag Archives: Donald Trump

Sanctions Busting, European Style

This blog post is a guest post on BullionStar's Blog by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold. BullionStar does not endorse or oppose the opinions presented but encourages a healthy debate.

U.S. officials were infuriated last week when Germany, the UK, and France unveiled plans to create a European payments channel to help Iran to avoid U.S. sanctions. Even more surprising was their chosen allies: in announcing their sanctions busting plan, the Europeans were joined by Russia and China.

There has been very little detail provided on the proposed payments channel. The press release describes it as "a Special Purpose Vehicle, to facilitate payments related to Iran's exports (including oil) and imports." Nor did EU High Representative Federica Mogherini's comments after the press release contain much information about the special purpose vehicle's technical specifications, other than to say that it would be "opened to other partners in the world."

Despite the lack of particulars, I'll make some educated guesses in this post about the intended role of the Special Purpose Vehicle (SPV) and how it will be designed. I think that the SPV will probably be able to carve out some space for the rest of the world to engage in Iranian trade, but we shouldn't overestimate its power. The U.S., after all, wields an incredible amount of economic might and under Trump hasn't been shy about deploying it.

Trump leaves the Nuclear Deal

The background for the creation of the new European payments channel is the Trump administration's recent departure from the Iran nuclear deal, officially known as the Joint Comprehensive Plan of Action (JCPOA). This was a deal signed by the France, UK, Germany, U.S., Russia, and China, or the E3+3, in 2015. The JCPOA promised to normalize Iran's economic relations with the rest of the world in return for fully-audited limitations on Iran's nuclear efforts.

The U.S.'s exit from the JCPOA this spring brought with it a re-imposition of the same harsh U.S. sanctions leveled on Iran prior to the deal. The most damaging of these, oil-related sanctions, will go into effect on November 4. Oil is by far Iran's largest export. Without the ability to export oil, Iran can expect to be stuck in an autarkic limbo.

In response to the U.S.'s re-imposition of sanctions, many multinational companies that had previously recommitted to Iran after the JCPOA's passage have been exiting, including Total, Daimler, Maersk, and Mitsubishi UFJ. Nevertheless, Iran continues to keep its end of the deal, the International Atomic Energy Agency verifying that it is implementing its nuclear-related commitments. But the economic damage that the U.S. is creating threatens to undermine the remaining five signatories' pledge to normalize economic relations with Iran. If Iran ceases to get enough economic benefits from the JCPOA to justify its promise to give up on nuclear weapons, it may simply walk away.

The E3+2's new payments channel is an attempt to counteract some of the negative economic effects of the Trump administration's sanctions and thus keep Iran in the deal. To gauge the effectiveness of the tool, we first need to touch on how U.S. sanctions work.

Blacklists: Economic Weapons of Mass Destruction

The U.S. has been using a set of blacklists to sever Iran from the global economy. These blacklists were devastatingly effective during the previous round of Iranian economic sanctions (2010-2015), and given the current parade of multinationals leaving Iran, they have not lost any of their potency.

Some of these blacklists designate specific individuals, companies, and organizations owned or controlled by Iran as offenders. The National Iranian Tanker Company (NITC), for instance, has landed on one of the U.S.'s lists, as has Bank Melatt, one of Iran's largest banks. Another set of blacklists targets activities. For instance, buying Iranian oil has been blacklisted, as has the sale of automotive goods to Iran.

Any foreign institution that does business with blacklisted entities, or engages in blacklisted activities, will be sanctioned by the U.S. The punishment for this involves a restriction of access the U.S. economy. This might mean no longer being able to business in the U.S., having its access to U.S. currency curtailed, or being cutoff from U.S. financial markets and banks.

For instance, a European bank that facilitates Iranian oil purchases may find that it can no longer open a correspondent account with U.S. banks. These sorts of accounts are vital for facilitating U.S. dollar payments. A European auto parts firm that sells suspension systems to Iranian automakers might find that it can no longer buy products from U.S.-based car parts companies. Because losing access to the U.S. economy is so much more damaging than being unable to transact with Iran, many companies have chosen to comply with U.S. sanctions and have left Iran.

The only companies that will risk doing business with blacklisted organizations or deal in blacklisted commodities are those that have no connection to the U.S., and thus little to lose. Government-owned enterprises might qualify. For instance, Chinese and Indian state-owned refineries have little need to access the U.S. market, and can therefore serve as natural buyers of blacklisted Iranian oil.

This option has its limits however. If Iranian oil traders were to sell exclusively to Chinese and Indian buyers, they can expect to be paid with Chinese yuan or India rupees. But Iranians need to import a broad variety of products and services, many of which China and India simply cannot offer. The result would be large amounts of sterile yuan and rupees accumulating unspent in Iranian accounts.

A European tool for countering U.S. Blacklists

This is where a European payments option may come in handy. Large European firms simply cannot afford to export to Iran or buy Iranian oil. The biggest refiner in Europe, for instance, is France's Total. Because it has 6,750 employees in the U.S. and millions of American customers, Total has too much at stake to risk offending American rules. But as Iran sanctions veteran Richard Nephew points out, European small & medium size enterprises (SMEs) may step up as a group of "willing to be sanctioned." These European SMEs might not have U.S. subsidiaries nor depend on U.S. supply chains, and little to lose from being sanctioned. If so, they would be able to provide Iran with the sorts of goods and services that India and China cannot export.

To complete this European connection, Indian and Chinese firms would have to open euro denominated accounts in Europe. They could then buy a portion of their Iranian oil imports with those euros. These euros would flow into Iranian accounts, only to be spent  at European SMEs, say to buy manufactured goods, which would be sent back to Iran. The SMEs could then draw down their euro accounts to pay their employees and suppliers.

The recently announced European SPV could be a way to formalize this trading circuit. All three groups - Indian & Chinese state-owned refiners, Iranian oil merchants, and European SMEs - would establish euro denominated accounts at the SPV. The SPV would act as a euro-based clearing house between these various parties, matching buyers with sellers. In theory this clearing function could also be provided by private European banks, but in practice they would be wary of playing such a role due to concerns about being punished by the U.S. A newly-constituted SPV that has no U.S. function or appendages needn't share those concerns.

The effectiveness of this payments channel depends on how many European SMEs would be willing to participate. In our interconnected world, many SMEs will have some sort of existing U.S. connection, whether these be American suppliers or customers, and may not be willing to jeopardize this relationship. If a limited number of SMEs sign up to use the SPV, only a small amount of oil trade will be settled in Euros, and Iran will find that the SPV does not provide them with much shelter from sanctions.

It is possible that European governments could incentivize SMEs to join the SPV arrangement.  The European Union's ‘blocking statute’, for instance, would allow SMEs to recover damages that might result from sanctions. The blocking statute was originally proposed by the EU in 1996 to counteract an American trade embargo on Cuba and sanctions related to Iran and Libya

However, if an SPV were to become too successful, that would doom it. An SPV that attracts large amounts of European exporters would encourage Trump to advance the front lines of his sanctions war and attack the SPV participants themselves. He would go about this by blacklisting all European SMEs that are directly engaging in SPV-backed Iran trade. European suppliers to these black-listed firms would suddenly face immense pressure to stop doing business with their black-listed customers. Even if blacklisted SMEs have no direct U.S. dependencies, odds are that their domestic suppliers will have some sort of vital connection to U.S. supply chains or customers. If they wish to retain this connection, these firms will have to immediately dissociate from SMEs that engage in Iran trade.

Additionally, European banks would face pressure to freeze the accounts of black-listed SMEs for fear of being cut off from the U.S. banking system. This combination of a collapsing supply chain and an exile from the banking system would leave blacklisted European SMEs incapable of doing business not only with Iran, but everywhere else too. In short, they could go bankrupt.

One way or the other, American dominance of the global economy necessarily limits the ability of any European SPV to successfully bust U.S. sanctions. It is certainly possible that the creation of a new payment channel encourages some round-trip trades, say between India/China, Iran, and European SMEs, that wouldn't otherwise occur. But in the end, the European SPV can never nullify the effects of U.S. sanctions, it can only slightly dampen them. It remains to be seen if this will be enough to keep the Iranians in the JCPOA.

Trump and Gold

It was an event-filled and turbulent evening last night as the results for the 45th US presidential election rolled in, signalling that the majority of the American electorate had voted for Republican candidate Donald Trump. Trump received over 270 of the 538 electoral college votes needed to secure a majority. Trump will now be inaugurated as US President on Friday January 20, 2017.

Media and Polls eat Humble Pie

This, the 58th US presidential election, will no doubt go down in history as one of the most unusual, divisive and wrongly predicted US presidential elections of all time. The official surveys of the expected outcome were proven to be way off the mark, and in fact the entire US polling industry may have to reassess its methodologies and enter a period of self-reflection. The mainstream media machine, particularly but not exclusively in the US, was also shown up throughout this election campaign to be glaringly slanted and in favor of the Democratic candidate Hillary Clinton at the expense of Trump, and a large amount of shock, back-peddling and embarrassment seems to have hit that section of the media today, in a 2017 version of 'Dewey defeats Truman'.

The media and survey driven, but shockingly wrong, consensus of an assured Clinton victory, which was relentlessly pitched over the last few months, also seems to have been priced into the financial markets, which is arguably why the actual outcome of a Trump victory caused acute volatility and large moves across the markets last night and into today.

Market Volatility

US stock market index futures all fell sharply during trading in US evening hours last night as the prospects of a trump victory began to crystallize. S&P 500 futures and Nasdaq 100 futures both went limit down in trading, each losing about 5%, and Dow equity index futures at one stage was 800 points lower. Asian market equities were also weaker, and the US Dollar weakening against most major currencies, and the Mexican Peso also plummeting.

The markets had a very Brexit feel to them, in a similar fashion to how the markets had reacted overnight between late Thursday June 23rd, the day the Brexit EU referendum was held in the UK, and early morning Friday June 24th, when it became clear that the referendum results pointed to a majority of voters wanted the UK to leave the European Union. In both these events, Brexit and a Trump win, financial market uncertainty has been a big factor.

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Florida and Ohio

Results from the battleground states of Florida, Ohio, and to a lesser extent North Carolina were decisive to Trump’s election and to the market’s moves. Florida, with 29 electoral votes, and the 3rd highest population by state at just over 20 million people, was called to Trump late on Tuesday night before 11pm. Ohio, with 18 electoral seats and 7th largest state population of 11.6 million people went to Trump at about 10:20pm. North Carolina, with 15 electoral seats and a 10 million population, was called for Trump just after 11pm NYT. Within the space of an hour, Trump had won the 3 key states of Florida, Ohio and North Carolina, which between then have 62 electoral college seats. By just after 1:30am, Pennsylvania was called to Trump, and following that Wisconsin. A trump majority in Iowa also helped. The rapidity of these results coming in also had a resonance with the Brexit results back in June.

Previously, the states of Florida, Ohio, Iowa, Pennsylvania, Wisconsin, and Michigan, had all majority voted for Obama on both occasions when he had been elected. This is why these particular state results going to Trump were a) critical for Trump and b) caused the volatile market reactions due to the markets' perceptions that a Trump presidency will create more unknowns and greater uncertainty.

Precious metals prices, as would be expected, moved higher on the back of the market uncertainty and the Trump gains. Gold’s low in US Dollars was about $1270 at 8pm New York time (NYT), then it made a $50 ascent to a high of $1336 just after midnight NYT, an up move of 5.2%. See BullionStar gold chart for one day move. Silver in US Dollars moved up from $18.40 at about 8pm NYT to $19.02, an up-move of up 3.37%. Platinum also had a sizable up move, at one stage rising $20 from $1000 to $1020. These moves in precious metals prices were also reminiscent of similar moves on the morning of the Brexit results.

Trump and a Gold Standard

Beyond these short-term benefits to the gold price and the prices of other precious metals from a Trump victory, there are some other longer-term benefits to gold that a Donald trump presidency might create.

These longer term potential benefits to gold stem from Trump's affinity for the use of a gold standard as part of the US monetary system. A gold standard, to define the term generally, is a monetary system that employs gold as a monetary unit, and links the economy's currency to that monetary unit of gold. When used by a number of countries, each country's currency can then be expressed in terms of gold, i.e. the exchange rates between the currencies are defined in terms of gold.

Donald Trump is known to be sympathetic to the concept of a gold standard, and even attracted to the prospect of implementing a gold standard as a way of maintaining the stability and value of the US Dollar. The first of Trump's recent references to a gold standard came in a 2015 interview with WMUR-TV, New Hampshire, in a segment called ‘Conversation with the Candidate’, published on March 31, 2015, in which Trump commented on the gold standard in response to an audience question:

Question: “Can you envision a scenario that this country ever goes back to a gold standard?”

Trump: “In some ways, I like the gold standard and there is something very nice about it but you have to go back at the right time... We used to have a very solid country because it was based on a gold standard for it. We do not have that anymore. There is something very nice about the concept of that. It would be very hard to do at this point and one of the problems is we do not have the gold. Other places have the gold."

The transcript of this interview can be read in an archived page of the WTAE-TV Pittsburgh website. See ‘web extra’ section. WTAE is a sister channel of WMUR.

It's slightly odd that Trump thinks the US doesn't have the gold, or maybe he knows something about Fort Knox and the US Treasury gold reserves that has not been made public.

Following his March 2015 comments, Trump again addressed the gold standard in November 2015 in a short video interview with GQ magazine when he said:

“Bringing back the gold standard would be very hard to do, but boy would it be wonderful. We'd have a standard on which to base our money."

You can see the short GQ video interview with Trump on visiting this page.

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Some of Trump's economic advisers also have notable views on gold, and the possible utilization of gold within the US currency system. In an interview with Forbes magazine in August this year, Dr. Judy Shelton, part of Trump's economic advisory team, was asked on her view of a gold backed monetary system:

Forbes Question: "You’ve written before about going back to some sort of gold-based monetary system. Is that something the U.S. could do unilaterally, or would we need to convene other nations and get them on board?"

Shelton: "In terms of gold being involved [in the system], some people may think of that as a throwback, but I see it as a sophisticated, forward-looking approach because gold is neutral and it’s universal.

It’s a well-accepted monetary surrogate that transcends borders and time. If you look at the foreign reserves of the most important countries, they keep them mostly in gold. I don’t want to read too much into it, but it proves that gold is not some barbarous relic.”

Shelton also referenced a Bretton Woods style conference:

"I’m not opposed to a new Bretton Woods conference, and if it takes place at Mar-a-Lago, I’m fine with that."

Bretton Woods being the 1944 conference in New Hampshire at which the attendee countries planned the introduction of a gold backed system of fixed exchange rates, where the value of  the US Dollar was linked to gold and other participating currencies were linked to the Dollar. Mar-a-Lago is a hotel and club in palm Beach, Florida, owned by Trump.

John Paulson, the founder and head of the well-known and successful hedge fund company Paulson & Co Inc, is also an economic advisor to Trump. Paulson is known, among other things, for his fund's investments in gold, and for example, Paulson & Co is currently the 5th largest institutional investor the SPDR Gold Trust (GLD). The appointment of Paulson to a position on Trump's team could also arguably bolster Trump's position on gold in the monetary system.

As an aside, in the WMUR-TV interview in March 2015, Donald Trump also expressed a view on auditing the Federal Reserve, a view that it will be interesting to see if he still holds during his Presidency. In another answer to a question from the audience, Trump agreed that the Fed should be audited:

Question: Let's go back to our audience now coming from Bob. What is your question? ...[Bob]:"My question is about Federal Reserve. What if any changes would you make to Federal Reserve and do you think they should be audited on a regular basis?"

Trump: "Audited, absolutely. I really think you can have it or not have it. A lot of people like it and a lot of conservative people like it. They think there is an adjustment with interest rates and other things. I'm not a fan. I'm not a big fan. Audit, 100%."

Keynes, Greenspan and Bernanke

Any time the gold standard is mentioned, such as when Trump mentioned it on the occasions back in 2015, there are invariably sections of the financial media which wheel out the old misquote by the economist John Maynard Keynes, and state that Keynes said that gold is a barbarous relic. Even Shelton seems to have used the old misquote.

However, Keynes never said that gold was a barbarous relic. Keynes actually wrote the words “the gold standard is already a barbarous relic”, in chapter 4 of his 1924 book “A tract on Monetary Reform”, when specifically discussing whether Britain should return to a gold standard. Britain returned to a gold standard in 1925, against the advice of Keynes. The quote is at the bottom of page 172 of Keynes book “A tract on Monetary Reform”, (1923, this edition Published 1924), chapter 4, “Alternative aims in Monetary Policy”.

Arguably, Keynes was referring to the move after World War I by some countries to return to a gold standard (the inter-war gold standard), and even if he was talking about the classic gold standard (which ran from 1821 to 1914), Keynes just had a personal view that the gold standard was too constraining for what he saw as a "modern" economic system. But what Keynes was essentially advocating at that time, in other language, was a debasement of currency. Fast forward nearly 100 years and its obvious now that fiat currencies' purchasing power has been heavily debased vis-a-vis the gold standard period.

Contemporary endorsements and appreciations for a gold standard are not actually the far out radical ideas that some might claim them to be and are not exclusive to Trump and his advisors. The concept of a gold standard is actually discussed by serious and mainstream monetary economists and even to an extent endorsed by them. In June this year, in an interview with Bloomberg in the aftermath of the UK’s Brexit results, Alan Greenspan, former Fed chairman had this to say about the gold standard:

“Now if we went back on the gold standard and we adhered to the actual structure of the gold standard as it exists let’s say, prior to 1913, we’d be fine. Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the U.S., and that was a golden period of the gold standard.”

And in March 2004 in a speech 'Money, Gold, and the Great Depression', even ex Federal Reserve chairman, Ben Bernanke, who always seemed to give a somewhat grudging partial endorsement to gold, had this to say:

"The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called "classical" gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value. The gold standard was suspended during World War I, however, because of disruptions to trade and international capital flows and because countries needed more financial flexibility to finance their war efforts.

With Trump soon at the helm and in the White House, it's not beyond the bounds of possibility that Trump and his advisors may explore the utilization of gold within the US monetary system over the next 4 years. And who knows, they might even bring Greenspan and Bernanke in as consultants, but perhaps only if Trump does not audit the Fed!