By Gary Dorsch, Editor, Global Money Trends

Tension in the Middle East has always been a favorite tactic for the “Axis of Oil” – Iran, Russia, and Venezuela, to keep the price of crude oil pegged at artificially high levels. Talk of war in the world’s most unstable region can inflate a hefty “war premium” into each barrel of OPEC and Russian oil. In the Middle East, wars seem to break-out every few years, and lulls in the fighting are often just a timeout, in order to re-supply and prepare for the next round of fighting.

Earlier this week, crude oil jumped $4.50 to as high as $88.20 /barrel in New York, and is commanding a “war premium” of roughly $10 /barrel. The price of West Texas Sweet is $10 /bl higher since Sept 12^th, when the OPEC cartel agreed to boost its daily oil output by 500,000 to help meet winter demand. But the token increase in OPEC output has done little to hold down surging premiums for Mid-East oil.

Instead, with the Americans looking for a way out of the Iraqi quagmire, Arab oil kingdoms worry that if the US falters and Iraq degenerates into a failed state, it could spread instability and terror through the region. The ingredients are there for civil war on three levels, Arabs against Kurds, Shi’ites against Sunnis and everyone against the US, all battling for control of Iraq’s 220 billion barrels of oil.

An accurate reading of the global supply and demand picture is certainly a big help in predicting global oil prices. But if one wants to point the “finger of blame” at the biggest culprit behind the historic rise in crude oil prices, it’s no other than Federal Reserve chief Ben “B-52” Bernanke, whose decision to bail-out Wall Street brokers and banks this past summer, by slashing short-term interest rates, set in motion another US dollar devaluation, and sent global oil prices and gold sharply higher.

The Fed is the guardian of the world’s top reserve currency, and has a responsibility to defend the purchasing power of the greenback, and keep global inflation in check. But when push comes to shove, Mr Bernanke has always voted to speed up the printing presses, to inflate the US economy out of a tough bind. Today, the US M3 money supply is 14.7% higher than a year ago, it’s fastest in history, and up from 8% when Bernanke got his hands on the printing presses in March 2006. 

Bernanke’s money printing binges are supported by his cohorts at the Fed. On October 9^th, St Louis Fed chief William Poole said, “I do not see any implication for inflation, at least with the magnitude of the US$ depreciation that we’ve seen so far. I did not see any evidence of a raft of dollar price increases for foreign goods. For manufactured goods, I think the pass through is very, very small,” he said.

On Sept 287^th, Federal Reserve Governor Frederic Mishkin was trying to brainwash his audience at a globalization conference held in Washington DC. “Inflation has come down in the old-fashioned way. Tighter monetary policy and a commitment to price stability by central banks throughout the world have led to lower inflation and an anchoring of inflation expectations,” Mishkin declared. On Sept 11^th, Mishkin said, “Gold was not a particularly useful indicator of inflation.”

When answering an audience question about inflation after a speech before the New York Economic Club on Oct 15^th, “B-52” Ben did admit, “One cannot deny that when the dollar depreciates there is some inflationary impact.” However, to alleviate any fears that the Fed might combat inflation with higher interest rates, Bernanke added, that “expectations for slower growth may moderate price increases.”

Whenever the stock market has a bad day, reporters from the mainstream media try to find plausible explanation, for why the market turned south. This week, the surge in crude oil prices above $85 per barrel was widely blamed for the market’s sudden tremors. Yet since the first quarter of 2003, the Dow Jones Industrials and crude oil have thrived together in peaceful harmony, both climbing in unison to all-time highs. So why blame the stock market’s downturn on an “oil shock” this week?

At what point, would sharply higher oil prices begin to rattle the global stock market? (This topic will be covered in an audio broadcast on October 17^th, for paid subscribers to Global Money Trends). And how would Ben “B-52” Bernanke, react in a “Twilight Zone” episode in which crude oil jumps to $100 per barrel? Nobody knows for sure, but on October 21, 2004, Mr Bernanke responded to such as question, “I would argue that the Fed’s response to the inflationary effects of an increase in oil prices should depend to some extent on the economy’s starting point.”

“If inflation has recently been on the low side of the desirable range, and the available evidence suggests that inflation expectations are likewise low and firmly anchored, then less urgency is required in responding to the inflation threat posed by higher oil prices. In this case, monetary policy need not tighten and could conceivably ease in the wake of an oil-price shock,” Bernanke said.

So don’t be surprised if “B-52” Ben argues that a weak US economy and doctored inflation statistics, justify a further easing in Fed policy, pouring more gasoline on the flames of inflation, in the event of a surge in crude oil prices to $100 per barrel.

European Central Bank Telegraphing Rate hike to 4.25%,

On the other side of the Atlantic, European central bankers are starting to talk tough, and laying the groundwork for a quarter-point repo rate hike to 4.25%, but still lingering far behind the inflation curve. The ECB has permitted the Euro to climb 12% against the US dollar this year, to help hold down import prices of key raw materials and commodities, such as iron ore, copper, crude oil, and platinum.

But once the Euro moved above $1.40, ECB chief Jean “Tricky” Trichet, tried to slow the Euro’s ascent, “We consider excessive volatility very counterproductive from the standpoint of global growth, and I stick with what I have said, that we appreciate what the Secretary of the Treasury in the United States says on the strong dollar being important,” he said on Oct 4^th. (The October 19^th edition of the Global Money Trends newsletter includes our forecast for the Euro and German bund yields).

Mr Trichet’s decision to hold the ECB’s repo rate unchanged at 4.00% in Sept and Oct, re-ignited inflationary pressures in the Euro zone, sending gold 8% higher to 536 euros /oz since mid-August. The ECB is permitting its Euro M3 money supply to expand at an 11.6% annualized rate, its fastest acceleration in history, which is inflating gold prices in Europe. North Sea Brent crude oil hit a record 60 euros per barrel this week, now that the Euro’s rally vs the US$ has stalled out.

Finally on Oct 11^th, Bundesbank chief Axel Weber hinted at a resumption of the ECB’s baby-step tightening campaign, which was derailed by the Fed’s exercise of the “Bernanke Put”. “There is a danger that additional action will arise against the expected pickup in inflation in coming months, particularly if the price increases occur more broadly and not only in energy and volatile food prices,” Weber said.

“Monetary policy can be accommodative, that is support the economy in certain phases, as long as the medium-term inflation expectations remain in line with price stability. But if risks to price stability threaten to materialize, monetary policy must stop supporting already robust growth or turn restrictive,” Weber warned. Those are some pretty tough words, but the ECB is still in the “jawboning” stage, and has no intention of lifting its repo rate in November.

The ECB’s move to drain 60 billion euros from the banking system on Sept 10^th did put a floor under the German 10-year bund yield at 4.05%, and talk of a tighter monetary policy has elevated yields to 4.37% today. But German bund yields remain far below their July highs of 4.70%, and the ECB’s operations in the money markets are simply not high enough to curb inflation pressures in the commodities sector.   

Turkish Saber Rattling lifts Crude Oil

Earlier this week, Turkish PM Recep Erdogan asked his parliament to approve plans for an invasion into northern Iraq to attack Kurdish militants, defying a US demand for restraint. Turkey built up its military forces on Iraq’s border, a move meant to pressure Baghdad to rein in the rebels of the Kurdistan Workers’ Party, who are launching raids into southeast Turkey from hideouts in Iraq. Turkey must also deal with its own rebellious Kurdish minority, which makes up 20% of its population.

But Ankara also has its eyes on a bigger prize, the oil fields of Kirkuk that contain 40% of Iraq’s proven oil reserves. Ankara still holds its claim to Kirkuk, which was taken from Turkey as a result of the 1923 Lausanne Treaty. Turkish nationalists still regard it as historically part of Turkey. Ankara also asserts guardianship over the Turkmen ethnic minority in northern Iraq.

Ankara fears that Baghdad will allow the Kurds to make Kirkuk part of their autonomous zone. For Ankara, this would be excessive Kurdish autonomy, its red line in Iraq, and it might resort to military intervention to prevent the emergence of an oil-rich Kurdish political entity on its southern border.

Erdogan said his country will not be deterred by the diplomatic consequences if it decides to stage a cross-border offensive against Kurdish rebels. “If such an option is chosen, whatever its price, it will be paid. There could be pros and cons of such a decision, but what is important is our country’s interests.” With regards to whether or not a Turkish invasion of Iraq could destroy the relationship with the US Erdogan said, “Let it snap from wherever it gets thin.”

Republicans call for Military Strike against Iran,

A possible Turkish invasion into northern Iraq is only a small sideshow compared to the heated rhetoric that’s building up on the Republican campaign trail. On October 16^th, Republican candidates Rudy Giuliani and John McCain said they would use military force against Iran to prevent it from getting nuclear weapons. Giuliani said Iran is a state sponsor of terrorism that is seeking nuclear weapons, and needs to understand how the US would respond.

“Anybody who wants to be president of the United States would say a prayer at the beginning that you would never have to use American military power. But as president, you can’t hesitate to do that, if it’s in the best interest of the US. You have to stand up to dictators and tyrants and terrorists. Weakness invites attack. Strength keeps you safe,” Guilianni declared.

On Iran specifically, he said, “We’ve seen what Iran will do with ordinary weapons. If I’m president, I guarantee you we will never find out what they would do with nuclear weapons because they’re not going to get them.” McCain agreed, “At the end of the day, we cannot allow the Iranians to acquire nuclear weapons.”

On July 4^th, Republican presidential candidate Mitt Romney said he would use military force against Iran if attempts to isolate and pressure its current regime fail. “I’m not going to shrink away from Iranian President Ahmadinejad,” Romney said. “Ahmadinejad is a dangerous man and a threat to US interests.” On Oct 16^th, Romney added, “It’s time to take Ahmadinejad at his genocidal word.”

On June 12^th, the UN atomic agency said Iran could have 8,000 centrifuges enriching uranium by December, a significant rise in nuclear capability likely to fuel fears that Tehran seeks nuclear weapons. “The concern is that they will have a sensitive number of centrifuges without having resolved the question marks surrounding the history of Iran’s program. It becomes a greater proliferation concern,” IAEA chief Mohamed El-Baradei told political leaders in private conversations.

Then on October 15^th, US Defense Secretary Robert Gates called Iran “an ambitious and fanatical theocracy. With a government of that nature, only a united front of nations will be able to exert enough pressure to make Iran abandon its nuclear aspirations.”

“Our allies must work together on robust, far-reaching and strongly enforced economic sanctions. We must exert pressure in the diplomatic and political arenas as well,” he said.

“And, as President Bush has said, with this regime we must also keep all options on the table,” he said, in a veiled reference to possible military action.

Gates said Iran seems increasingly willing to act contrary to its own interests. “We should have no illusions about the nature of this regime or its leaders - about their designs for their nuclear program, their willingness to live up to their rhetoric, their intentions for Iraq, or their ambitions in the Gulf region.” Among the US objectives in the Middle East, Gates listed an “Iran that does not build nuclear weapons or holds Israel hostage with the threat of attack.”

Gates will meet with Israel’s new defense minister, Ehud Barak, in Washington on October 16^th, to discuss the joint anti-missile Arrow-2 project, designed to intercept missiles that could deployed by Iran and Syria. Israel’s satellite, the Ofek-7, flies over Iran, Iraq, and Syria once every 90 minutes.

Last month, Barak, Israel’s most decorated soldier and legendary former commander of the Sayeret Matkal, directed an attack on a secret military compound near Dayr az-Zawr in northern Syria, inhabited by North Korean nuclear technicians. Today, the site lies in ruins after it was pounded by Israeli F15I’s, reminiscent of the attack on Iraq’s Osirak in 1980. 

The UK’s Sunday Times said preparations for the attack began in May, when Meir Dagan, the head of Mossad, presented PM Olmert with evidence that Syria was seeking to buy a nuclear device from North Korea. Dagan feared such a device could later be mounted on North-Korean-made Scud-C missiles. Sergei Kirpichenko, the Russian ambassador to Syria, warned President Bashar al-Assad last month that Israel was planning an attack, but suggested the target was the Golan Heights.

Equally important, the Pantsyr-S1E missiles, purchased by Syria from Russia, failed to down the Israeli jets that penetrated northern Syrian airspace from the Mediterranean. The “absolute jamming immunity” which the Russian manufactures promised for the Pantsyr missiles were immobilized by the superior electronic capabilities of the Israeli jets.

Such valuable information on Russian missile consignments to Syria or Iran is vital to any US calculation of whether to attack Iran over its nuclear program. Iran is especially concerned over the failure of the Russian-made radar systems, and is slated to purchase more radar equipment in a future deal worth $750 million, the American weekly Aviation Week reported on October 4^th.

Battle for the Strait of Hormuz,

On June 12^th, Admiral Ali Shamkhani, a former Iranian defense minister, told the US Defense News weekly, in the event of an American attack on Iran’s nuclear installations, “Ballistic missiles would be fired in masses against targets in Persian Gulf states and Israel. The objective would be to overwhelm US missile defense systems with hundreds of missiles fired simultaneously at specific targets.”

He said Iran anticipates that US forces will strike without warning against its military’s command-and-control network, and will order ballistic and cruise-missile battery crews to launch the plan within an hour after a US attack begins. In retaliation, “Iran will open a freeway for 40,000 suicide bombers from Afghanistan all the way to Lebanon, to strike in almost every country in the Middle East.”

Most importantly, is the potential shutdown of oil supplies through the Strait of Hormuz, a strategically important stretch of water between the Gulf of Oman and the Persian Gulf. On average around 17-million barrels of oil is shipped thru the Straits of Hormuz each day, roughly 20% of the world’s daily oil production.

The closing of the Straits for the passage of tankers will create a severe shortage that would send shock waves to the energy markets already beset by tight supplies and a limited spare capacity. It is anybody’s guess as to how high the price of crude oil could go if Iranian threats were materialized. A surge above $100 per barrel could trigger a world economic recession of untold consequences.

Yet Tehran, with all of its threats and alleged ability to destroy anything that sails or floats in the Straits of Hormuz, might opt for a less risky retaliation, since the cessation of its crude oil exports and gasoline imports could bring down the Islamic regime. With unemployment rates as high as 20% any disruption in the levels of food and gasoline subsidies, from the drying up of oil revenues, could trigger a serious riot in the volatile Iranian street against the Mullahs in Tehran.

France hints at Military action against Iran,

One is not accustomed to hearing threats of war from the enlightened French government, but since Nicolas Sarkozy became the president of France and moved into the Elysee, France has changed course and is almost reflecting the same policies as the neo-cons of the United States. In his speech to the UN General Assembly on Sept 25^th, Sarkozy said, “There will be no peace in the world if the international community falters in the face of nuclear arms proliferation.”

“If we allow Iran to acquire nuclear weapons, we would incur an unacceptable risk to stability in the region and in the world.” And in a broader warning against the dangers of appeasement, the new French leader said, “Weakness and renunciation do not lead to peace. They lead to war.” Sarkozy said that if the UN Security Council was unable to agree on further financial sanctions, the European Union should take its own measures to raise pressure on Iran.

In light of the Iranian nuclear crisis, French Foreign Minister Bernard Kouchner shocked the world on Sept 16^th, “We have to prepare for the worst, and the worst, sir, is war,” he said in an interview on LCI television and RTL radio. Iran’s state-run news agency IRNA angrily attacked the French government on Sept 18^th, “The new occupants of the Elysee want to copy the White House,” it declared.

Mr. Sarkozy went to Moscow on October 10^th, urging tougher economic pressure on Tehran, but Russian kingpin Vladimir Putin quickly deflated the idea. “We don’t have information showing that Iran is striving to produce nuclear weapons. That’s why we’re proceeding on the basis that Iran does not have such plans,” Putin said. The Kremlin is a member of the “Axis of Oil” and a staunch ally of Tehran, and is unlikely to agree to tougher economic sanctions on Iran.

In a visit to Tehran on October 16^th, Putin declined to say when Russia will start delivering fuel to Iran’s nuclear power plant in Bushehr. “At the moment Russia and Iran are discussing the issue of changing the contract. In general there is a common understanding of the problem. As soon as this is solved, supplies of nuclear fuel will start.  Russia declares that it is committed to carrying out the contract,” Putin said.  

Oct 16^th, Putin said Russia would not accept military action against Iran and he invited Iranian President Mahmoud Ahmadinejad to Moscow for talks. In comments aimed at the United States, Putin said, “We should not even think of using force in this region. We need to agree that using the territory of one Caspian Sea state in the event of aggression against another is impossible," he declared.

The Caspian nations of Iran, Azerbaijan, Kazakhstan, and Turkmenistan backed Putin’s call, saying “under no circumstances will we allow the use of our territories by third countries to launch aggression or other military action against any of the member states.” According to the UK Telegraph’s Sept 16^th edition, Pentagon planners have developed a list of up to 2,000 bombing targets in Iran, anticipating that diplomatic efforts to slow Iran’s nuclear weapons program are doomed to fail.