Seizing Assets and Sunsetting Deals: Long-Term Implications
Two stories that we have chronicled before have come together in the past week in spooky juxtaposition. We readily admit the stories are somewhat “wonkish”, and have not gotten much press coverage or analysis. The two stories are related to the seizure of Russian assets, as part of the sanctions against Russia several years ago, and the sunsetting of the 50-year-old “petrodollar agreement” with the Kingdom of Saudi Arabia.
We can assure you that both these stories will be important in the longer term, even if they seem arcane in the present.
As to the first, the seizure of Russian assets, we said at the time that such an illegal taking was a bad idea. It proved that keeping international monetary reserves in dollars and the Western banking system was now hazardous. Without any legal proceedings, the US and its allies froze the monetary reserves of another sovereign country. Other countries we said, including China, India, Indonesia, and Saudi Arabia, now must think again about current financial procedures. If they are at risk of the changing political whims of the US, then the dollar and Western banks are not safe places to put your money.
After that seizure, the discussion eventually evolved to the idea of not just freezing the assets, but using them against Russia in the war in Ukraine. Many countries were not willing to go so far as to seize and liquidate the assets outright to be given to Ukraine because of the bad precedent it would set. This past week they came up with a clever twist. What the West will now do is keep the frozen assets but give the interest it has earned as a “loan” to Ukraine.
This is too clever by half, as they say. It still sets a bad precedent because if you steal the income from my property, you are still stealing my property.
So, Russia’s some $300 billion in assets will stay “frozen” while the $50 billion earned”interest” will be “loaned” to Ukraine. How good of a credit is Ukraine?
We can’t see how this clever scheme would make any other major country likely to have disputes with the US feel any better about the state of the current international economic system. They will see this as simply a clever ruse. It still erodes confidence in the system but does not provide enough money to win the war. The message to others is the same: don’t keep your international reserves in dollars or our banks.
It also creates a revenue source outside of democratic control. Now the debate about the merits of aid to Ukraine aside for a moment, if the argument is valid, then representatives of the people of various nations should openly assess the costs and benefits, and charge the appropriate taxpayer for the policies undertaken. It is not a good idea to wage war with a special piggy bank outside of the control of the democratic system. But, that is what they have done.
One of the reasons countries are hesitant to go to war is that it is always costly. This new funding gimmick seems like a moral hazard, making it easier to go to war without the broad consent of the populace.
The other story is that a 50-year agreement or “understanding” with Saudi Arabia has been sunsetted because the Kingdom no longer felt the agreement useful. What was the agreement? It was not a ratified treaty but more of a diplomatic understanding.
This so-called agreement is a matter of some controversy since it was never codified as a treaty. However, secret deals and practices over many years are often just as important, or more so, than a piece of paper.
The US promised military aid to the Kingdom as far back as 1933 when the Kingdom was formed. After the 1973-74 Mid-East War, these ties were strengthened. Whether by treaty or by practice, the US began widespread training and supply of the Saudi military, and they correspondingly started pricing oil in the dollar, settling payments in dollars, and reinvesting oil revenue into US Treasury bonds. We saw military cooperation in the recent Gulf Wars where Saudi Arabia allowed US military assets to be located in their territory and they contributed significantly to the necessary fuel supply for the attack on Iraq.
In short, the argument about the absence of documents is a bit silly. The actual behavior of nations is more important, and clearly, the US and Saudi Arabia have had a special relationship going back many years.
After the devaluation of the dollar in 1971, and the 1973 Arab-Israeli War, Henry Kissinger struck a deal with Saudi Arabia to stabilize the price and availability of oil. Certainly, the diplomatic background is known and it appears in Kissinger’s book, Years of Upheaval.
You might recall the 1973 oil embargo which caused a severe shortage of oil and gasoline in the US. One could get gasoline only on odd or even days, based on your license plate. Everyone drove around with spare gas cans in the car and had locking gas caps. Word spread quickly if you knew a place to find gas. It was a terrible mess.
As mentioned before, the essence of the “understanding” was the US would protect the Kingdom of Saudi Arabia, and the Saudis would, in turn, only price and allow payment for oil in US dollars. Since the dollar no longer had any gold backing, it would now be indirectly supported by oil. The reason is if nations could only buy Mid-East oil in dollars, they needed to hold a lot of dollars. Since few just held noninterest-bearing “dollars”, but rather US dollar-denominated bonds, this created an artificial demand both for dollars and US Treasury debt.
So, the Saudis agreed to price and settle in dollars, invest in dollars, and help coerce the rest of the world to seek dollars if they wanted Mid-East oil. That has been established practice for about 50 years, the existence of documents notwithstanding.
This substantial increase in the demand for dollars made the dollar stronger than it otherwise would have been, and deepened the market for US Treasuries, allowing the US government to fund its trade and fiscal deficits more easily and at a lower cost.
After the key part of Bretton Woods was broken (the settlement of foreign claims in gold), nevertheless the basic structure of the treaty was maintained in practice. As the largest economy and the world’s greatest military power, the dollar maintained its role as the reserve currency of the world. The US became the only country that could settle both its internal and external debts with money it could print. No other country had such a privilege.
The French said it was “an exorbitant privilege”, allowing the US to finance deficits “without tears.” We could even print money and use that to buy oil. Other countries had to produce something in trade, to get a trade surplus, to acquire dollars needed to buy oil. This combination of reserve status and petrodollar arrangements made the dollar the king currency of the world.
While it has not gotten much press, the whiz kids in the Biden Administration seem to have quietly blown up the international monetary system, the petrodollar, and the privileges attached thereto.
Over time, it means less energy security, a weaker dollar (which will cause the cost of all imports to go up), and higher US interest rates than would otherwise be the case.
In a sense, the relationship with Saudi Arabia is like dating a girl seriously for a long time and then having that awkward conversation where both parties agree to see other people. The special relationship has changed and no documents were either abrogated or signed. The Saudis are now attracted to the Chinese and have formed a new relationship with the BRIC nations. They will no longer be dating the dollar exclusively.Â
The Biden Administration has given the world’s financial community two good reasons not to own the dollar and not to own our dollar-denominated bonds. International reserve deposits are subject to seizure without due process and the dollar is not backed by gold, or required for oil. Rather, the dollar is backed by the full faith and credit of a geriatric imbecile. It is pure fiat money…Bidenbucks.
This will cost all of us dearly in the years to come.
