MARKET PERSPECTIVE

By J Mulraj

Apr 1 – 7,  2023

Bad decisions have created this crisis

The Bretton Woods Conference, after WW II, gave the US $ the status of a globally accepted currency. This was underpinned by a pledge by USA to exchange the USD for gold, at $35/ounce, whenever asked to. In 1971, Nixon reneged on that pledge, and took off the gold backing for the dollar. This allowed America to print it, whenever it  desired, without the tether of gold backing it.

A subsequent deal with Saudi Arabia, in 1973, after the Yom Kippur war, created a huge demand for the $, as SA agreed to price its crude oil in that currency. This meant that the US could print money without it resulting in runaway inflation, as had  happened in Weimar Germany, because other nations bought the $ and kept it outside the American borders.

Thus the US was enabled to consume more than it could afford, borrow money, and kick the can of fiscal responsibility down the road. We are now seemingly at the end of that road.

The Balance Sheet of the US Federal Reserve has gone up from $ 0.9 trillion in 2007 to $ 8.3 trillion in March 2023, due to events like the 2007-8 Global Financial crisis, and, recently, the Covid pandemic, during which the Fed Balance Sheet went up by nearly $ 3 trillion in a year. US Government debt has hit $ 31.6 trillion, and has hit the ceiling imposed by Congress. Unless the (Republican controlled) Congress agrees to raise it, there is a specter of USA defaulting on its debt obligation.

Governing is not easy; it is a continuous battle of making choices. Like, whether or not to fund deficit by raising taxes, cutting expenses or raising debt. The last choice being the most palatable, electorally, is the one adopted. But it is merely kicking the can of cutting expenditure, down the road.

The exercise of every choice has its consequence. One of the first acts of President Biden was to scrap permission for new Federal leases for fracking, and to cancel the Keystone pipeline to deliver Canadian crude to the American midwest. This was made to protect the environment from dirty fossil fuels. A worthy cause.

But there are consequences, of course. Prior to Biden, the US was, thanks to fracking, a net exporter of crude oil; it has now become an importer, dependent on OPEC Plus for supply. Biden had to plead to Saudi Crown Prince, Mohammed Bin Salman (MBS), to increase production, so that the price of gasoline could be reduced, prior to the last mid term election. MBS didn’t. Perhaps because, at the meeting, Biden said he held MBS accountable for the murder of journalist Jamal Khashoggi. (Dale Carnegie would be appalled).

The consequences of the accusation did not end there. It drove a sledgehammer into a five decade old agreement, between USA and the Kingdom of Saudi Arabia (KSA) which gave birth to the petrodollar, and so allowed US inflation to be exported to other countries. It drove KSA closer to China. KSA is now pricing sale of its crude to China in renminbi, instead of in USD. US has lost its power to influence events in the Middle East; it was China that brokered a rapprochement between KSA and Iran, age-old rivals.

Last week KSA announced its decision to reduce OPEC crude production by 1 million barrels/day (around 1%), which has driven up crude prices. Brent crude is now at $ 85/ b.

This article will outline the utter lack of vision of its energy policy. USA is the world’s largest energy consumer. Currently, it consumes 7.4 billion barrels of oil/day. Its proven reserves represent 6 years of annual consumption. Yet the US exports 1.5 million tonnes of shale oil, over half its tight oil production! In Jan ‘23 it exported more crude to rival China than to ally UK! I am unable to explain the logic behind all this. Hopefully, some of these inane policies may get corrected if a new bill, The Lower Energy Costs Act, introduced by Republican Senator Steve Scalise, is approved. It seeks to increase domestic production of oil and to reform the permit process for all industries.

Let’s go back a bit. So, ok, the US chose to cut back on its shale oil production, showing its concern for the environment. This resulted in the above consequences. But, hey, where was the concern for the environment when the US blew up, as pointed out by veteran journalist Seymour Hersh, the two Nordstream pipelines, an act that probably released the largest amount of methane ever recorded. Methane is more harmful than CO2.

Where was the concern for the environment when Russia, which for years pleaded with the West not to admit Ukraine to NATO, that being considered as an existential threat, was ignored, and literally pushed into a conflict with it, one that has done unimaginable harm to the environment? The conflict has destroyed Ukraine’s farmlands. It is one of the main suppliers of wheat, especially to Africa and the Middle East. This year’s crop has not been planted, which will cause a terrible famine in Africa in 2024. And, with it, civic unrest.

It was America’s prerogative as the globally accepted currency, combined with the demand for USD created by the petrodollar, that allowed it to live beyond its means, and print money, without fearing inflation. It was America’s pre-eminence in the global financial system that allowed it to enforce its will, by using its ability to sanction other countries. This ability stems from its control over the SWIFT messaging system, which facilitates inter-currency transactions.

The overuse of sanctions has caused a backlash. Several countries are working towards de-dollarization, in order to bereft themselves from the yoke of sanctions. Let’s go back a bit, again.

The ignoring of Russian please to discuss its fears of an existential threat if Ukraine were inducted into NATO, led to its military operation. In turn, this made Europe, mainly Germany, an uncompetitive manufacturer, thanks to cutting off of cheap Russian oil and gas. The cheap Russian oil and gas was redirected, mainly to China, via two Power of Siberia pipelines. In effect, USA made its ally, the EU, weaker, and brought together its two foes, Russia and China, making them economically interdependent. That’s a poor geopolitical strategy. A Pavlovian response.

Choices also include how to spend money. The US is gifting Ukraine financial and military aid to Ukraine (depleting its own stocks). This, at a time when, according to Senator Cassidy, the Social Security system, which looks after pensioners, is running out of funds. Unless it is replenished, pensioners face a 24% cut in pension payments, after 9 years. Choices, choices, choices.

With all that Quantitative Easing and over borrowing to pay for it, the US is hitting the debt ceiling. Congress, Republican controlled, must approve the raising of the ceiling. It is asking Biden to discuss how he plans to cut spending, which is the only commonsensical approach. Biden is, so far, ostrich-like in refusing to discuss spending cuts. Getting Republican approval has been made immensely tougher by the recent arraignment of Donald Trump.

Last week the BSE sensex rallied, primarily in the belief that the US Fed would start cutting interest rates, after recent bank collapses. It ended the week at 59832, up 1041 points over the week.

French President Macron accompanied by EU President Von der Leyen, are appealing to Chinese President Xi Jinping to convince Russian President Putin, to end the war they helped push him into! The world can’t get more Kafkaesque than this! The US job numbers recently announced don’t look promising. Tough times ahead.

Picture Source: https://www.dreamstime.com/photos-images/red-crushed-soda-can.html

Comments may be sent to jmulraj@asiaconverge.com