Meet the IMF-SDRs — which will chip away at the dollar’s preeminence until…
In 1960, a handful of resource-rich Third World nations, tired of being shoved around by the giant oil companies, met in Baghdad to discuss their mutual problems. Attending were Saudi Arabia, Iran, Iraq, Kuwait, and Venezuela. They decided to form a group they named the Organization of Petroleum Exporting Countries — “OPEC.”
At the time, the idea that a handful of poor countries could stand up to the “Seven Sisters” (Esso, Mobil, Shell, Gulf, BP, Chevron and Texaco) — let alone their patrons, the United States and Europe — seemed like a fantasy. Certainly oil lay within their borders but the oil companies pumped it out of the ground, and shipped it by pipeline or tanker to its destination, all the while dictated a price. One habit that particularly galled the OPEC nations was “discounts.” Although the producing countries had long-term contracts, every time the world price dropped the Seven Sisters would announce “discounts” and cut their royalty payments. At best, OPEC hoped to end this practice.
Nothing much happened over the next ten years until November 1970, when America’s domestic oil production hit an all-time peak of 10 million barrels per day. Then production began to decline. It had never happened before. The Texas Railroad Commission, which had limited production since the 1930s to forestall price collapses, told American producers that all bets were off — go ahead produce all they could. It didn’t make any difference. American oil production had peaked. In three short years our imports shot from 18 percent of consumption to 34 percent and OPEC suddenly had market power. Most of American subsequent history has been written around this market shift.
Is there another OPEC on the horizon right now? There is. It’s called Special Drawing Rights (SDRs) of the International Monetary Fund (IMF). It probably won’t make any difference for another few years, but if and when it does, the impact will make the Arab Oil Boycott of 1973 look like a picnic.
The declining resource this time is the American dollar. We have a very privileged position in relation to the rest of the world. Other countries accept our currency, not only in exchange for goods and services but also because the dollar has such a sound reputation that the rest of the world uses it as the international reserve currency. No other country has this privilege. This means we can print far more money than is backed by our national wealth. About one-third of the dollar’s value reflects other countries’ willingness to store their national wealth in dollars.
All this is the gift of our forebears, built up by our sober, hard-working ancestors over the course of the 19th and 20th centuries. As late as 1965, the United States was the world’s largest creditor nation.
We are the profligate heirs who have squandered this inheritance. We now manufacture very little of anything in this country except entertainment, lawsuits, and environmental impact statements. We pay $250 billion a month for foreign oil. We are now the world’s largest debtor nation, with a $10 trillion national debt, and annual deficits now headed for $1 trillion. Future unfunded obligations to Social Security and Medicare total $40 trillion. No one knows how these commitments will be met.
In relation to the rest of the world, we are a declining aristocracy. Such circumstances are not unfamiliar to history. Its pages are filled with the stories of aristocracies that achieved economic success that gave them positions of immense privilege, then saw the source of that that success crumble beneath them. In medieval times, land was regarded as the source of all wealth. People who owned large quantities took titles such as “duke,” “baron” and “earl” to make their privileges seem permanent. Yet soon they found their wealth being challenged by city-bred merchants whose productivity exceeded theirs. Several European revolutions resulted.
The common reaction of such aristocracies is to ignore what is happening right up until the last moment. At the outbreak of the French Revolution, the First Estate — the landed aristocracy — was completely exempted from taxes. For almost a century Britain’s landed aristocracy maintained control over Parliament through “rotten boroughs” that gave them inordinate representation. One of the most poignant portraits of a declining aristocracy in is Chekhov’s The Cherry Orchard, where a landed Russian family sits musing about trivialities while a local entrepreneur — a former serf, no less — carves up their beloved cherry orchard into condominiums. Even as their wealth and privilege slip out from under them, they barely understand what it happening.
America is now in a similar position, particular in relation to the rising economies of Asia. And, like the family in The Cherry Orchard, we continue to absorb ourselves with trivialities while our estate slips away. Thorstein Veblen had a deadly accurate description for this phenomenon in The Theory of the Leisure Class. In a chapter called “Industrial Exemption,” he argues that people who have benefited most from industrial progress are often the most opposed to further industrial advances. Their privileges, he says, keep them immune to the exigencies of change:
The leisure class is in great measure sheltered from the stress of those economic exigencies which prevail in any modern, highly organized industrial community.… and as a consequence of this privileged position we should expect to find it one of the least responsive of the classes of society to the demands which the situation makes for a further growth of institutions and a readjustment to an altered industrial situation.… [B]y precept and prescriptive example, [the leisure class] makes for the perpetuation of the existing maladjustment of institution, and even favors a reversion to a somewhat more archaic scheme of life. [Emphasis added.]
There could not be a better explanation of why, at a time when China is currently planning to build 132 nuclear reactors in the next 20 years, America is absorbed in the fantasy that we can run an industrial nation on windmills and solar collectors.
So how will this play out? China, Russia, Brazil, and other rising economies are all making noises that America has overdrawn its account and they no longer want to be dependent on the dollar for world trade. The Euro has been making steady advances, rising from 18 percent of the world’s reserves to 26 percent over the last decade while the dollar has declined from 71 percent to 64 percent. But the real challenge is likely to come from the International Monetary Fund’s Special Drawing Rights.
Two weeks ago China announced it would be exchanging $50 billion in dollars for IMF-SDRs. That represents only one-fifteenth of China’s $775 billion holdings in U.S. dollars, but it represents a beginning. As the world’s largest holder of U.S. debt, China cannot afford to start a run on the dollar and set off a worldwide panic.
And so the situation will probably bubble up beneath the surface for a few more years until history will suddenly hit one of those seismographic shifts, just as occurred with OPEC. When that happens, watch out. Every American will lose 30 to 40 percent of his net worth overnight. Instead of paying $250 billion a month for foreign oil, we will be paying $400 billion. People will call it “inflation” but in fact it will represent our failure to deal with the realities of the world.
Is there any way we can avoid this? The answer is simple. We can stop acting like pampered aristocrats whose tastes are too refined for the drudgery of making and doing things and start producing something of value to the rest of the world.
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