Money, Oil and Power
August 12, 2009 by John Myers
"The Capitalists will sell us the rope with which we will hang them." Vladimir Ilyich Lenin.
China is building itself the world’s largest war chest. Not in tanks, planes or even secret submarines. It has accumulated the largest collection of IOUs in history.
In an age where real politik is of greater import than Otto von Bismarck could ever have imagined, China is positioned to use the once almighty buck against the very nation that gave birth to it—the United States of America.
The U.S. has unprecedented debt and its largest creditor is China. But Beijing has aims on much bigger things than accruing depreciating dollars. Number one among its objectives is access to Middle East oil.
China Zeros in on Middle East
With real gross domestic product growing at a rate of 10 percent per year, China’s need for energy will surge by 150 percent by 2020. To sustain its growth China requires increasing amounts of oil. Its oil consumption grows by almost 8 percent a year, seven times faster than America’s! At the end of the next decade China will consume more oil than the United States.
There is only one place on earth that can meet China’s and America’s demand for oil and that is the Middle East. The region holds two-thirds of the world’s conventional oil reserves, and China is thirsting to control the world’s last remaining rich oil reservoirs.
Some 60 percent of China’s oil imports come from the shifting sands of Arab lands. By 2015 the share of Middle East oil sustaining China will reach 70 percent.
With Mexico’s elephant fields rapidly declining and Canada unable to make up the difference, the United States must also focus its attention on securing Arab oil.
“Where is the oil (of tomorrow) going to come from?” asked future Vice President Dick Cheney in 1999. “The Middle East, with two-thirds of the world’s oil and the lowest cost, is still where the prize ultimately lies."
If Cheney understood the importance of the Middle East a decade ago, we can be certain that Beijing understands it today.
There is no question that China and the U.S. are planning a future powered by Middle East oil. The real question is whether this last bastion of crude can meet the demands of both countries.
“Tensions over oil resources reflect the larger distrust between the sole superpower and the rapidly rising China.” wrote MSNBC a couple of years ago.
History Lesson about Ike and Real Power
If push comes to shove, China may hold the trump card. The reason is its unprecedented leverage over the United States.
The U.S. Treasury is auctioning off $200 billion—yes BILLION—in new debt every week.
“China has an estimated two-thirds of its more than $2 trillion in reserves in dollar assets, including more than $800 billion in Treasuries,” wrote The Wall Street Journal on July 29th.
In less than two years China will have its hands on $1 trillion in liquid U.S. IOUs.
That one country would leverage the debt it held of another for political and economic gain is not unprecedented. In the summer of 1956, England and France hatched a secret plot to re-capture the Suez Canal with force if Egyptian President Nasser nationalized the waterway.
After World War II the ruling elite in London saw the Suez Canal as the Anglo-Saxon expressway to its remaining colonies in North Africa and India. The canal was also taking on new importance.
“In 1948, the Suez Canal was gaining a new role—as the highway not of empire, but of oil…. By 1955, petroleum accounted for half of the canal’s traffic, and, in turn, two thirds of Europe’s oil passed through it,” wrote Daniel Yergin in his bestseller: The Prize: The Epic Quest for Oil, Money, and Power.
That meant the Suez Canal was a potential chokepoint and the most valuable waterway in the world. Not a property to be trusted to Arab hands thought some members in the House of Lords. Key among them: British Prime Minister Anthony Eden.
So when Egypt nationalized the Suez Canal, France and England were putting together a response. In October 1956, British and French forces attacked Egypt. Soon after, British paratroopers hoisted the Union Jack over the Suez Canal.
Eden knew that the U.S. opposed the operation. But he also knew that President Eisenhower would never send American forces into combat against its two closest NATO allies.
The Sun Sets on the British Empire
It turned out Ike didn’t have to. The Eisenhower administration forced a cease-fire on Britain and France without firing a shot. It did it with money.
At the time the U.S. was the world’s largest creditor and one of its biggest borrowers was Great Britain. The U.S. had sustained England through the war and was using the Marshal Plan to help rebuild the nation.
Ike told Secretary of the Treasury George Humphrey to prepare to liquidate U.S. government holdings of British bonds. London was made aware of Ike’s plan.
The Chancellor of the Exchequer Harold Macmillan told Eden that he believed Eisenhower would sell England down the river if British troops did not withdraw immediately. He had an even more pressing message from Macmillan—if London resisted and the Treasury sold its Sterling bonds—England would be bankrupt within a month! The island nation would face a winter without food or oil.
The next day Eden announced a cease fire and evacuated England’s troops from Egypt. He did it without even consulting the French.
For centuries England had been indomitable. Yet, with a phone call, Ike had done what the Spanish Armada, Napoleon’s army and Hitler’s Luftwaffe had all failed to do. He had brought the British Empire to its knees.
England was humiliated. Britain would never again been seen as a world power and its currency, the Pound Sterling, began a freefall which lasted for decades.
As the above chart shows, in 1956 it took almost $3 to buy a British pound. But a long decline in the value of the pound that had started in World War II began in earnest. By the 1970s London no longer had the financial wherewithal to peg the pound to the dollar. By 1985 the pound was trading at par with the buck!
Bond Market Peril
Britain’s and the pound’s decline occurred as America rose to super-power status. Today America finds itself where England was half a century ago—defending its interests, but facing an economic giant in China, a country that does not have the military to dominant but does have the money to dictate their vision.
Last spring the U.S. Treasury market was close to panic when China hinted it might want to diversify out of U.S. government debt. And as an investor you should understand that China doesn’t even have to sell its huge holdings of U.S. Treasuries for the bond market to go into a tailspin.
All it simply has to do is sit out a few Treasury auctions. If that were to happen, market forces would drive up U.S. interest rates. All of which makes today’s political and economic environments very risky for bond holders and potentially lucrative for real asset investors.