Petrodollars Petrodollars: The 1970s Redux
by Chris Mayer
Whiskey & Gunpowder
Gaithersburg, MD
June 29, 2005 Chris Mayer discusses the oil price surge of the 1970s, what happened to all the Petrodollars created then, and what's likely to happen during the current, similar surge. Greg's note: Today Whiskey presents a new essay by Chris Mayer. Below, Chris describes the origin and early history of the Middle Eastern oil industry ( as opposed to Byron's meme of Pennsylvanian oil. ) Chris goes on to describe the outrageous wealth that the Mid-Eastern oil sheiks accumulated when the price of oil rose in the 1970s...but what happened to all of that oil money? Read on and you'll see... Oil: The 1970s Redux FEW WILL REMEMBER Adam Smith's book Paper Money. This Smith is not the 18th-century economist, but the financial columnist George Goodman, who wrote under that pseudonym and is mainly remembered today as the author of the classic book The Money Game. The great value in older books is that they give you perspective about what people were thinking at a certain point in time, which is made all the more interesting since you know what happened afterward. Paper Money was published in 1981, and Smith worries a lot about inflation and the whole global oil and banking complex. Surely, these were big topics weighing on the minds of most investors at the time. This particular book is not remembered much today, because its worries were so spectacularly mistimed. Shortly after the book was published, the price of oil began its collapse and inflation slowed dramatically. But still, the arguments made were stimulating and are still applicable today, in a time when oil recently rallied past $60 per barrel and appears on its way to fresh heights. In particular, some of Smith's history is fascinating, reminding investors how rapidly the world can change. In the 1960s, the apparent great glut in oil worried the big oil companies, contra the worries of 2005. Oil routinely sold for a couple of dollars per barrel. When the chairman of Exxon stood before his glum shareholders in May 1967, he wistfully told them, "I wish I could say I will be around when there is a shortage of crude oil outside of the United States." The industry's specialized journals worried about a lot of things, but no one worried about the supply of crude oil. There seemed to be no end to the surplus. ~~~~~~~~~Special~~~~~~~~~~~~~~~ Invest Less Often and Still Make 7 Times More Money... With 30% Less Risk! Two independent studies revealed how a 100-year-old trading system can actually BEAT "buy-and-hold" returns by nearly 7-to-1... with much less time spent holding stocks... and just one-third the risk of index funds. It used to be impossible to time markets like this. Now it's easier and more precise than ever before. Here's all you need to know to get started : http://www.agora-inc.com/reports/CPT/WCPTF600 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Petrodollars: The Wolf Is Here So when a career State Department official by the name of James Atkins published a piece in Foreign Affairs in April 1973 with the provocative title "The Oil Crisis: This Time the Wolf Is Here," predicting that the consumption of oil in the next dozen years would push the price of oil to $5 -- it caused quite a stir. Foreign oil producers didn't need a State Department official to tell them what they could very well see for themselves. The volume of oil in international trade had gone up nearly tenfold in the years 1950-1973. From 1973-74, the price of oil would soar from $2.69 per barrel to $11.65, far surpassing Atkins' gasp-inducing estimate. By 1980, the price of oil was pushing $40 per barrel, and the world was forever changed. A massive shift in wealth began, the likes of which the world hadn't seen since Spanish galleons were laden with Incan gold and silver or Britain ruled and exploited the treasures of India. Except this time, it was the sheiks in Dubai who became rich virtually overnight. There is perhaps no patch of Earth that changed so dramatically in so short a time. As late as the 1930s, these nomads, shepherds, craftsmen, and small-time cultivators lived as they had since biblical times. The lightly populated desert and salt marshes on the Persian Gulf didn't yield a first oil strike until 1957; slavery was only abolished in 1962. Before oil, sheiks collected customs fees on ships that passed through their ports. Feuds with rival townships were carried out with World War I-era weapons, and even cannonballs. The cannonballs were apparently scarce; the combatants would scour the battlefields in the evening to retrieve them to use again the next day. But the discovery of oil changed all that. The sheiks who before could not afford cannonballs were suddenly making $1 billion per year. But it would take some time. Not until the price of oil surged in the 1970s did the sheiks get really rich. Not only the Arabs, but also oil-rich Mexicans and Venezuelans grew wealthier virtually overnight, as well as oil-producing Texans, Alaskans, Louisianans, and others who had a stake in oil. The benefits of higher-priced oil fanned out all over the globe. Suddenly, icy oil platforms in the heaving gray waters of the North Sea became viable -- which delighted not only the Brits, but the Norwegians as well, since they owned the other half of the oil field. Petrodollars: What Did They Do with the Money? But this tells only half the story; yes, the oil-producing countries got rich. They exported oil and were awash in cash receipts. The key question is what did they do with all the money they made? In this, the 1970s have something to teach us today. They teach us that a rising price of oil is inflationary, but not for the reasons you might think. It was not "cost-push" inflation; it was, and remains, a monetary phenomenon. The 1970s also ought to have seared into our consciousness the idea that you can have runaway inflation with a weak domestic economy. Sign Up for Whiskey & Gunpowder
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So let us circle back to our original question and see if the answer sheds any light on what could happen today. What did the oil producers do with their oil money, or their petrodollars, as it was called? Some oil companies bought other natural resources, locking up supplies of coal, uranium, oil shale, and timberland. Some of the countries bought armaments -- Iran and Saudi Arabia inked deals for billions in military hardware. But their purchases, though enormous by the standards of the time, barely dipped into their gushing supply of petrodollars.
Much of the money found its way into banks, usually in short-term deposits. New banks opened up to cater to the petrodollar market. In Bahrain, a small, sleepy island off the coast of Saudi Arabia, there were over 120 banks established to gather petrodollars. Many banks joined the chase -- the Bank of America, Chase, the Bank of Tokyo, and many others, as well as the banks the Arabs started themselves. They sprouted up in other places of the world as well. There were some 32 Arab banks opened in Paris, for example. The oil-producing countries had gobs of money. People would play a little game, "What OPEC Could Buy," in which they would figure out how OPEC could buy The New York Times or some other American icon for a fraction of daily surplus. Adam Smith reminds us that money in bank deposits can be lent out again in the form of loans. In the United States, there are reserve requirements, requiring some portion of the money to be held back and only the rest loaned out. With petrodollars earned overseas and deposited in offshore banks, there is no such requirement. Petrodollars can be "recycled" at a dizzying pace. Smith tells us that these banks then made loans, often to oil-consuming countries. Loans were made to places like Brazil, Turkey, Kenya, Zaire, Nicaragua, and many others. Most were hurt by the increase in the price of oil, and their economies softened, including the United States. Adam Smith got the to the nub of the impending problem: "Things being what they are, the tendency is for the oil-consuming countries to print a little more money to ease the pain of recession. That's politics, not economics or banking."
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Will the march to $60 and beyond have an effect similar to the 1970s? The oil producers will have a lot of money, money that will be parked in banks or spent. The money parked in banks will find its way as new loans, as bankers hustle up new business in increasingly risky credits -- developing countries, speculative companies, increasingly leveraged real estate investments, and more. The oil consumers, like the United States and Asia (which accounts for 40% of world oil demand), will print money. Greenspan will buckle as the U.S. economy slows, and the spigots will open up freely once again. But not just Greenspan -- Euroland and Asia will also apply the Keynesian snake oil of printing money. The politicians will be unable to resist. Voters will grow disenchanted with their expensive gasoline and their dwindling paychecks. The value of currencies will fall against the value of tangible and hard assets. Sound possible? In a sense, it is already happening. The dollar has weakened, gold is $434 an ounce, oil is $60 per barrel, and real estate has become absurdly expensive. Alternatives to currency have soared. The bond market still seems to be sleepwalking, but that could change very quickly. Though the Fed has been raising the fed funds rate target, monetary conditions remain accommodative. The only question is how far will all this go? The answer will be one of the great flash points in investing in the years ahead. Sincerely, Chris Mayer
Editor,
Fleet Street Letter
Crisis Point Trader Greg's final note: You may know that Chris Mayer runs an options trading service based on the century-old ( and century-proven ) system called the Dow Theory. He has put a proprietary twist on that system though - by pairing it up with "Crisis Points" that tell him when a single stock's on the verge of a big move. His system seems to work, too - he's delivered cumulative gains of 21.8% to his subscribers since launching the service a couple of months ago. Please look here for more information: http://www.agora-inc.com/reports/CPT/WCPTF600 For More Information, Please Read: 06/22/2005 - Oil: Looking In All the Right Places
By Byron King
Byron presents us with an article about the early days of an oil boom, except this boom is happening in the here and now. It involves some rock formations of Pennsylvanian age, but not those located within the Keystone State. Instead, Byron introduces us to ancient geology and current events up in the Maritimes of eastern Canada, the northeast part of the North American continent. 03/10/2005 - U.S. Oil Consumption: Pollution Absolution
By Jim Amrhein
Jim explains why oil consumption is actually good for the environment, and clears up some misguided assertions about U.S. oil consumption. | 
