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Living on the razor's Edge
We Send Their Oil Up in Smoke, While They Buy America

That, year after year, the United States imports far more than it exports, has meant a titanic outpouring of dollars into the coffers of other countries. Those holdings are now poised to explode with oil priced beyond $100 barrel.

The dollar being the world’s premiere reserve currency, countries flush with cash from their exports to the U.S. have, year after year, reliably sent the money back to Washington, investing it in Treasury notes, thus propping up the American government’s chronic deficit spending.

It’s a tenuous symbiosis. We hold each other hostage. Even in stasis, it is a foolhardy way to float an economy. The bigger question is whether this arrangement is about to change, and decidedly for the worse.

 AMERICA BLEEDING OUT

The huge increase in U.S. debt, which has skyrocketed from $5.7 trillion to $9.2 trillion since 2000, has caused a plunge in the U.S. dollar – a drop of 35% against the Euro during the period. Interest rate cuts to combat the recession are causing further dollar deterioration, as investors worldwide effectively sell their dollars at fire-sale prices to buy assets denominated in more stable currencies.

Yes, there is some consolation in that U.S. goods now look cheap to other countries paying with their stronger currencies. Exports in 2007 increased 12.7% over 2006, and the trade deficit dropped 6%. But that deficit was nonetheless a frightening $711.6 billion in 2007, double that in 2001, and soaring prices of imported oil will overwhelm export gains.

For Americans, the weakening dollar means ever higher prices for oil and all imported goods, exacerbating the trade deficit still further. For petrodollar and other countries, watching their dollar holdings in the U.S. shrink in value is causing them to look elsewhere for where to invest, creating new vulnerability for the U.S.

 RUMBLINGS OF DISCONTENT

Some foreign voices have called for a move away from the dollar. Russia wants to establish “a new international financial architecture” to “challenge U.S. supremacy”, in Vladimir Putin's words. He called the current financial structure “archaic, undemocratic and unwieldy” and suggests that countries should “hold reserves in a wider selection of currencies”. He wants to establish “a world class oil exchange” denominated in rubles; a facility is in fact being readied in St. Petersburg's bourse.

I place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared. To preserve our independence, we must not let our rulers load us with perpetual debt."
   
Thomas Jefferson

At a summit meeting of OPEC last fall, Iran's Mahmoud Ahmadinejad said that U.S. buyers “get our oil and give us a worthless piece of paper”. Hugo Chavez added, “The empire of the dollar has to end”. This was not bluster; they were recorded when a microphone was inadvertently left open.

They were not alone. A chorus of OPEC nations voiced a desire to price oil in Euros rather than dollars. The United Arab Emirates has announced an intention to shift 8% of its foreign exchange reserves from dollars to Euros, and Saudi Arabia conceded that it would have to consider such a move were the dollar to take a “precipitous” decline.

OPEC is, however, being given ever higher stacks of dollar bills to compensate for their reduced value, and the various petro-states have since made reassuring noises to calm the markets. All export countries know that a precipitous retreat from the dollar would plunge the U.S. into a permanent recession, sending the dollar into a tailspin, and that would reverberate in their own economies by curtailing America's ability to import their goods.

 DIVERSIFYING THEIR PORTFOLIOS

Nevertheless, nations with huge dollar reserves are no longer content to earn anemic returns on U.S. government bonds and are taking a different tack. America is on sale at discount prices and they are shifting to direct investments, buying up assets in this country and around the world. Foreign investors paid $414 billion for stakes in American companies and other assets in 2007, up 90% from the year before.

As recently as a year ago – and despite that some have been in existence since as long ago as the 1950s – the term “sovereign wealth fund” (SWF) was unknown to all but central bankers. These are the huge foreign government pools of money that have since become page one news, thanks to their multi-billion dollar bailouts of U.S. financial firms.

Aside from wounded pride, as we watch large chunks of iconic American financial firms fall into foreign hands, what's wrong with that?

Everyone welcomes foreign investment. It strengthens our economy, creates jobs, and it could be said that SWFs are the best kind of investor from a corporate point of view: long term and undemanding of board seats and even voting shares. Yet they are almost designed to raise suspicions.

Beset with subprime losses, credit paralysis, and the looming threat of credit default swaps, American banks are not today's prime money-making opportunities. So why did the SWFs choose our financial companies, investing in haste, with next to no prior analysis? “There has to be a political objective over and above the rate of return” was Felix Rohatyn's view in a New York Times interview. Rohatyn, a managing director at Lazard Frères known for his role in preventing the bankruptcy of New York City in the 1970s, and subsequently ambassador to France, told Business Week, “This is capital we need desperately, but I don't think we should have any illusions that these are totally benign investments…You don't need to appoint two directors to a board to have influence when you own 10% of the company”. To think that their views will be ignored is delusional.

New York Senator Charles Schumer makes the case that, “sovereign wealth funds, by definition, are potentially susceptible to noneconomic interests; the closer they come to exercising control and influence, the greater the concerns we have”.

The concerns are many. Lawmakers and regulators think we should throw up barriers to prevent control of our financial institutions or access to companies producing military technology. Nor should we, for example, allow Russia to buy an energy company, given their having wielded natural gas as a weapon against Ukraine and Belarus. Russia and China in particular are viewed as having a political agenda alongside an economic interest.

Of great concern is that ownership by government sovereign funds amounts to nationalization of western assets. It raises the specter of interference in free markets. These funds are opaque; no one is privy to their investment strategies. They are subject to the dictates of their governments, which are not always sympathetic to western investor interests. There is the fear that shifts of these massive funds in and out of investments could roil the economies of the countries in which the assets reside. Another Times article wondered whether, faced with an economic emergency, Treasury Secretary Henry Paulson might find himself not just calling the major central bankers but would have to win the cooperation of directors of the SWFs as well. Might that be happening now?

Then there is the fear that ownership will expand to the point that sovereign funds will exert political influence in the countries where they control massive assets. Imagine that, in return for keeping money in Treasury bills to finance U.S. debt as it hurtles toward $11 trillion, a sovereign fund exerts secret pressure on an administration to lighten regulatory oversight at one of its market holdings, a meat-packing plant, for example, where it would rather not have such stringent quality inspections, or raids looking for undocumented workers.

Imagine further America taking sides with Taiwan when China finally makes its move to annex the island nation. Financial threats could force the U.S. to stand aside or see its economy ruined and the dollar in free fall.

It is easy to lapse into paranoid scenarios. But as Schumer says, “there're only two choices: have foreign companies invest in these firms or have massive layoffs”.

Short of adopting financial protectionism, there's a whiff of helplessness in the air. Not only the U.S. is apprehensive. In a news conference last July, German Chancellor Angela Merkel asked, “How do we actually deal with funds in state hands?” In a speech French President Nicholas Sarkozy said, “I believe in globalization but I don't accept that certain sovereign wealth funds can buy anything here and our own capitalists can't buy anything in their countries.”

THE GROWING POWER OF ELSEWHERE

The larger portent is that the West's share of the world economy is shrinking. Emerging economies are growing much faster than developed ones. They represent 30% of world GDP but 45% of its exports, and they hold 75% of global foreign exchange reserves. Oil threatens to beggar the United States. With the tripling of oil prices, the petro-states will become leviathans.

Six Gulf states—Abu Dhabi, Dubai, Kuwait, Oman, Qatar, and Saudi Arabia -- account for nearly half the world's SWF assets, controlling some $1.7 trillion. The United Arab Emirates' Abu Dhabi Investment Authority alone boats a war chest of $875 billion. A Morgan Stanley economist predicts the combined hoard will grow by about $400 billion annually over the next several years – more if the Saudis unleash a new $500 billion fund they are considering.

The Wall Street Journal says “Saudi Arabia has taken in nearly $900 billion in oil revenues in the last six years”. To get an idea of just how much more money is flowing to the oil-producing countries, the $243 billion they exported in 2000 has soared to $688 billion in 2007, according to Cambridge Energy Research Associates.

That estimate, from last fall, didn't take into account the recent price surge to over $100 a barrel. Morgan Stanley tracks 29 SWFs around the world and estimates their current holdings at $2.9 trillion. But that pales compared with what is to come. The firm estimates that sovereign wealth could be worth $10 trillion by 2012, $12 trillion just three years after that, $17.5 trillion by 10 years hence.

Feeding off America's insatiable need for imported oil, the Gulf countries cannot absorb the wealth they are generating, so we can expect them to go on a buying spree. They will be unstoppable. We are seeing a transfer of wealth of unimagined dimensions from west to east.

And the band plays on. For decades our negligent inattention to the looming problem, our failure to diversify away from oil, has allowed us to become engulfed by this rising tide. With three million manufacturing jobs lost since 2001, are we destined to become a hollowed-out economy, staggering under a $9.2 trillion debt, burdened with a giant military complex keeping the world safe for the rise of new hegemonies?

Perhaps $4.00 a gallon gasoline and economic austerity will finally force Americans to adopt the conservation measures needed to stem the consumerist excess that got us here. Or is it too late?

- Stephen Wilson, PlanetWatch Editor, http://www.planetwatch.org