Donald Trump's Attack on Saudi Arabia Led OPEC Makes No Sense - Vivek Kaul's Diary
Free Reports

Donald Trump's Attack on Saudi Arabia Led OPEC Makes No Sense

Jun 19, 2018

28

The American president, Donald Trump, has taken to bullying countries on Twitter. Recently he tweeted: "Oil prices are too high. OPEC is at it again."

OPEC is a cartel of oil exporting countries and stands for Organization of the Petroleum Exporting Countries.

While OPEC has been regularly referred to as a cartel, it is important to understand that the structure of OPEC is different from that of a cartel. It is probably better to define the structure of OPEC as what economists call a 'leading firm' model of oligopoly, a market which is dominated by a small number of sellers and in which the largest producer sets the price and the others follow.

The largest producer of oil within the OPEC is Saudi Arabia and any attack on the OPEC is basically an attack on Saudi Arabia. The thing is can the American president afford to do that?

In order to answer this question, we need to go into a little bit of history.

In February 1945, the then American president Franklin Roosevelt travelled quietly to the USS Quincy, a ship anchored in the Red Sea. Here he met King Ibn Sa'ud of Saudi Arabia, the country which was by then home to the largest oil reserves in the world. They talked over several days.

The American obsession with the automobile had led to a swift decline in its domestic reserves, even though it was the biggest producer of oil in the world at that point of time. The country needed to secure another source for an assured supply of oil. In return for access to the Saudi Arabian oil reserves, King Ibn Sa'ud was promised full American military support to the ruling clan of Sa'ud.

--- Advertisement ---
One of Our Best Offers…Ending Soon!

This is one of the best invitations we have designed for our Guru-Based stock recommendation service - Smart Money Secrets.

An offer that gives you access to two Special guides worth Rs 950 each…30-day unrestricted access to Smart Money Secrets…and a lot more.

All of it for an unbelievable price of Just Rs 99.

So, if you've still not gone through the details, I would request that you go through it right away.

Click here to read on…
------------------------------

Also, in the aftermath of the Second World War, the US dollar remained the only currency that was freely convertible into the dollar. This gradually led to the US dollar replacing the British pound as the currency in which global trade was carried out. This happened simply because the dollar was convertible into gold, and the pound wasn't.

The OPEC also sold oil in dollars.

Oil is a commodity that most countries don't produce as much as they consume. (Take the case of India. Our import dependency ratio was close to 82% in 2017-2018). Given this, they need to buy oil from countries which produce more oil than they require. For this, they need dollars.

Where do these dollars come from? The countries need to earn these dollars. How do they earn these dollars? They price their exports in dollars.

The only country that does not need to earn dollars is the United States. It can simply print them. It has an exorbitant privilege.

One reason a bulk of international trade happens in American dollars is simply because many countries need dollars to buy oil. And the only way to earn these dollars is to earn them by exporting their products in dollars.

In fact, OPEC was formed in 1965 and over the years there have been several attempts by members of the OPEC to start selling oil in a currency other than the dollar. But this has been resisted by Saudi Arabia (remember the military guarantee to the ruling clan of Sa'uds).

If Saudi Arabia and OPEC decided to abandon the dollar, it would have meant that the demand for dollar would have come crashing down. And the United States would have lost its exorbitant privilege.

This exorbitant privilege benefits the United States tremendously. The fact that a bulk of the global trade is carried out in dollars means that countries end up with huge dollars reserves.

These dollars are then used to pay for imports from the United States and other parts of the world. Also, a significant chunk of the surplus dollars, in case of countries like China and Japan, find its way back into the United States, to be invested in American financial securities, primarily the American treasury bonds.

These bonds are issued by the American government to finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.

When it comes to foreign ownership, China is the biggest owner of treasury bonds. As of March 2018, it owned $1.19 trillion worth of these bonds. Japan came in next at $1.04 trillion.

All the demand for American treasury bonds, allows the American government to offer a low rate of interest on its bonds. The interest rate on American treasury bonds essentially sets the benchmark for other interest rates in the American financial system.

If the government is borrowing at a low rate of interest, so will others. Low interest rates have played a huge role in ensuring that Americans keep living the great American dream. Consumption and home-ownership are a very important part of this dream, and both tend to thrive when interest rates are low.

All this has been possible to a large extent because of the way the global trade system has evolved, with America at the heart of it, financing global demand, and in the process helping countries earn surplus dollars, which find its way back to the United States, and play a role in maintaining low interest rates.

If this structure unravels, all this money coming back to the United States, will stop. American imports will fall, leading to American exports falling as well. Interest rates will go up.

One of the main factors this structure hinges on is the fact that the Saudi led OPEC continues to sell oil in dollars. And an American president attacking that simply makes no sense. The sooner Trump understands this, the better it will be for the United States.

Regards,

Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul's Diary

PS: Every value investor knows that we buy when markets are correcting. The worry then becomes - buy what? The small cap space has enormous potential - and especially at a time like this. Do not miss this moment - Get Hidden Treasure now.

Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Recent Articles

Our Newest "Fixer-Upper" July 20, 2018
Bill Bonner talks in detail about US president been accused of treason, biggest debt default in China, the problem of growing inflation and the trade war.
How to Build Affordable Homes in India July 19, 2018
Rajiv Talwar, the CEO of DLF, makes a few interesting points in a recent interview.
Deep State Turns on Trump July 19, 2018
In the last half-century, no president has ever seriously challenged the Deep State. Bill discusses the repercussions of same in today's issue...
A Sense of Melancholy July 18, 2018
...

Equitymaster requests your view! Post a comment on "Donald Trump's Attack on Saudi Arabia Led OPEC Makes No Sense". Click here!

4 Responses to "Donald Trump's Attack on Saudi Arabia Led OPEC Makes No Sense"

Vijay

Jun 21, 2018

That is one way of looking at it, alternatively:

Firstly, "In oligopoly there is no formal agreement among the firms. A cartel is an agreement among competing firms". When Russia and Saudi's agree on Production levels ? (to raise prices ) ... one could say it's a cartel !

Secondly, ?US has tremendous leverage over Saudi's and Saudi's will stay with dollar for foreseeable future.

1) Saudi's need US as leverage against Iran / Shia moves into Middle-East and US is sole supplier of Military equipment and Intelligence to Saudi Monarchy - So, Saudi's need US !

2) Saudi's / MBS (Mohammed Bin-Sultan) are in reform mode/drive, the religious people / extremists are waiting to strike back at MBS should he fail... So, again Saudi's/MBS need US !

3) Saudi's / MBS need foreign monies (hard currency) for reform and Saudi Aramco is planning to do IPO next year in US market ... So, again Saudi's/MBS need US !

4) Just last week Sunni lead coalition, headed by Saudi's/MBS, are driving into Yemen in war against Shia lead Houthi's - This operation is with approval of US and US is providing military intelligence ... So, again Saudi's/MBS need US !

These are some reasons why Saudi's/Sunni's desperately need US and will not change course vs. dollar.

Next, US wants lower oil prices, as high oil is inflationary for US markets and could bring US and Global recovery to a stop.
Also, Saudi's colluding with Russian to lower production and forcing higher prices ... indirectly also helps Iranians (US and Israeli enemies) as they can sell cheaper oil (since US is again on sanctions drive) and displace Saudi markets.

?So, attacking Saudi's makes sense if you look at it from US geopolitical perspective.

Like 

Nagarajan

Jun 20, 2018

Oil price at 75 $ is too much. Cartelisation by opec is a fact. Trump s trade war and criticism of opec is going to help india in the long run. Even though trump is acting not in favour of india as for as h1b visa and green card, his actions net net will help india.

Like 

Syed Taffazull Hussain

Jun 19, 2018

The reason why dollar became supreme was. because The U.S forced a ruined Europe to accept the dollar as equivalent to 1/35 ounce of gold as a exchange standard. The proposal of British representative John Maynard Keynes to use a new international currency the bankor was violently opposed by the US representative White who forced its rejection at the Bretton Woods conference. Later when it suited the U.S it refused to supply gold at the rate it had promised as it was now the most powerful economy. Thus it was Heads I Win ,Tails you loose.

Like (2)

Ravi Prakash Arora

Jun 19, 2018

Excellent analysis Sir

Like (2)
  
Equitymaster requests your view! Post a comment on "Donald Trump's Attack on Saudi Arabia Led OPEC Makes No Sense". Click here!