When it comes to bailouts and government programs, doesn't money seem to appear by magic? Congress and the President, and their well-paid magician's helpers think they can solve any problem. Those in the audience just have to reach out a hand and grab what they need. Do any of those with their hands out ever wonder what’s going on behind the curtain?
The Tipping Point
In 1964 LBJ (D) announced his vision of the "Great Society," a continuation of FDR's socialization of America.[1] LBJ wanted to "re-form" America using the magical power of the federal government. He signed legislation to end racial injustice and poverty, create a permanent food stamp program, protect the environment, supply federal aid to public schools, fund the arts, create public television, create consumer protection laws, create the Department of Housing and Urban Development, create the Department of Transportation, fund mass transit, and create Medicare and Medicaid. If it was possible to legislate utopia, why hadn't anyone done all of this before?
The Social Security Act of 1965 created Medicare and Medicaid, America's first public health "insurance" and LBJ's proudest moment. Today out of control Medicare spending is one of the Obama (D) administration's excuses to "re-form" healthcare again. The chart shows federal healthcare spending as a percentage of GDP. The percentage starts increasing after 1965. This also marks the start of Bacevich's tipping point, when the US government started spending more dollars than it was taxing, Americans demanded services they couldn't afford, and the magical ability of the federal government to create wealth out of nothing started to go out of control.
Federal Government Spending in inflated dollars as a percent of GDP, source www.usgovernmentspending.com
While massively increasing spending at home for his "Great Society," LBJ was also busy escalating spending on a foreign war. To work his magic, LBJ wanted lots of guns and lots of butter.[2] He left his successor a bloated federal bureaucracy, a war in Vietnam, and the seeds of a bad economy. Americans picked a new magician and substituted an R for a D. Nixon (R) continued LBJ's policies, just as today Obama continues Bush's (R) policies.
Tipped Over
On August 15, 1971, Nixon halted US Treasury payouts of gold for foreign central bank dollars, preventing the French and the Swiss from depleting the US Treasury by redeeming their dollars for gold. In 1944, the Bretton-Woods agreement of fixed currency exchange rates based on a gold-backed dollar had created a system of US dollar hegemony. The almighty US dollar was the preeminent currency--as good as the US Treasury gold that backed it. The French and Swiss central banks must not have believed the magic of all those dollars the US government created for its "Great Society" and the war in Vietnam.
Unhindered by foreign central bank redemptions of dollars for the limited supply of US-held gold, the federal government could continue to inflate the US money supply at an even faster rate. The politicians began to truly create wealth from nothing. That was really magical!
But if the dollar was no longer backed by gold and the US was flooding the world with it, why would anyone accept it for real goods?
Behind the Curtain: Black Gold and the Petrodollar
The dollar is still accepted because the U.S. government made a deal. In exchange for US military protection for some of the oil-rich kingdoms in the Middle East, particularly Saudi Arabia, OPEC agreed to price oil in US dollars. Since 1972, OPEC oil has been priced in US dollars. Oil--black gold--backed the dollar. Now everyone in the world would need dollars to purchase oil. Dollar hegemony was saved. The world would still use dollars, but instead of gold-backed dollars, they would be oil-backed petrodollars.[3][4] The artificial demand for the dollar, due solely to US military might, put the US in a position to “rule” the world.[5][6] The global dollar flood could continue.
The oil price shock of the mid-70s marks the end of Bacevich's tipping point and the beginning of the full-scale slide to the destruction of the American financial system. The price of a barrel of oil tripled in 1973-4 and doubled in 1979-80 when OPEC reduced production in reaction to both US support of Israel and continuing US government dollar inflation.[7] The Nixon administration figured the price shock would hurt their trading partners, and now economic rivals in Europe and Japan, worse than it would hurt the US. In his memoirs, Henry Kissinger confirmed the view that the US government welcomed the oil price rise in 1973 as an economic blow to the strengthening economies of Europe and Japan.[8] It didn't matter to Kissinger that everyday Americans suffered the consequences of the 1970s stagflation.
From 1972 on, oil had to continue to be priced in dollars to maintain the magic of dollar hegemony: any threats to this arrangement were forcefully suppressed by the US military. Recognizing where the magic for the fiat dollar came from, then President Carter (D) created the Rapid Deployment Force in 1977. The US military had to be available for police work wherever the oil was. The Iraq invasion, US saber rattling against Iran, and a coup attempt in Venezuela are the most recent examples of the US government using force to maintain dollar hegemony.[9]
Of course dollar hegemony isn't really magic, and we can't continue to expect to flood the world with worthless paper forever. But the US government and many people continue to believe we can: for the last four years, the trade deficit, Bacevich's symptom of America's unhealthy financial system, has averaged over $700 billion. The national debt of the US government is $11.8 trillion and growing. Instead of the French dumping dollars, today our largest trading partner, the Chinese, don't want to hold dollars; they're converting theirs to gold. Because there is no longer a gold standard, they're buying gold on the open market. If they dump all of their dollars at once, the US economy will collapse. The petroeuro is now challenging the dying petrodollar to be the new exchange currency.[10]
Soon the dollar will be worthless and everyday Americans will suffer. The magic show is over, most just don't know it yet.
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[1] "No Good Choices LBJ and the Vietnam/Great Society Connection," (pdf) Francis Bator, expanded version of a Presidents’ Week Lecture given at the American Academy of Arts and Sciences on February 28, 2006, p.14.
Bator was a deputy national security adviser to Johnson.
[2] Bator, Ibid., p.12.
[3] "The End of Dollar Hegemony," Speech by Congressman Ron Paul, February 16, 2006.
According to Paul:
"...elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence 'backed' the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished."
[4] The Hidden Hand of American Hegemony, David E. Spiro, Cornell University, 1999, p. 121.
William Clark summarizes:
"In 1974 the Nixon administration negotiated assurances from Saudi Arabia to price oil in dollars only, and invest their surplus oil proceeds in U.S. Treasury Bills. In return the U.S. would protect the Saudi regime. The purchases were done in relative secrecy and created the phenomenon known as 'petrodollar recycling.' "
"A petrodollar is a dollar earned by a country through the sale of oil. In 1972-74 the US government concluded a series of agreements with Saudi Arabia to support the power of the House of Saud in exchange for accepting only US dollars for its oil. Saudi Arabia has been the largest oil producer and the leader of OPEC."
A December 2006 NY Fed article: "Recycling Petrodollars" explains how it works:
"A look at how oil exporters 'recycle' their revenues reveals that roughly half of the petrodollar windfall has gone to purchase foreign goods, especially from Europe and China, while the remainder has been invested in foreign assets. Although it is difficult to determine where the funds are first invested, the evidence suggests that the bulk are ending up, directly or indirectly, in the United States."
A pre-Iraq invasion article in The Observer, "When will we buy oil in euros?", explains the motivation of US government to use the military to pay for its profligacy:
"Oil trading, whether from Norway to the Netherlands, Britain to Bermuda, or Bahrain to Bangladesh, operates through the US greenback.
"The oil-dollar nexus is one of the foundations of the world economy that inevitably filters through to geopolitics. Recycling so-called petrodollars, the proceeds of these high oil prices, has helped the United States run its colossal trade deficits. But the past year has seen the quiet emergence of the 'petroeuro'.
"Effectively, the normal standards of economics have not applied to the US, because of the international role of the dollar. Some $3 trillion (£1,880 billion) are in circulation around the world helping the US to run virtually permanent trade deficits. Two-thirds of world trade is dollar-denominated. Two-thirds of central banks' official foreign exchange reserves are also dollar-denominated.
"Dollarisation of the oil markets is one of the key drivers for this, alongside, in recent years, the performance of the US economy. The majority of countries that require oil imports require dollars to pay for their fuel. Oil exporters similarly hold, as their currency reserve, billions in the currency in which they are paid. Investing these petrodollars straight back into the US economy is possible at zero currency risk.
"So the US can carry on printing money - effectively IOUs - to fund tax cuts, increased military spending, and consumer spending on imports without fear of inflation or that these loans will be called in. As keeper of the global currency there is always the last-ditch resort to devaluation, which forces other countries' exporters to pay for US economic distress. It's probably the nearest thing to a 'free lunch' in global economics."
The Saudis are the staunchest allies of the US government in OPEC:
" 'The Saudis are holding the line on oil prices in Opec and should they, for example, go along with the rest of the Opec people in demanding that oil be priced in euros, that would deal a very heavy blow to the American economy,' Youssef Ibrahim, of the influential US Council on Foreign Relations, told CNN.
"Last year the former US Ambassador to Saudi Arabia told a committee of the US Congress: 'One of the major things the Saudis have historically done, in part out of friendship with the United States, is to insist that oil continues to be priced in dollars. Therefore, the US Treasury can print money and buy oil, which is an advantage no other country has. With the emergence of other currencies and with strains in the relationship, I wonder whether there will not again be, as there have been in the past, people in Saudi Arabia who raise the question of why they should be so kind to the United States.' "
[6] "The End of Dollar Hegemony," Ibid.
Congressman Paul makes Bacevich's point, connecting the money system to its domestic effect--enabling businesses and everyday Americans to get something for nothing:
"Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people-- just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.
"The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases personal responsibility for one’s actions is rejected."
[7] "Petrodollar Recycling And Global Imbalances," Presentation by Saleh M. Nsouli, Director, Offices in Europe International Monetary Fund, At the CESifo's International Spring Conference, Berlin, March 23-24, 2006.
Chart 7 from the presentation shows two sharp increases in the oil price of approximately 250% and 125% in the 1970s.
[8] "The Global Minotaur Or how the voracious US deficit causes wars, economic domination, and pushes ‘old’ Europe into an embrace with Peace activists," by Joseph Halevi and Yanis Varoufakis.
"The American quagmire in Indochina was giving rise to two antagonistic effects. On the one hand it was generating the quantitative conditions for global growth but, on the other hand, it was creating acute rivalries between the US and its two major protégés (Europe and Japan) in the context of the former’s balance of payments deficit and the ensuing pressure on the dollar.
"In his 1982 memoirs Henry Kissinger said quite categorically that the push to increase oil prices came from the US. It is now well accepted (see Oppenheim, 1976/7) that Kissinger’s memoirs impart quite accurately the manner in which US decision makers seized upon the OPEC-imposed embargo to push for a sharp increase in oil prices, well beyond OPEC’s planned price rises. The aim was to redress the balance of payments situation between the three major zones: the US, Europe and Japan. The basic assumption here was that, in the estimation of the US authorities, both Japan and Western Europe would find it much harder than the US to deal with a significant increase in oil prices."
[9] "The End of Dollar Hegemony," Ibid.
Congressman Paul gives examples of military intervention to defend dollar hegemony:
"In November 2000 Saddam Hussein demanded Euros for his oil. His arrogance was a threat to the dollar; his lack of any military might was never a threat. At the first cabinet meeting with the new administration in 2001, as reported by Treasury Secretary Paul O’Neill, the major topic was how we would get rid of Saddam Hussein-- though there was no evidence whatsoever he posed a threat to us. This deep concern for Saddam Hussein surprised and shocked O’Neill.
"It now is common knowledge that the immediate reaction of the administration after 9/11 revolved around how they could connect Saddam Hussein to the attacks, to justify an invasion and overthrow of his government. Even with no evidence of any connection to 9/11, or evidence of weapons of mass destruction, public and congressional support was generated through distortions and flat out misrepresentation of the facts to justify overthrowing Saddam Hussein.
"There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in Euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war. Within a very short period after the military victory, all Iraqi oil sales were carried out in dollars. The Euro was abandoned.
"In 2001, Venezuela’s ambassador to Russia spoke of Venezuela switching to the Euro for all their oil sales. Within a year there was a coup attempt against Chavez, reportedly with assistance from our CIA.
"The military might we enjoy becomes the “backing” of our currency. There are no other countries that can challenge our military superiority, and therefore they have little choice but to accept the dollars we declare are today’s “gold.” This is why countries that challenge the system-- like Iraq, Iran and Venezuela-- become targets of our plans for regime change.
"Ironically, dollar superiority depends on our strong military, and our strong military depends on the dollar. As long as foreign recipients take our dollars for real goods and are willing to finance our extravagant consumption and militarism, the status quo will continue regardless of how huge our foreign debt and current account deficit become."
[10] "Petrodollar or Petroeuro? A new source of global conflict," Cóilín Nunan, from November 2004 Feasta Review online.
"Were the euro to become a reserve currency equal to, or perhaps even instead of, the dollar, countries would reduce their dollar holdings while building up their euro savings. Another way of putting this would be to say that Eurozone countries would be able to reduce their subsidy to American consumption and would find that other countries were now subsidising Eurozone consumption instead.
"A move away from the dollar towards the euro could, on the other hand, have a disastrous effect on the US economy as the US would no longer be able to spend beyond its means. Worse still, the US would have to become a net currency importer as foreigners would probably seek to spend back in the US a large proportion of the estimated three trillion dollars which they currently own. In other words, the US would have to run a trade surplus, providing the rest of the world with more goods and services than it was receiving in return. A rapid and wholesale move to the euro might even lead to a dollar crash as everyone sought to get rid of some, or all, of their dollars at the same time. But that is an outcome that no-one, not even France or Germany, is seeking because of the huge effect it would have on the world economy. Europe would much prefer to see a gradual move to a euro-dollar world, or even a euro-dominated one."
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