Consequences and Causes

 

I’m reluctant to attempt analysis of DJT’s war. It is easy to confuse consequences with causes. One obvious result is that US is now the principal supplier of liquid natural gas (LNG) to Europe. After Russia was forced out when their pipeline was blown up, Qatar was partners with US selling LNG to Europe. Now Qatar is struggling while Saudi Arabia is moving oil to China out its back door. Given the rivalry between Saudi Arabia and Qatar this appears providential. You may be dismissive of this as a cause. How much revenue is received as against war expenditure? What you fail to grasp is the much larger financial value of the new relationships and contracts.

Again, who knows how those decisions were made. But US now supplies almost all LNG to Europe. 

I find President Grants struggle with his Great Financial Depression instructive. Grant recognized a presidential responsibility for the economy, advocated several innovative solutions and then, unpopular as it was, ended US paying silver and onto using just gold. Given that the British Empire ruled the world, wanted to be paid in gold, and had financed our civil war, this was a given. Nixon taking US off the gold standard was the second moment when we had a fiat currency after Washington and Hamilton’s Coinage Act. Nixon quickly realized the dollar had to be worth something and today the dollar is valued in oil, the petrodollar. You can still see the gold value of the dollar and it has declined dramatically.

Capital or investment is much larger than its associated revenue. Capital is also aspirational; we invest in hopes of future profit. Oil is declining as an opportunity. When Dumb Dumb Donald held his meeting with oil leaders proudly displaying his recent theft of Venezuela oil they stared in open mouthed astonishment. They were facing an oil glut. US has become the new OPEC. We are not the largest export state but US is the largest oil producing state. US fracking has turned our southwest into toxic sludge. China, after much criticism, has managed to reduce its oil consumption. The glut of oil had lowered the value of our dollar, which is shown by the price of gold.

The value of the dollar isn’t only determined by oil, or even liquid natural gas. One measure of dollar worth is wage inflation. When undocumented were successfully terrorized, wages rose. Responding to what looked like a structural change the Federal Reserve increased the discount rate that they charge banks. Poor Biden tried to meet the challenge with documented immigrants. Documented are more expensive than undocumented, so it takes more, and they are apparent. Bringing in more people may have ameliorated the wage increase but combined with the Covid shocks it wasn’t sufficient and interest rates rose.

When the Federal Reserve raises the discount rate, businesses must pay more interest when they borrow. This chokes off new and smaller companies that compete in the labor markets and that should, eventually lower salaries. Choking off new companies reduces competition and innovation, raising prices. Raising interest rates benefits lenders and hurts owners who borrow.

The Federal Reserve must raise the discount rate to meet treasury yield. When treasuries are auctioned at less than their offering price, yields rise. If banks can borrow money from the Fed at less than treasury yield, then buy the treasuries themselves, the Fed is losing money. One tactic the Federal Reserve can use to cushion interest rate rise is buy the treasuries on their own account. The hope is that the Fed can sell these treasuries when rates decline. It doesn’t look like rates are declining anytime soon and the new chairman has said the Fed will no longer accumulate treasuries.

Arbitrary tariffs also discourage faith in the dollar and US management. Free trade amendment anyone? It should be easier to indict judges. Destroying health care, research, social investment, intelligence services, diplomacy, courts, while prattling about AI doesn’t inspire confidence.  When you buy treasuries, you are expressing faith in US policy.

Why haven’t the other currencies risen against the dollar? In large part because those economies are dependent on oil. In the short term the Golden Goblins war has held the value of the dollar. It is also because the Federal Reserve is one of several institutions that maintain dollar value. Our trading partners either explicitly or through other means buy our debt and manage the dollar to promote trade and stability. At the same time our partners must watch a government where every pejorative directed against Iran is current US policy. That influences investment.

Even banker’s eyes glaze over when they hear “Federal Reserve”. The Fed also guarantees deposits (slow pay), audits banks (sort of), determines banks’ reserve requirements (not much), and uses these responsibilities to justify intervention (bailouts and mergers).  Maybe people don’t want to recognize how crude central banks market management mechanisms are or that they focus on wage inflation, only occasionally or may I say periodically pop the bubble on capital inflation. 

Please Jimmy Carter, don’t sanctimoniously rant about reducing debt. The one statesman who reduced the rate of debt expansion was Bush Sr. who lied and increased taxes. Clinton was smart enough to keep that policy. Tax cuts combined with destroying social investment, however privileged it may be, and deterring immigration is scavenging the train for fuel to keep it moving.

I don’t pretend to understand how Fat and Furious went to war. The initial consequence of closing the Strait of Hormuz has been to raise oil prices, stop the slide of the dollar and raise interest rates. Perhaps this will hold until the midterm elections. Longer term this should reduce oil consumption, increase exploration, the dollar should resume its slide and interest rates continue to rise. Even Saudi Arabia is buying gold and trading in Yuan. Algeria is planning to steal Libyan natural gas to sell to Europe. Capital is aspirational, the dollar’s future slide against other currencies discourages investors. 

Judging by the results, maintaining the dollar by supporting oil price appears to be the goal. The war has also solidified the Iran Revolutionary Guard Corps control of that country when it looked endangered. Destruction of competing Qatar’s natural gas trade has been achieved. This has been accomplished without losing the domestic support of the critical third of our country before the midterms.