What’s Really At Stake: Hubbert, China, and the Dollar

Every once in a while, I read a blog post ties together a number of memes I’ve been thinking about. I’ve recently met Elliot Ng at a dinner in San Francisco, and found him to be an incredibly sharp guy whose recent posting me pause to tie together many of the themes I’ve spoken about here.

The World Says We Suck

But let me start at the beginning here. The BBC recently reported on the results of a regular survey of 17,000 respondents around the world, who were asked to rate the influence of countries around the world as positive or negative. Here’s a breakdown of the average:

Elliott compared the results of the U.S. and China responses, and compared the two. The results are sobering:

Which country has a more positive influence in the world, U.S. or China?

  • Overall: China. 47% for China vs. 35% for U.S. (excluding subject country)
  • Latin America: China. 45% for China vs 32% for U.S.
  • Europe: China. 39% for China vs 31% for U.S.
  • Middle East: China. 63% for China vs. 34% for U.S.
  • Africa: United States. 66% for China, 70% for U.S.
  • Asia (ex-China): China again. 40% for China vs 39% for U.S.

In fact, only 9 of 23 countries rated the U.S. higher than China: Portugal, Italy, Israel (just barely), Kenya, Ghana, Phillipines, South Korea, Indonesia, and Japan.

Caveat: Data was collected in December 2007 before the recent March Tibet events and the torch run. Things may have changed.

Neither country garnered a majority positive opinion, but folks in the U.S. may be surprised to note that the bastion of freedom is viewed as a more negative influence on the world than an authoritarian governed nation. How did we get into this mess? It’s misleading to dismiss this as baiting and resentment ala Faux news. The easy answer is Iraq, but more specifically Iraq has become a symbol for the perception that the US has and will in the future act capriciously. Fair warning: here’s where I turn up the ecogeek rant..

The Intersection of Peak oil, Iraq, and the Value of the Dollar.

Geoscientist M. King Hubbert saw this coming. He noted in 1956 that there’s a simple fact to oil production – the amount of hydrocarbons under the ground in any region is finite, therefore the rate of discovery which initially increases quickly must reach a maximum and decline (this is called “Peak Oil“). The U.S. stopped finding places to drill in the 1950s, and domestic oil production peaked in 1970, dropping mercilessly after that. The British were able to float our hydrocarbon dependence for a while from the North Sea oil fields while domestic supplies dried up, but eventually the North Sea production fell precipitously. Enter the complex and inscrutable U.S.-Saudi relationship of convenience. Of course it’s only a matter of time before Saudis’ own production starts falling out. Stuart Staniford believes it’s already happening.

The blue line represents drilling activity and the other graphs are oil production averages. The punchline here is that the Saudis are drilling for new holes as fast as they can, but total oil production isn’t rising. This isn’t OPEC shenanigans here – there’s nothing the Saudis can do about output drops, despite their reassurances.

There’s a double hit to the United States however, as hydrocarbon commodities are traded commonly in world markets in U.S. Dollars. Hence the continued reliance on an unsustainable fossil fuels infrastructure is reinforced by a political need to maintain a system on which the value of the U.S Dollar is predicated – the value of the U.S. Dollar partly relies on demand from countries who need Dollars to meet energy needs.

There’s a number of hydrocarbon reserves adjacent to Saudi Arabia of course, specifically northward. Saddam Hussein virtually sealed his fate in September 2000 when he announced Iraq would no longer accept dollars for oil being sold under the UN’s Oil-for-Food program, and decided to switch to the euro as Iraq’s oil export currency. The Financial Times reported that “Saddam Hussein in 2000 insisted Iraq’s oil be sold for euros, a political move, but one that improved Iraq’s recent earnings thanks to the rise in the value of the euro against the dollar”. He was playing the foreign exchange game as an insider, hoping to reap the windfall. The Bush-meister implemented the currency transition despite the adverse impact on profits from Iraqi’s export oil sales (In mid-2003 the euro was valued approx. 13% higher than the dollar, and thus significantly impacted the ability of future oil proceeds to rebuild Iraq’s infrastructure). Funny enough, none of the five U.S. major media conglomerates who control 90% of information flow in the U.S. touched this.

So the perception the U.S. is acting in a unilateral and capricious manner stems from the last few years’ activity, but there’s more to the story. The next chapter is more ominous.

Iran’s nuclear ambitions have taken center stage in the media, but there are again unspoken macroeconomic drivers underlying the second stage of petrodollar warfare. I’m talking about Iran’s upcoming oil bourse. In essence, Iran is about to commit a far greater “offense” than Saddam Hussein’s conversion to the euro for Iraq’s oil exports in the fall of 2000. Beginning in March 2006, the Tehran government has plans to begin competing with New York’s NYMEX and London’s IPE with respect to international oil trades – using a euro-based international oil-trading mechanism. Without some sort of U.S. intervention, the establishment of the Iranian trading center firmly establishes a euro based international energy trading system. That means the U.S. will no longer have the ability to effortlessly expand its debt-financing via issuance of U.S. Treasury bills, and the dollar’s international demand/liquidity value will fall.

Circling Back to China

Will Clark notes that “China’s announcement in July 2005 that it was re-valuing the yuan/RNB was not nearly as important as its decision to divorce itself from a U.S. dollar peg by moving towards a “basket of currencies” – likely to include the yen, euro, and dollar.” Interestingly, the Chinese re-valuation immediately lowered their monthly imported “oil bill” by 2%, over Dollar-denominated oil trade, but it is unclear how much longer this monopoly arrangement will last. Note that 2% is the inflation tax we’ve been passing along to them.

So the negative opinions are grounded in a rational fear of the U.S. intervention as China seeks to diversify its foreign currency reserves and has Sinopec signs a sourcing deal with Iran, which will ostensibly revolve aroudn the Iranian exchange. China’s voracious hydrocarbon appetite would allow an expanding credit-fueled Dollar valuation to continue unabated, effectively passing our inflation abroad. In short, we can float the value of the Dollar by increasing the amount of fear, uncertainty, and doubt around the world about our motivations.

Add yet another reason to move the U.S. beyond a hydrocarbon-based economy. I hope you’ll keep this in mind during our 2008 election season and vote for change.

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This entry was published on April 17, 2008 at 12:07 AM. It’s filed under Uncategorized and tagged , , . Bookmark the permalink. Follow any comments here with the RSS feed for this post.

5 thoughts on “What’s Really At Stake: Hubbert, China, and the Dollar

  1. The sad thing for Americans is that:
    1) There is no quick way to make the US dollar healthy again and
    2) There is no quick way to slow down China’s and India’s demand for more oil to fuel their economic growth and
    3) There is no quick way to switch to a post-oil economy in the US and the rest of the world, since that is the only economy the world has known for the past hundred years, and it will take at least another 30 years to create a new business and economic ecosystem based on a new clean technology.

    Put it together, and you get only one possible answer. The US standard of living is going to decline as China and India pay for oil in other non-US dollar currencies, and Americans do not have enough money to invest in a post-oil economy.

    Basically, the US economy will get pushed aside, and unless the US goes to another post-US dollar currency and writes off its debt, there will be no way to get out of the current mess.

  2. Wow. My takeaway:

    1. Peak oil is coming.
    2. USD will no longer be needed as reserve currency for the Middle East.
    3. USD will decline vs. trading partners with growth and inflation like China and India.

    I disagree slightly with Paul’s comment that the US cannot invest in a post-oil economy. There are huge assets in intellectual capital, talent, innovation centers like Silicon Valley, solid IP regulation, risk-taking financial markets…that the US can continue to play the innovation game successfully. But Main Street is going to feel a world of hurt as we make this transition.

  3. Thanks for the insightful posts Paul and Elliot. IMO, Peak oil for the world will probably arrive in the next year or two if it hasn’t already. That means we’ve got a limited amount of time (15 years by some estimates) to get the house in order for both energy and currency. That’s a tough deadline. It’s not out of bounds to imagine U.S. debt relief. Maybe Bono will help us out.

    I too am optimistic to some degree. I do think our standard of living will not be the same in 15 years, but that’s not all bad. Suburban living has drawn people further apart, to the point where it’s common to not know who your neighbors are. Discarding the sprawl and rebuilding closer communities in a world of $20/gallon oil isn’t a bad thing. There’s a silver lining here.

    The key here is to make sure that if we are running up debt, that the debt is financing investment in energy infrastructure and investment in education instead of consumption. This is the basic stuff we learned in freshman economics, which somehow policymakers have forgotten. It plays to our benefit that a crumbling dollar will cause a lot of pain to everyone, so it’s likely the Dollar would be tossed a lifeline if we regain fiscal sanity.

  4. Changing to a post-oil economy requires a huge amount of investment in infrastructure, something which only governments can do. (If you think that private infrastructure development is the answer to all problems, I’d be happy to show you some interesting projects in China. Long story short: they are not built to last.)

    It is true that they US has great IP in clean technology. It’s also true that the government is not willing to invest in it. So far, the US government has encouraged ethanol production, which has already increased food prices in many parts of the world, especially among the poor.

    Maybe the answer is for more far-sighted governments to invest in post-oil infrastructure development. After WWII, the US and Soviet Union were heavily dependent on German scientists for rocket and space technology. Could that become the model?

  5. You’re totally spot-on Paul – this is no different than the railroads or interstate highways in the US. We need another Eisenhower. I had not considered the German WW2 model, but now that you mention it, it’s likely to be the case.

    It will likely come from Europe again. Spain in particular has been on the forefront of commercialized solar, which I’m convinced is the only technology likely to save our bacon in the long term, unless someone comes up with magic.

    More reading here on that If your’e curious: https://ericgonzalez.wordpress.com/2007/10/15/the-sunny-side-of-blog-action-day/

    Quick question for you – are ethanol and biodiesel obtaining funding to any significant extent in China? I hope not!

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