Monday, June 6, 2016


Have you ever wondered why printing so much money to bailout Wall Street after the 2008 market collapse is problem? In a few words, like any addict, it's made Wall Street and rest of the world dependent on the U.S. continuously pumping cheap money into the economy. When the supply begins to dry up things begin to unravel for everyone.

The story below should help you understand. It's not pretty ...


The essence of this story is built around easy money, pegged currency rates, and national panic over the threat of a forced devaluation. I know, I know, boring! Simply put, most Americans have no clue what any of this means, or why it matters. Recognizing this, what's presented below is an allegory of what's been happening in Saudi Arabia, and how U.S. easy money policies have helped put Saudi Arabia in a financial mess that's forced them to ban speculation on their currency, the Riyal.

Remember, what's presented below is a conceptual metaphor. There are a lot of loose ends, but the goal is not to over think the issue.

Imagine that we live in a world where negotiators from the U.S. and Saudi Arabia get together and eat every day. The U.S. brings meat and beer, while the Saudis bring couscous and falafel. This happens every day for decades, especially after 1973. Every day 100 people show up from the U.S. side and 100 people show up from the Saudi side. The 200 people eat together every day.

Some days 120 will show up from each side, some days even more. It doesn't matter because there's an agreement that each side will always bring enough to feed each other's group - and then some.

One day, however, the U.S. stops bringing enough food for 200 people. The U.S. now brings only enough meat and beer for 40. Since we're not bringing enough meat and beer to feed 200 people we feel guilty and only bring 40 people to our daily feast.

Initially, the Saudis don't care because they don't actually consume much of the meat or beer. They've been hoarding it so they can use it to trade with others, especially the Germans and Japanese who give them BMWs and stereos for their meat and beer. However, the Saudis are accustomed to producing enough couscous and falafel to feed the 100 people in their group, plus the 100 people the U.S. usually brought to the feast.

The Saudis can't really trade their couscous and falafel because other nations - but especially the Germans - don't much care for couscous or falafel. So the Saudis are now confronted with the situation where they have too much couscous and falafel on their hands. Their cup runneth over with couscous and falafel. They're going to have to cut back.

But if they cut back the couscous and falafel producers are going to be dissatisfied because they have less business. They're going to have to either reduce production and/or reduce prices in the hope that they sell more. The former will eventually lead to scarcity, while the latter will lead to less money for the producers.

Oh, and the Saudis can no longer plan on trading for or buying stereos or BMWs from the Germans and Japanese in the future.


What I've described above is what's happening to the Saudi currency, the riyal. What was once a straight conversion/trade of U.S. dollars and Riyals (represented by meat and beer being being equal to couscous and falafel) has been disrupted because the U.S. has stopped bringing as much to the table as they once did (represented by the price of petroleum collapsing). The Saudis, who built their entire economy around an expected transaction now have to cut back because they no longer receive what they used to get.

In the real world the Saudis are so accustomed to producing as many riyals as necessary to match the amount of U.S. dollars the U.S. brought to the table. They are now confronted with a dilemma caused by collapsed oil prices, and fewer dollars: Do they ignore fewer U.S. dollars coming in, and continue printing their currency at the rate they have in the past? Or do the Saudis reduce the amount of riyals they print, in the process maintaining the "par value" of their currency?

The first option invites speculators to bet on the eventual collapse or devaluation of the riyal, while the second invites economic slowdown.

In all cases, the Saudis are starting to panic, and have banned speculation on the riyal.

But wait, there's another problem. And it involves the U.S.

With fewer dollars the Saudis - and other OPEC producers - may find it more and more difficult to continue lending us money (through the purchase of U.S. Treasury Bonds). This would make it more difficult for us to continue spending like drunken sailors.

Here's yet another issue to consider. Because the U.S. continues to pump out dollars, under the aegis of Quantitative Easing (among others), we have been reducing the value of the dollar others are holding around the world. At some point the Saudis, and others, might begin to believe that voluntarily tethering their currency to an ever expanding, and devalued, U.S. dollar no longer brings benefits (think Charles de Gaulle's "exorbitant privilege").

If this happens, who's going to be in trouble then? Let me give you a hint: You and me.

The story described here is actually a bit more technical, and somewhat more complex. For those who like getting into issues built around currencies and forced devaluations, you can read about the Saudis decision to ban speculation on the Riyal in this Zero Hedge piece.

- Mark

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