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INTERNATIONAL PETRODOLLAR CRISIS HEARINGS BEFORE T H E SUBCOMMITTEE ON INTERNATIONAL FINANCE OF T H E COMMITTEE ON BANKING AND CURRENCY HOUSE OE REPRESENTATIVES NINETY-THIRD CONGRESS SECOND SESSION JULY 9, AND AUGUST 13, 1974 Printed for the use of the Committee on Banking and Currency U.S. GOVERNMENT PRINTING OFFICE 37-211 O WASHINGTON : 1974 C O M M I T T E E O N B A N K I N G A N D C U R R E N C Y W R I G H T PATMAN, Texas, Chairman W I L L I A M B. WIDNALL, New Jersey W I L L I A M A. BARRETT, Pennsylvania ALBERT W. JOHNSON, Pennsylvania LEONORK. (MRS. J O H N S . ) SULLIVAN, J. W I L L I A M STANTON, Ohio Missouri BEN B. BLACKBURN, Georgia HENRY S. REUSS, Wisconsin GARRY BROWN, Michigan THOMAS L. ASHLEY, Ohio LAWRENCE G. W I L L I A M S , Pennsylvania W I L L I A M S. MOORHEAD, Pennsylvania CHALMERS P. WYLIE, Ohio ROBERT G. STEPHENS, JR., Georgia FERNAND J. ST GERMAIN, Rhode Island MARGARET M. HECKLER, Massachusetts P H I L I P M. CRANE, Illinois HENRY B. GONZALEZ, Texas JOHN H. ROUSSELOT, California JOSEPH G. M I N I S H , New Jersey STEWART B. McKINNEY, Connecticut RICHARD T. HANNA, California B I L L FRENZEL, Minnesota TOM S. GETTYS, South Carolina ANGELO D. RONCALLO, New York FRANK ANNUNZIO, Illinois JOHN B. CONLAN, Arizona THOMAS M. REES, California CLAIR W. BURGENER, California JAMES M. HANLEY, New York M A T T H E W J. RINALDO, New Jersey FRANK J. BRASCO, New York EDWARD I. KOCH, New York W I L L I A M R. COTTER, Connecticut PARREN J. MITCHELL, Maryland WALTER EL FAUNTROY, District of Columbia ANDREW YOUNG, Georgia JOHN JOSEPH MOAKLEY, Massachusetts FORTNEY H. (PETE) STARK, Jr., California L I N D Y (MRS. H A L E ) BOGGS, Louisiana P A U L N E L S O N , Clerk and Staff Director C U R T I S A . P R I N S , Chief Investigator BENET D . GELLMAN, Counsel J O S E P H C . L E W I S , Professional Staff Member D A V I S COUCH, Counsel O R M A N S. F I N K , Minority Staff Director SUBCOMMITTEE ON INTERNATIONAL FINANCE HENRY B. GONZALEZ, Texas, Chairman ALBERT W. JOHNSON, Pennsylvania HENRY S. REUSS, Wisconsin J. W I L L I A M STANTON, Ohio W I L L I A M S. MOORHEAD, Pennsylvania P H I L I P M. CRANE, Illinois THOMAS M. REES, California B I L L FRENZEL, Minnesota R I C H A R D T. HANNA, California JOHN B. CONLAN, Arizona WALTER E. FAUNTROY, CLAIR W. BURGENER, California District of Columbia ANDREW YOUNG, Georgia FORTNEY H. (PETE) STARK, JR., California ROBERT G. STEPHENS, JR., Georgia (II) CONTENTS Hearings held on— July 9, 1974 August 13,1974 Background material on the "International Petrodollar Crisis" prepared by the staff of the Subcommittee on International Finance Page 1 75 123 Statements Bennett, Hon. Jack F., Under Secretary of the Treasury Grant, James P., president, Overseas Development Council Kurtz, Victor, E lvie Import Corp., New York, N.Y Wallich, Hon. Henry C., member, Board of Governors of the Federal Reserve System Additional Information Submitted for the 77 Record Board of Governors of the Federal Reserve System, statement presented by Hon. Henry C. Wallich, member of the Board Gonzalez, Hon. Henry B., excerpts from articles appearing in: Foreign Affairs, July edition, by Walter Levy Washington Post Grant, James P., prepared statement Kurtz, Victor: "Controls Put On Currency Mart Trade," article from the Journal of Commerce of July 11, 1974 "Foreign Exchange Abuses by Some Banks Alleged at Convention, Spurring Debate," article from the Wall Street Journal of April 11,1974 Letters from: Chairman Wright Patman, dated August 16, 1969 Hon. William Proxmire, U.S. Senator from the State of Wisconsin, dated: May 5, 1971 October 4, 1971 Joseph A. Califano, Jr., former Special Assistant to President Lyndon B. Johnson, dated February 5, 1968 "Pricing Impact Called Global," article from the New York Times of January 17, 1974 Overseas Development Council, statement presented by James P. Grant, president Treasury Department, statement presented by Hon. Jack F. Bennett, Under Secretary of the Treasury Wallich, Hon. Henry C., prepared statement (in) 5 12 62 77 76 76 20 70 69 72 72 73 72 68 12 5 83 INTERNATIONAL PETRODOLLAR CRISIS T U E S D A Y , J U L Y 9, 1974 H O U S E OF SUBCOMMITTEE OF T H E REPRESENTATIVES, ON I N T E R N A T I O N A L COMMITTEE ON B A N K I N G FINANCE, AND CURRENCY, Washington, D.C. The subcommittee met, pursuant to notice, at 10:10 a.m., i n room 2128, R a y b u r n House Office B u i l d i n g , the Honorable H e n r y B. Gonzalez [chairman of the subcommittee] presiding. Present: Representatives Gonzalez, Rees, Hanna, Young, Johnson, Crane, Frenzel, and Burgener. M r . G O N Z A L E Z . T h e subcommittee w i l l come to order. I am going to announce f r o m the outset that unfortunately many of the members of this subcommittee are also members of the Housing Subcommittee, of which I am also a member, and today the conferees on the housing b i l l are meeting to see i f they can reconcile their views. I am sure t h a t we w i l l be getting additional members as they leave the conference. B u t under the rules, the subcommittee is permitted t o proceed. I believe t h a t the first t h i n g we should mention is i t is a very happy occasion because Secretary Bennett w i l l be f o r m a l l y inaugurated at noon, he tells me, to replace our f r i e n d P a u l Volcker as the Under Secretary f o r Monetary Affairs, and so this is really an auspicious occasion i n more ways than one. I t h i n k we ought t o explain t h a t one of the i m p e l l i n g reasons f o r this projected series of meetings goes back to what some of us have f e l t very keenly f r o m the beginning, and t h a t is t h a t i n this area or sphere o f action, the Congress sits sort o f as a reacting body. The President makes an announcement, and subsequent to t h a t we are asked t o consider intricate monetary matters i n v o l v i n g monetary legislation, the question of our continuing obligations w i t h respect t o the international financial institutions, the consequent impact on the domestic matters, and so this has relegated to this subcommittee a new area o f responsibility. I was a member of this subcommittee f r o m the first pionth t h a t I came to the Congress i n 1962, and t o give you an idea of how the emphasis has changed, between January 1962 and 1971, this subcommittee met f o u r times. B u t between 1971 and today we have met almost 20 times. So we have a relatively obscure and inactive subcommittee now confronted w i t h some pretty heavy responsibilities i n a very intricate and complex area, and one i n which the Congress does not have the primacy o f i n i t i a t i n g policy, and yet we feel very keenly t h a t we have a d u t y and a responsibility t o discharge. A t this particular time we are very much concerned w i t h what has developed since the o i l crisis and the very heavy outflow of our moneys because of the tremendous increase i n the price of the oil t h a t we must import. (l) 2 I n these hearings we w o u l d like t o cover the f o l l o w i n g topics, specifically: (1) what oil-producing countries w i l l do w i t h t h e i r new f o u n d wealth as i t would have an impact on our international policies, and consequently domestic policies: (2) the potential damage t o the I n t e r n a t i o n a l Monetary System and t o the w o r l d economy as a result o f a petrodollar g l u t ; (3) the v i a b i l i t y of the proposals f o r recycling petrodollars. W e pick up the newspaper and we find t h a t we have f o r eign news stating t h a t the President i n his recent trij> t o the M i d d l e East either made o r i m p l i e d some commitments i n this respect. I f i t is possible, the Congress w o u l d like t o know at this t i m e the details of any commitments so t h a t we can provide at least a sympathetic background, i f such becomes necessary, instead o f w a i t i n g u n t i l i t develops into a crisis, and then we would have knockdown and d r a g out legislative fights similar t o the ones we had recently w i t h I D A . I m i g h t mention by way of parentheses here t h a t the f u l l committee has created an ad hoc subcommittee chaired by the Honorable T o m Rees f r o m C a l i f o r n i a t h a t w i l l go specifically into the o i l deficit problems o f the developing w o r l d . F o u r t h , w h a t the U n i t e d States should be doing about the petrodollar problem and its l i k e l y detrimental effects. A s background, I w o u l d like to f o r the record cite a few facts and opinions t h a t contribute, at least i n part, t o the c a l l i n g o f these hearings. H o b a r t Rowen, i n the Washington Post, says, and I quote : Everything done so far in the wake of the oil crisis—for the industrial or the developing countries—including the steps taken at the C-20—the group of 20 countries—is inadequate or spineless. Untold hazards lie ahead unless there is some alteration in the vast shift of funds demanded by the oil producing and exporting nations. That requires lower oil prices. D r . A r t h u r Burns, Chairman of the Federal Reserve Board, who w i l l appear before t h i s subcommittee early next month, i n a recent letter t o me said " f o r the longer run, I see no viable alternative t o a reduction i n the price o f petroleum." W o r l d renowned o i l economist W a l t e r J . L e v y , w r i t i n g i n F o r e i g n A f f a i r s , warns t h a t we are witnessing an erosion of the world's o i l supply and financial systems, comparable i n its potential f o r economic and p o l i t i c a l disaster t o the Great Depression or the 1930's. T h e respected Economist magazine said, a n d I quote: The world's rich countries are digging the foundations for a major world depression. The rich are almost doing everything possible to insure a trade war and a slump. I n M a y , the M a n a g i n g Director o f the I n t e r n a t i o n a l Monetary F u n d said: I t is no exaggeration to say that the world presently faces the most difficult combination of economic policy decisions since the reconstruction period following World War I I . P r o f . M . A . A d e l m a n o f Massachusetts I n s t i t u t e of Technology, i n a speech before the National Press C l u b said: My opinion is that what's bad for the cartel is good for the United States. The burden for paying for oil imports has been exaggerated but is still very great. For most of the underdeveloped countries, it is ruinous. There is no way they can pay, and we will need to bail them out. We are embroiled with our friends and trading partners in attempts to shove the burden of higher prices on each other. Our Government denounces bilateral deals of armaments or other goods 3 for oil, while we, ourselves, negotiate one of the biggest bilateral deals of all. The cartel is making the world a much more dangerous place. A vast arms buildup is just beginning in the Persian Gulf. What do the oil prices and their increases mean to the less developed countries? These countries face an additional import bill approaching $10 billion, a figure roughly equivalent to their total official development assistance. For the industrialized world, Italy is reported to be nearly bankrupt and France and Great Britain may not be far behind. The oil producing nations will, this year, run up a trade surplus of $65 billion, compared with $7 billion last year. Bankers have expressed fears that this petrodollar glut will wreck the Eurodollar markets and cause havoc in the foreign exchange markets. The fact is that the oil producing and exporting countries form a group that consists, and in reality is. an international oil monopoly which has quadrupled prices i n a period of less than a year and threatens to do something in the way of an increase every 3 months as regular as a clock. I n the Mideast, the oil prices are 70 times the cost of production. By no stretch of the English language can this be described as anything but price gouging. I have read about the plans for recycling the oil producers' revenues through the I M F and other institutions and I feel that such plans at least are certainly necessary to be formulated, but more importantly, I have watched as we scurry about trying to find ways to channel some of this oil money back to the less developed countries. How long can the world tolerate such a situation in which we must beg the extortionist to aid his victims. I cannot see any other way to describe the poor countries but as victims. None of the proposed aid programs can even make a dent in the increased burden on the less developed countries. Where is there a country today which would permit within its boundaries the operation of a monopoly which cruelly manipulates supply and gradruples prices ? Even the most laissez-faire government in the world would have to try to cope with such a monopoly. Yet OPEC and the Secretary General threaten us when we talk about getting together with other consuming nations. The Arab oil producers make no pretense about their continuing willingness to use their oil and new found wealth as political blackmail. OPEC points out that the prices of wheat and other goods have risen substantially, and therefore, i t is all right for oil prices to go up. But the United States, Canada, and the other wheat exporters have not colluded to raise the price of wheat to a price 70 times its cost. By exercising monopoly power over a vital commodity—power which we have never thought to be morally right—a small group of people may control by 1980, 70 percent of the world's total monetary reserves. Here is clearly the new generation of robber barons. I feel that the oil producers are engaged in economic warfare no less serious to the continued peace and prosperity of the world than armed warfare. The staff of this subcommittee has prepared background material which has been placed before each member. I wish to place this material in the record at this time with unanimous consent. 4 [ T h e background material referred to appears at the end o f the hearing, and may be f o u n d on page 123.] M r . G O N Z A L E Z . W e can proceed w i t h witnesses, t o whom I wish to express a profound note of thanks f o r their willingness to take time t o be w i t h us, and also, as I said to those who were absent at the time, today coincides w i t h M r . Bennett's swearing i n as the replacement and our new U n d e r Secretary f o r Monetary Affairs. I t h i n k i t is a happy occasion and we wish you complete success and assure you o f our cooperative interest and willingness t o do w h a t we can on our level and f o r our pant t o w o r k w i t h you. M r . Bennett, would you proceed, unless a member of this subcommittee wishes t o make some p r e l i m i n a r y remarks a t this time. M r . Hanna. M r . H A N N A . M r . Chairman, since I have t o go t o the H o u s i n g Subcommittee meeting, I would appreciate i t i f I m i g h t put on the record about 5 minutes of observations. M r . G O N Z A L E Z . W i t h unanimous consent, and there being no objections, so be it. M r . H A N N A . I apologize to M r . Bennett f o r t a k i n g this time, but I would like t o summarize f o r the record of this subcommittee m y own extraction of i n f o r m a t i o n f r o m m y visits to the finance ministries of both Saudi A r a b i a and K u w a i t . I t h i n k t h a t at the outset one sees the history of the investment of the A r a b oil countries as h a v i n g t w o prime principles: One, l i q u i d i t y , and the other, anonymity. T h e Arabs have sought this over the years. I n this new f o u n d wealth they realize t h a t they have to go beyond that, and they indicated t o me that they had three basic desires f o r the use of t h a t money. The first was t o invest i n the extension of petrochemical and other related industrial activities w i t h i n their own lands and f o r the betterment of their own people on the basic community facilities level. T h e second t h i n g they wanted to do was invest i t i n other A r a b countries who d i d not produce oil, t o make investments i n industrialization activities, agricultural activities, and i n the general improvement i n housing, education, and so f o r t h . The t h i r d t h i n g they wanted to do w i t h t h e i r money was to invest i t i n the M u s l i m countries of A f r i c a , and they had i n m i n d some k i n d of an A r a b f u n d f o r underdeveloped M u s l i m countries. They indicated to me that they were w i l l i n g t o include underdeveloped countries who were not M u s l i m so that they would not preclude some of the countries who are suffering because of the h i g h price of oil. T h e other t h i n g they t o l d me was their attitude t o w a r d the price of oil. They said they were p r i c i n g oil on this basis, first, to discourage the h i g h use of i t i n industrialized countries, which they f e l t was to some degree wasteful; second, to find a competitive price to any alternative to o i l and consider that as one of the hallmarks of pricing. The other t h i n g that they were looking at was the problem of converti n g oil i n the ground to some other k i n d of asset t h a t would be equal i n value and i n safety to the o i l i n the ground. They indicated to me that the transfer of oil i n the ground t o the currencies t h a t they saw around the w o r l d d i d not look too attractive because those currencies were subject to float. I was there r i g h t after the French had floated down 5 percent and they had just sold a large cargo of oil to the French and they could not understand w h y they 5 should take the 5 percent rap by h a v i n g picked up the French currency. So they said as long as currencies are subject t o these kinds of float and unless there were some k i n d of quick investments i n the Western W o r l d or preferably they would like to see their oil, i n terms of the Western W o r l d , coming back as the needed materials, technologies, manpower, machines, t h a t would do the three jobs t h a t they sought i n terms of industrializing t h e i r own country, i m p r o v i n g the non-oil-producing A r a b countries, and i n doing the w o r k they hope t o be able to do i n the underdeveloped countries. I t seems to me t h a t the U n i t e d States has been somewhat derelict i n not finding where the A r a b m i n d is i n these matters, and i n t r y i n g to w o r k out a cooperative program. The most promising t h i n g , as you have indicated, M r . Chairman, that I have seen is the willingness on the p a r t of the Arabs to use the I M F and the W o r l d B a n k and some of the others f o r the purposes t h a t they have described, and particul a r l y i n the underdeveloped countries. I t r i e d to point out to them that i t is not easy t o get into -the business of investment i n improvement, that you have t o have a developed expertise i n the f u n d t h a t is going to hold the money and you have to have a developed expertise i n the borrowers who are going t o use the money. T h a t has not been demonstrated yet i n any of the places i n which they have talked about doing their investments. B u t I personally feel very strongly, M r . Chairman, that you are doing a great service to this Congress and to the country by these hearings, and I want to j o i n you i n welcoming M r . Bennett to his new post and assure h i m t h a t this subcommittee w i l l take an interest i n his position and h i m personally, as we have his predecessor. I thank you, M r . Chairman. I thank the subcommittee. M r . G O N Z A L E Z . T h a n k you, M r . Hanna. W e deeply appreciate your keen interest and your strong support and membership on this subcommittee. I t h i n k the members of the subcommittee have had a sense of frustration when events happen and then we have to come i n after the event, and we like to feel t h a t the Members of the Congress w i l l have some direct i n p u t and some immediate responsibility w i t h respect to some of these issues. M r . Bennett, you may proceed as you wish. I thank you once again. I f you have a prepared statement, you can use your option of either reading i t or summarizing i t . A g a i n , I say t h a t we are very grateful f o r you t a k i n g time out, especially r i g h t before you are about to be sworn in. STATEMENT OF HON. JACK OF T H E F. B E N N E T T , UNDER SECRETARY TREASURY M r . B E N N E T T . M r . Chairman and members of the subcommittee, I appreciate your k i n d words of welcome. A s you note, these hearings are particularly opportune f o r me. A t any time i t would be a challengi n g assignment to succeed Paul Volcker. B u t i t has not escaped m y attention any more than i t has escaped yours t h a t conditions i n the foreign exchange and financial markets and i n rates of g r o w t h of prices and production are not entirely satisfactory around the w o r l d today. So i t seems p a r t i c u l a r l y fitting t h a t I be subjected to some cross-examination as I enter i n t o these new duties. B u t I am p a i n f u l l y aware 6 t h a t the oath w h i c h Secretary Simon w i l l administer to me today w i l l not make me an instant expert i n a l l aspects of economics. I n t r y i n g t o understand our present difficulties, I could perhaps make m y position clear. I tend to t h i n k t h a t p r i m a r y attention should be given t o t w o m a j o r developments over the recent years: F i r s t , the shortfalls and cutbacks i n previously anticipated levels of production of i m p o r t a n t basic raw materials, most i m p o r t a n t l y oil. Second, a widespread tendency f o r governments t o p r i n t more money and more government I O U ' s than were appropriate i n such conditions of supply stringency around the world. I n m y prepared statement this m o r n i n g I propose to concentrate on the first of these developments, and p a r t i c u l a r l y on the impact o f the reduction i n the anticipated levels of o i l production. T h a t impact continues to be large, and our difficulties are exacerbated by the uncert a i n t y as to just how large the cutback w i l l be i n the future. Last September, before the outbreak of f i g h t i n g i n the M i d d l e East, the production o f o i l i n the non-Communist w o r l d was just short of 48 m i l l i o n barrels a day. B y November, certain governments i n the Mideast and A f r i c a had cut production back by about 5 m i l l i o n barrels a day, and this large cutback was n a t u r a l l y followed by a large increase i n prices on new short-term o i l sales. Even now, some of those producing countries are continuing to cut back production f a r below the levels o f last September. B u t elsewhere production has grown, so the total w o r l d production is probably now about at least September's l e v e l — w i t h i n 200,000 or 300,000 barrels a day one way or another. B u t i t is i m p o r t a n t to note t h a t the level o f actual production today s t i l l reflects restraints b y cert a i n governments w h i c h are h o l d i n g total production roughly at 4 m i l l i o n barrels a day below the level which could be produced efficiently w i t h existing capacity i n place. New contract o i l sale prices have fallen f r o m the temporary peaks of early t h i s year, b u t some producers are s t i l l attempting t o charge e x t r a o r d i n a r i l y h i g h prices. I n view o f these h i g h prices, consumers both i n the U n i t e d States and abroad have continued to h o l d t h e i r consumption well below the levels predicted earlier, and i n fact, below the levels o f a year ago. O n a worldwide basis consumption has been less t h a n production f o r some time. Inventories have been b u i l d i n g u p and are now approaching the spillover point. U n d e r these circumstances, o i l prices today are clearly under strong pressure t o decline f u r t h e r on international markets, though not on the b u l k o f U.S. production, which remains under severe price control. Y e t there are those i n the producing countries who are u r g i n g their governments to make sharp new cutbacks i n production i n order t o t r y t o m a i n t a i n today's h i g h o i l prices, or even to t r v t o increase them again. T h e producing governments are being urged to raise prices on t h a t p o r t i o n of the o i l production being sold directly b y the governments and to renege on long-term contracts t o make some o i l available on the basis o f agreed specified payments o f royalties and taxes t o the governments. I n m y view, any new cutbacks i n o i l production b y anv government at this time should clearly be regarded by the U n i t e d States and b y a l l other consuming countries, both more developed and less developed, 7 as a counterproductive measure. Moreover, even apart f r o m the p o l i t i cal and security implications f o r the producers, I am convinced t h a t any such cutbacks w o u l d t u r n out to be economically h a r m f u l t o the producers f o r t w o reasons. I n the first place, the price effects o f such cutbacks w o u l d inevitably lead to such f u r t h e r intensification o f research and investment relating t o alternative sources of energy and to alternatives t o energy use that the effect would be to reduce the total value w h i c h the exporters would receive f o r their o i l over the l i f e of their producing fields. Cutbacks m i g h t b r i n g a higher price f o r a short period, but they w o u l d b r i n g a more t h a n offsetting reduction i n revenues f o r a long t i m e thereafter—in view of the importers' increased commitment t o alternatives. I n the second place, maintenance o f present costs o f export o i l — even w i t h no increases—would threaten severe economic and i n some cases political damage to a large number of consuming countries t o an extent which could not help but cause damaging backlash t o the producers as well. T h e damage to consuming countries i n the first instance w o u l d be simple but real—the result of an increase i n the costs o f t h e i r o i l imports f a r greater t h a n the increase i n the prices of t h e i r exports. I n this regard, I realize t h a t some officials of oil-producing countries have attempted t o j u s t i f y f u r t h e r o i l price increases by reference t o increases i n the prices of goods imported into those countries. P r o v i d i n g the producers w i t h this argument has undoubtedly been one additional damage we i n the developed nations have inflicted on ourselves by our miserable performance i n relation t o inflation. B u t we should not lose our sense of proportion. Since 1970, f o r example, the new contract F O B export dollar price of Saudi A r a b i a n l i g h t crude has increased approximately 730 percent, whereas the average cost o f imported goods and services i n t o the producing countries has increased only about 70 percent over the same period. Clearly, the increase i n o i l prices has been about 10 times as large. O n a similar calculation, the oil price increase has been about seven times as large f r o m 1960 to the present. T h i s large and sudden adverse change i n their terms of trade finds different nations w i t h widely v a r y i n g capabilities t o adapt. F o r most i m p o r t i n g nations, including the U n i t e d States, the impact is reducing our standard o f l i v i n g and is reducing our rate of economic growth, but our lives and our institutions are not seriously threatened. I n a number of other nations, however, nations whose standards o f l i v i n g were already at the literal m a r g i n and whose hopes f o r economic advancement were f r a g i l e i n any case, the sudden increase i n the cost of oil and consequently of fertilizer as well could be catastrophic unless there is emergency assistance. Even i n some countries whose standards of l i v i n g are f a r above the subsistence level the new prices could, i n the absence o f farsighted international cooperation, threaten the collapse of existing institutions. Such severe damage to the consuming countries would create a backlash on the producers—apart f r o m political dangers—through underm i n i n g the economies t o which the o i l producers must export i f they are t o derive the m a x i m u m value f r o m their l i m i t e d resources; and t h r o u g h undermining the economies i n which the o i l producers must 8 temporarily invest i f they are to sell their o i l at the most r e w a r d i n g time and spend the proceeds on equipment and services f o r t h e i r own diversified development at the optimal, nonwasteful pace. M r . Chairman, you w i l l observe that, i n discussing these implications o f actual ancl potential o i l production cutbacks, I have stressed the u n d e r l y i n g and real economic effects. I do this because I t h i n k they are serious, because I t h i n k the w o r l d should be aware of the contrast between the deliberate cutbacks by some o i l producers on the one hand, and the determined efforts being made, on the other hand, by the U n i t e d States and other nations t o increase t o the m a x i m u m t h e i r production o f agricultural and other commodities to supply w o r l d markets. W h i l e I stress these basic effects, I do not wish t o ignore the impacts of the o i l cutbacks on the financial institutions and arrangements of the free w o r l d . The indirect effects have been serious and well publicized f o r a small number of banks, f o r example. Yet, i n m y judgment, our financial institutions and international monetary arrangements are not l i k e l y t o be basically threatened by these developments i n the commodity field. Current problems are real f o r some individuals, f o r {>articular companies, and f o r entire countries, b u t they are the probems o f reduced supply o f goods; they are not l i k e l y to be intensified by f a i l u r e of our instruments o f financial cooperation. Neither do I feel t h a t current developments pose a serious threat of w o r l d depression. Those who concentrate their w o r r y i n g today on the possibility o f w o r l d depression have brought t o my m i n d the picture of a m a n immobilized i n the face of a charging b u l l by the fear t h a t i f he t r i e d t o escape the animal by j u m p i n g sideways he m i g h t possibly brush u p against an unseen rattlesnake. Certainly, rattlesnakes—and also inadequate demand f o r our economic production—are always conceivable dangers; but, r i g h t now, the clear and present danger before us is not inadequate demand, but f a r too much monetary demand faci n g existing capacity t o produce. E f f o r t s t o d r a w a parallel between today's circumstances and the early 1930's seem to me farfetched. The problem then was too l i t t l e demand facing large amounts of unused capacity. T h e developments i n the commodity markets have resulted i n large changes i n previous patterns o f financial flows. Consumers a n d consuming nations are choosing to borrow a l o t more t h a n before i n order t o ease t h e i r t r a n s i t i o n t o a w o r l d of higher cost energy. Some of the o i l producers are choosing t o export a large p a r t of t h e i r o i l i n exchange f o r I O U ' s f r o m the consuming countries. There have been various estimates t h a t the oil-producing countries i n combination w i l l increase t h e i r investments abroad by $50 b i l l i o n to $60 b i l l i o n d u r i n g this year. I do not place confidence i n any precise estimate, f o r i t is now unclear, not only what the price of o i l w i l l be d u r i n g the rest of this year, b u t even what i t was f o r the first h a l f of this year, since various negotiations on this subject are s t i l l underway. Furthermore, at any particular price, i t is unclear how much o i l any particular i n d i v i d u a l consuming country w i l l choose t o buy, t o what extent i t w i l l choose t o r u n current account deficits by l i g h t e n i n g its current economic burdens t h r o u g h b o r r o w i n g and burdening its f u t u r e w i t h repayment obligations. I t a l y and France, f o r example, have re- 9 cently taken forceful domestic measures t o reduce t h e i r o i l consumpt i o n and their reliance on o i l imports, and many other nations w i l l probably take steps i n the same direction. Forecasts of the rate o f f u r t h e r accumulation o f foreign investments by the oil-producing countries i n f u t u r e years are even more tenuous. M y o w n expectation, however, is t h a t the rate w i l l decline each year, not only because o f the lower o i l prices w h i c h I anticipate, but also because over t i m e the development plans o f the producers w i l l have progressed so t h a t they are using u p increasing proportions of current revenues. I t has been estimated t h a t this year o i l exporters w i l l be spending around 40 percent o f t h e i r receipts f o r current i m p o r t s ; I would expect this percentage to be much larger i n f u t u r e years—and ultimately, i t w i l l exceed 100 percent. Meanwhile, however, the o i l producers have been accumulating what, by any standards, are large investments. B y now, they quite probably exceed $30 b i l l i o n ; and m the early months o f this year the accretions were being largely placed i n short-term bank deposits concentrated i n the foreign branches and foreign currency accounts which comprise the so-called Euromarket. This concentration had begun to raise questions about capital adequacy i n the banks and about their vulnerability t o sudden large withdrawals. More recently, strong counterpressures have begun to exert themselves. T h e banks have begun to reject additional short-term deposits and t o insist on terms more i n line w i t h the relending opportunities available t o them. The oil-producing countries, themselves, and other depositors, have become more careful to insure they were not r i s k i n g their funds i n institutions w i t h an adequate capital base. There has accordingly been increased interest i n investing i n U.S. Treasury securities and i n other longer term securities, i n c l u d i n g U.S. corporate equities. Secretary Simon and I hope t o discuss these possibilities f u r t h e r d u r i n g our t r i p to the Mideast starting Thursday. I suspect the time may also be coming when there w i l l be increased interest both by foreign and b y domestic investors i n offering new equity f o r selected private banks. W i t h the expanded b a n k i n g business t o be had, there w i l l be those who wish to take advantage of the profitable investment opportunities which should exist. Obviously, new equity is the answer i f banks have more business t h a n they can handle w i t h their existing equity base. Secretary Simon, i n his recent speech to the International Monetary Conference i n W i l l i a m s b u r g , also recognized a governmental responsibility i n this area. W h i l e n o t i n g t h a t : Governmental regulation and emergency facilities can never substitute for prudent financial management, he nonetheless emphasized t h a t : I n the United States, it is clear that the authorities do have a responsibility to supervise U.S. banks in both their domestic and international operations, and a major part of that responsibility is to insure that they are in a sound position to meet their total liabilities. A l l of this recent attention to possible massive w i t h d r a w a l of funds should not lead anyone to conclude t h a t the oil-producing countries have been s h i f t i n g t h e i r funds about i n a volatile manner. I n fact, their officials have shown themselves to be very conservative investment managers, well aware of the loss i n the value of t h e i r investments 10 w h i c h would result f r o m any sudden effort t o unload a large amount of t h e i r securities on a capital market or to transfer a large amount of t h e i r funds f r o m one currency t o another. M r . H a n n a described, I thought, quite clearly the current trends of t h e i r t h i n k i n g i n this respect. I n relation t o the foreign exchange markets, the situation must be monitored carefully, b u t i t should be recognized t h a t any instability w h i c h may be caused by the large holdings of the o i l producers are l i k e l y t o nave arisen not f r o m sudden shifts o f these funds f r o m one investment t o another but rather f r o m swings i n market expectations as t o where t h e i r new accretions o f funds would ultimately be invested. I n view of the uncertainty on this subject, i t is fortunate t h a t before the question arose there had already been so much progress t o w a r d greater flexibility i n our international monetary arrangements. I n this period o f change i n trade and investment patterns, and i n the presence of widely d i f f e r i n g rates of inflation i n different countries, an attempt to m a i n t a i n a framework of r i g i d exchange rates w o u l d probably have led, i n practice, to explosive instability. There would have been substantial changes i n exchange rates since the u p w a r d spurt of o i l prices began last October. Y e t , these have been handled w i t h o u t serious int e r r u p t i o n to the world's trade and investment transactions. A small number o f banks d i d get i n t o trouble i n their foreign exchange deali n g d u r i n g t h i s period, b u t t h e i r difficulties seem to have been focused i n f a u l t y internal procedures and i n involvement i n foreign exchange speculation out of p r o p o r t i o n to the size o f the institutions. Regrettable as t h e i r experience was, i t probably has had the salutary effect of b r i n g i n g other institutions t o examine their foreign exchange practices more carefully. The recent Lochouse-Herstatt case i n Germany, i n particular, is leading banks t o consider whether changes are desirable i n interbank clearing procedures to reduce unintended r i s k exposure i n what were intended to be essentially riskless simultaneous exchange transactions. I n recent weeks, the U n i t e d States and other governments have also given consideration t o the possibility o f setting u p a new intergovernmental agency w h i c h w o u l d be designed t o borrow large amounts of money f r o m the o i l producers on commercial terms and then to relend those funds i n other countries again on commercial terms. T h a t type of agency remains a possibility, i f i t should be needed, but at the moment the consensus—which I t h i n k is wise—is t h a t i t w o u l d be better t o rely basically on the many different channels provided b y existing institutions f o r h a n d l i n g the large, new investment flows among nations. Governments, nonetheless, have an i m p o r t a n t supportive role. I n the U n i t e d States, we recognized t h a t earlier this year by removing the controls on the outflow o f capital f r o m the bilateral swap agreements b y w h i c h governments stand ready t o help each other i n case of shortr u n exchange market disturbances. W e and other governments recognized i t b y a wide range o f cooperative international initiatives. A t the recent final meeting of the " C - 2 0 " M i n i s t e r i a l Committee, there was a renewed dedication t o international monetary cooperation and agreement on a new pledge t o avoid restrictive trade measures f o r balance o f payments purposes. A new f a c i l i t y was created i n the I M F t o 11 provide 4- to 7-year credit assistance t o a i d nations i n adjusting to higher o i l prices, and there was agreement t h a t i n some cases— t h r o u g h a so-called extended F u n d f a c i l i t y — t h e I M F should be able i n special cases t o provide credit o f longer m a t u r i t y to less-developed countries undergoing major structural changes. There is also an understanding t h a t governments i n need may sell some p o r t i o n of their gold holdings i n t o private markets or use t h e i r gold as collateral f o r borrowing. A l l these actions were constructive responses w h i c h have strengthened our international monetary system. B u t we must recognize that f o r a small number o f particularly h a r d h i t countries these measures are not l i k e l y t o be enough. I am sure t h a t J i m G r a n t w i l l later this m o r n i n g be f a r more eloquent t h a t I can be on the prospective p l i g h t o f those countries whose standards of l i f e were already abysmally low and now have the distinction of being the "most seriously affected" by the new o i l prices. These are among the countries w h i c h have reason to be g r a t e f u l to you on this subcommittee f o r securing passage o f the I D A authorization a few days ago. Yet, those funds were intentionally clearly earmarked to be used on specific long-range development p r o j ects t o raise t h e i r people f r o m the sink o f poverty. Those I D A iunds w i l l not be, and should not be, available to help pay any o f the tremendous increase i n the costs of o i l and fertilizer f o r the immediate use of t h e i r s t r u g g l i n g economies. F o r this purpose, these^ countries w i l l be pleading, before this year is over, f o r some nonproject funds on a concessional basis. There is no likelihood, however, t h a t such funds could be repaid w i t h i n a few years; they w i l l have to be on a long-term, low-interest basis. I n most cases, the lack o f these funds is probably not a matter of l i f e and death this week, but that time is probably not many months away. The total sums i n question f o r this year are not immense. I doubt t h a t i t w i l l ultimately be decided t h a t a large amount is appropriate i n this calendar year f r o m a l l sources i n new forms of aid above those t r a d i t i o n a l forms of aid already scheduled. S t i l l , there is an organizational urgency i n reaching a consensus on some analysis o f the factual situation i n these countries and i n insuring t h a t there is an adequate response f r o m those countries of the w o r l d who are i n a more-favored position. Some of the oil-producing countries have begun t o respond w i t h isolated bilateral arrangements. There have also been appeals f o r funds b y the U , N . and there have been discussions of various possible j o i n t initiatives by some of the o i l exporters, as M r . H a n n a mentioned, but l i t t l e has actually been committed at this time specifically to alleviate the near-term distress of the "most seriously affected." The oil producers have agreed to purchase additional amounts of W o r l d B a n k bonds and to lend about $3 b i l l i o n t o the I M F , but these investments are at approximately market terms and they are effect i v e l y guaranteed as to repayment b y the major developed nations, inc l u d i n g the U n i t e d States. They do not represent provision o f the concessional funds appropriate f o r the "most seriously affected." F o r them, the rescue operation, i n large p a r t , remains to be organized. F o r this purpose, i t may well be t h a t no new financial institut i o n is needed; but there must be a group which is charged w i t h being 12 sure the job gets done. F o r t h i s purpose, I am placing great hope on the new ministerial development council t o be set u p along the C-20 lines, i n accordance w i t h a decision taken by the ministers when they were i n Washington last month f o r the final C-20 meeting. I certainly hope t h a t this new g r o u p representing o i l producers and o i l consumers, both developed and less developed, w i l l be small enough to f u n c t i o n effectively and w i l l have the competence and the conscience f o r the job. T h e problems which t h a t new council w i l l face and the problems w h i c h a l l of us face w i t h the new o i l prices are real. T h e appropriate remedy is t o lower those prices. Meanwhile, we must cooperate internationally t o mitigate the real problems as much as we can. I f we continue t h a t cooperation, i f we stay alert, those real problems w i l l not be made worse b y any freezing u p of the world's financial mechanisms. T h a n k you, M r . Chairman. M r . G O N Z A L E Z . T h a n k you, M r . Bennett, very much. I f i t is O K w i t h the members of the subcommittee, I w o u l d suggest t h a t we proceed to hear M r . G r a n t , and then we can direct questions to both gentlemen at the time we reach the questioning period. I f there is no objection, we w i l l proceed t h a t way. M r . Grant, thank you very much f o r being w i t h us this morning, and w i t h o u t any f u r t h e r ado I recognize you t o proceed as you see best. I notice you have circulated your prepared text. I f you wish t o read i t t h a t is fine. I f you wish to summarize i t , t h a t is fine, too. STATEMENT OF JAMES P. GRANT, PRESIDENT, OVERSEAS DEVELOPMENT COUNCIL M r . G R A N T . M r . Chairman, i t is a great privilege to be w i t h you here today and w i t h the members o f this subcommittee, and I w i l l take you u p on y o u r offer o f inserting the f u l l statement i n the record i f I may and then proceed to summarize i t . M r . G O N Z A L E Z . W i t h o u t objection, we w i l l enter y o u r prepared statement i n t o the record. M r . G R A N T . A S we consider today the impact of the petrodollar crisis on the w o r l d and p a r t i c u l a r l y on developing countries and our policies t o w a r d them, i t is i m p o r t a n t t h a t we recognize t h a t this crisis is occurr i n g i n a much broader context of a newly emerging international economic and political order. T h e crisis is a result of the very r a p i d g r o w t h of the past 25 years. T h i s is a s h i f t t h a t was symbolized w e l l before the o i l crisis by the soaring food prices t h a t we saw i n early 1973. A s you may remember this led t o a soybean embargo by the U n i t e d States and led to a fertilizer embargo on new export sales i n October t h a t has been i n effect u n t i l very recently. O i l prices soared f o u r f o l d resulting i n the embargo, and a series of other shortages— fertilizer, cotton, and rubber. T h i s basic set of scarcities results f r o m t w o factors. O n the one hand are short term and cyclical factors—the unprecedented, simultaneous boom of a l l o f the i n d u s t r i a l countries o f the early 1970's; the unprecedented drought t h a t went t h r o u g h Russia, I n d i a , Sahelian A f r i c a , and other parts of the w o r l d i n 1972 and 1973; the war i n the M i d d l e E a s t ; and the inadequate use of w o r l d i n f orma- 13 tion systems, w i t h the result t h a t we paid nearly $2 b i l l i o n to our f a r m ers not t o produce food i n fiscal year 1973 at a time when the Russians were depleting the w o r l d global food stocks. B u t even more fundamental i n our opinion are some long t e r m secular trends which indicate that this is not just another peaking of prices as we saw after W o r l d W a r I I — t h i s really is the tremendous increase i n demand. The gross global product of the w o r l d i n the late 1940's was about $1 t r i l l i o n . This year i t w i l l be about $4 t r i l l i o n . I n constant dollars i t is roughly a threefold increase i n global demand i n 25 years. W h e n we began t o move into the t h i r d t r i l l i o n of demand, we began to see system overloads emerging at every corner i n the late 1960's. W e could see i t ecologically when there was the problem of pollution i n the cities, and i t began t o reach unmanageable proportions ; the problem of purification of the lakes; and i n the last 2 or 3 years we have seen the overharvesting of the w o r l d fish catch, which after t r i p l i n g i n 25 years has declined the last three. W e have seen i t i n the ever-tightening food situation. Despite the world's largest crops i n history last year, w o r l d food reserves actually went down again. The w o r l d food system is h a v i n g trouble staying up w i t h an increasing demand, which is double that of 20 years ago. W e have seen i t i n the s h i f t f r o m buyers' t o sellers' markets f o r goods t h a t are not i n physically scarce supply but have become sufficiently t i g h t t h a t the sellers have become dominant—oil, coffee, and other commodities. T h a t this is p a r t of a long term trend was brought out by the fact t h a t the W o r l d B a n k was estimating that the o i l prices o f $8 a barrel we saw last f a l l and winter, would come i n due course i n the 1980's. They were brought u p much sharper as a result o f these short term cyclical trends. Basically this increase f r o m demand results f r o m t w o long-term circumstances t h a t w i l l probably be w i t h us f o r some time. One is the population increase which is double what i t was 20 years ago, an increase of 2 percent a year. Second, affluence around the w o r l d has increased about 3 percent a year f o r the last 7 or 8 years. T h i s is double the rate of increase of affluence that we had 20 years ago. These two forces together have been the basic surge behind increasing demand. F o r some commodities, such as food, 70 percent o f the increase i n demand comes f r o m population increase, only 30 percent f r o m increase i n affluence. F o r other goods l i k e oil the soaring increase i n demand has come p r i m a r i l y f r o m affluence and only secondarily f r o m populat i o n increase. A s we move closer to the $10 t r i l l i o n gross global product that is projected f o r the end of this century, w i t h each t r i l l i o n coming i n ever-shorter time periods, I t h i n k we can predict a series of consequences f r o m t h i s : Competition f o r l i m i t e d resources w i l l become considerably more intense, and there w i l l be more and more of a linkage effect when there is a shortage i n one area. As we have seen recently, the shortage of energy leads to a shortage of f e r t i l i z e r ; the shortage of fertilizer leads t o a shortage of food. The "quick f i x " and product substitution w i l l be much more difficult i n the next 25 years than i n the last 25 years. A n d finally, as we w i l l see, there w i l l be a sis^iificant s h i f t i n economic as 37-211 O - 74 - 2 14 well as political power to the raw material suppliers of the w o r l d away f r o m the processors. W h a t this means as we consider the petrodollar crisis and what to do about the current issues, is t h a t we need t o look at this crisis i n the broad framework and t h a t we need a whole new set of rules, institutions and approaches t o our problems i n the next 25 years. I t is clear, f o r example, t h a t the whole issue o f access t o supplies w i l l become as important i n the next 25 years as the key issue o f access to markets was i n the last 25. I n other words, i n the last 25 years the things t h a t concerned the G A T T , the U N C T A D , the T r a d e R e f o r m A c t of 1973, the Kennedy Round of negotiations, were a l l access t o markets, and now we have a new set of problems, access t o supplies— oil, fertilizer, food. Second, i t is very clear t h a t there w i l l need to be increased global efforts and machinery t o increase production of goods t h a t become i n t i g h t supply, whether i n oil, as was indicated by M r . Bennett, where we need t o somehow cope w i t h the restraints more effectively, or i n food, where there is need f o r a global effort to increase the supply. F i n a l l y , i t is clear t h a t we need t o begin t o t h i n k o f ways of reducing demand i n certain areas. W e have seen i t most notably i n the area of the use of energy i n t h i s country. B u t clearly, there is a global shortage of fertilizer l y i n g ahead. G r a i n farmers i n many parts of the w o r l d cannot get even h a l f of the fertilizer they got last year, w h i l e other parts of the w o r l d are s t i l l using indiscriminate amounts f o r lawns and other purposes. A l l o f these trends t o w a r d a new w o r l d o f t i g h t supply were w e l l along when the energy shock came i n the f a l l , and were f a r t h e r along when the second shock came on December 22d w i t h the additional sudden doubling of prices. T h i s has dramatized these trends very sharply and has accelerated f o u r m a j o r trends w h i c h I w o u l d l i k e t o discuss: One is the energy price shock on developing countries; second, the worsening w o r l d food problem; t h i r d , its aggravation of the global recession; and f o u r t h , its acceleration of the power s h i f t away f r o m some o f the major manufacturing, i n d u s t r i a l countries, l i k e the E E C and Japan and the populous countries l i k e I n d i a , t o w a r d the O P E C countries and the N o r t h American raw material-rich as well as i n d u s t r i a l powers. T u r n i n g first to the energy shock dislocations f o r the developing countries, as the chairman mentioned i n his introductory comments, the f o u r f o l d o i l price increase added $10 b i l l i o n to the i m p o r t b i l l of these countries. The aggravation of these increases was compounded as a result of the fact t h a t i n the preceding year the prices o f other goods t h a t these developing countries had t o i m p o r t f r o m the indust r i a l countries had already risen substantially. They already faced a $5 b i l l i o n increase i n their i m p o r t bills f o r food and fertilizers before this $10 b i l l i o n overload was added, f o r a total of about $15 billion. O n t o p o f this increased i m p o r t b i l l they faced the dangers o f an economic slowdown i n the West, which has already affected very substantially the tourism earnings of countries. I n the Caribbean and the Mediterranean, the flow of workers f r o m many developing countries 15 to the European countries, and the prices of some but not many raw materials. T h e impact of these price rises has varied very greatly on the developing countries. Obviously, the O P E C countries have benefited greatly, and, while we t h i n k normally of the A r a b nations as the O P E C countries, there are 260 m i l l i o n people i n this aggregation of O P E C countries. A m o n g the n o n - O P E C countries, there are a group of developing countries t h a t are net beneficiaries of the changes of the last 2 years. These are those countries which are minor o i l exporters, like Tunisia and Bolivia. There are other countries such as Malaysia that w i l l be beneficiaries of major price rises i n the products they sell and they are largely self-sufficient i n oil. There is a whole group of countries, i n c l u d i n g most of those i n L a t i n America, which are not too badly h u r t i n a fundamental sense by the changes of the last couple of years. They should be able t o ride out the difficulties assuming there is no major global recession, continuation of the I M F o i l f a c i l i t y over a several year period, continued access t o Eurodollar markets—this is a new feature f o r many developing countries, the access to the Eurodollar markets—and finally, continued access to supplier credits. There is no question but that a suspension of activities by the E x p o r t - I m p o r t B a n k would create a whole new set of crises f o r the Brazils, the Mexicos, the Colombias, this category of developing countries. A n d finally, this assumes an expansion o f W o r l d B a n k lending t o these countries on its regular terms. There is another category of countries which fits somewhat this same category. T h i s category includes the industrial developing countries— Korea, Taiwan, H o n g K o n g , and Singapore. These countries have a tremendous immediate adverse impact. Korea, f o r example, has to pay an extra b i l l i o n dollars f o r o i l and food. B u t these are flow-through economies t h a t can pass on the prices i n the goods they export, so there again, i f they can have a short term f a c i l i t y , i t should tide them over. T h i s leads us t o the hardest h i t countries, w h i c h Secretary Bennett was describing as the most severely affected. W e at the Overseas Development Council call them the newly emerging f o u r t h w o r l d of some 30 to 40 of the poorest, slowest moving countries. These countries have been h i t b y both very large rises i n the price they have t o pay f o r o i l and f o r food, while getting no comparable offsetting increases i n the price o f the goods they sell. F o r these countries, as Jack Bennett brought out, there is need f o r a substantial amount of emergency assistance to tide them over the short run, t o keep them f r o m going under d u r i n g the next 3 to 4 years. They w i l l need some $3 b i l l i o n a year t o keep f r o m going under over the next several years, a n d these are countries t h a t really cannot have access to the Eurodollar market. The I M F special f a c i l i t y rates are too h i g h f o r them t o borrow any large continued amounts. The suppliers' credits are not available to them since the Eximbanks of the w o r l d do not lend to these countries. These countries, however, need more than the short t e r m emergency assistance o f $3 b i l l i o n a year. They also need additional assistance t o get their economies back on sufficient keel so t h a t they are not so dependent upon food and energy imports f r o m the outside, and this w i l l require another b i l l i o n to $2 b i l l i o n a year. 16 The prospects of these countries are not at a l l hopeless. I f one takes I n d i a , f o r example, i t has a great potential f o r increasing food production at low cost. L i k e the U n i t e d States, i t has great reserves of coal. B u t these countries have a particular capital problem which is t h a t they pay out additional money f o r o i l and f o r food, and the O P E C countries which have a money surplus have no incentive t o lend i t back t o them at the current time. Whereas i n the U n i t e d States we pay out increased amounts f o r o i l and the O P E C countries take the capital surpluses and reinvest them i n the Western countries. W e have a problem between us, but the capital comes back to the West. T h i s is not t r u e f o r the poorest developing countries. T h i s immediate o i l crisis is coming i n conjunction w i t h a very serious worsening w o r l d food situation. I t has been apparent f o r some t i m e t h a t there is a basic change i n the w o r l d food situation f r o m the surplus state of the 1950's and the 1960's t o an era of t i g h t demand. W o r l d food reserves have gone down f r o m a supply of some 69 days i n 1970 t o 36 days a year ago, and 26 days now, and this is despite the world's largest g r a i n yields i n history. I n effect, we are i n a very perilous situation, and, as I said earlier, this is due to the r i s i n g demand f r o m population and f r o m affluence. The increase i n w o r l d demand f o r food 60 years ago was 3 or 4 m i l l i o n tons a year. Then i n the mid-1950's, i t went up to 15 m i l l i o n tons a year. Now i t is over 30 m i l l i o n tons a year. T h i s increase is coming at a time when the response capacity o f the w o r l d to increase food is slowing. I d l e land is no longer available, water is scarcer, and the benefits f r o m the use o f fertilizer are declining. W h e n the first 40 pounds of fertilizer is put on an acre of corn, the increased y i e l d is something like 27 pounds per acre. B y the time you get t o the t h i r d 40 pounds i t is down to 8 or 9 pounds of increased y i e l d per acre. W e have seen an overharvesting of the world's fish catch, and there has been no technological breakthrough i n either the production of soybeans or beef. So t h a t w h i l e the w o r l d food situation has been tightening, along comes the petrodollar crisis. T h i s has greatly aggravated the problems o f the poorest developing countries, first because of the fact t h a t faced w i t h serious dollar shortages they have cut back on o i l imports, and on imports of spare parts, so their whole^ economies are w o r k i n g more poorly. Second, there is a w o r l d fertilizer shortage o f 2 or 3 m i l l i o n tons a year t h a t w i l l continue t h r o u g h at least the next 3 o r 4 years, and the way the w o r l d system is w o r k i n g the developing countries are b y f a r the worst h i t f r o m this. Japan and Western Europe have both cut back on t h e i r f e r t i l i z e r exports. So has the U n i t e d States. W e have had an embargo on new export sales f r o m October through June 30, and the F E O now estimates t h a t the developing countries w i l l have a s h o r t f a l l o f about 2 m i l l i o n tons o f fertilizer nutrients i n the coming crop year. T h i s means t h a t they w i l l lose the production o f 16 t o 20 m i l l i o n tons o f food, food w h i c h w i l l now cost them some $4 b i l l i o n t o i m p o r t i n place of producing themselves. W e can see the impact of this on I n d i a , f o r example. C u r r e n t l y , I n d i a is r o u g h l y a m i l l i o n tons short on fertilizer over what she was prepared to b u y and was unable t o get because o f contract cancellations, slow 17 supply f r o m the U n i t e d States and elsewhere. T h e I n d i a n wheat crop harvested this M a y , o r i g i n a l l y estimated to be at 30 m i l l i o n tons, was finally harvested at 22 m i l l i o n tons. The main reason f o r the shortfall was the shortage of fertilizer, b u t also contributing was the shortage of oil, which i n one province alone led t o a shortfall, according t o the U S D A , of about a m i l l i o n tons. W h i l e we were w a i t i n g i n our cars f o r an hour at gas stations t o get gasoline i n February and March, Norman Barlaug, the Nobel Peace Prize winner i n the food area, was reporting t h a t i n the Punjab, f o r example, people had been w a i t i n g f o r 2 days at r u r a l gas stations, l i t t l e farmers w i t h their 5-gallon tins w a i t i n g to get o i l to r u n their i r r i g a tion pumps w i t h o u t which they could not grow their wheat. The impact of the o i l shortage was much worse, i t seems to me, on those countries than here. So, i t is quite clear now t h a t at best the g r a i n crop i n Asia this year w i l l be m i d d l i n g ; t h a t Asia w i l l need to i m p o r t more g r a i n i n the year ahead t h a n any region i n the w o r l d has ever imported i n its hist o r y and that the prospects of disaster are s t i l l very close. Last year China imported as much g r a i n as I n d i a d i d at the height of the famine. The i n i t i a l reports are that weather i n China is poor again this year. F o r I n d i a , as I have t o l d you, the wheat crop is way down this spring. T h e main crops, however, come this f a l l , dependent on the monsoon. A s of the weather reports a week ago, the monsoon was several weeks late i n h i t t i n g most of I n d i a . So, there is a significant prospect of tremendous demand f r o m these countries, f o r food next year. T h i s is coming at a time when I t h i n k we can say t h a t the U n i t e d States no longer has even a semblance of a global food policy other than to maximize the profits resulting f r o m the export of food. Secretary Kissinger has taken a commendable i n i t i a t i v e i n u r g i n g a W o r l d Food Conference, but specific action is now needed. U.S. food aid i n fiscal year 1974, just past, dropped t o 40 percent of fiscal year 1972—a year i n which we earned an extra $7 b i l l i o n f r o m our food exports, i n c l u d i n g more than $6 b i l l i o n f r o m the higher prices received f o r g r a i n we sold. Fiscal year 1974 has also been characterized by the fact t h a t f o r most of that year, the U.S. Government had an embargo on fertilizer sales, which p r i m a r i l y affected the developing countries. I t is very clear that a new food policy is needed, not only t o affect the lives of millions of people i n these F o u r t h W o r l d countries t h a t are so badly h i t by the petrodollar and food crisis, but also, i f we are ever t o cope w i t h the 2-digit inflation t h a t we have. I n the next 10 years the w o r l d w i l l have to grow or increase its food production by some 400 m i l l i o n tons, f r o m the present level of 1.2 billion, t o 1.6 billion. I f we have t o increase most of this production i n the developed countries, i t can only be done by going t o much higher priced land, and much higher priced use of inputs because of declining yields f r o m more and more fertilizer, and f r o m a higher cost of water. The p r i n cipal source of low cost production f o r the w o r l d i n the next 10 years is i n the developing countries. A responsible expert has estimated t h a t the amount of fertilizer needed t o get the next 100 m i l l i o n tons of food out of the developed countries would be 24 m i l l i o n tons of fertilizer. O n the other hand, to get 100 m i l l i o n tons of increased production i n 18 developing countries, w o u l d take only 10 m i l l i o n tons of fertilizer. I n other words, the comparative advantage is very clearly i n terms o f increasing production i n developing countries. B u t meanwhile, what has happened is t h a t the Japanese and the U n i t e d States have restricted fertilizer exports, so they would be p r i m a r i l y used on the least efficient sources i n the developed countries as a whole. A t the same time, there has been no appeal to the American people t o cut back on the use of fertilizer f o r n o n f a r m uses. A t a t i m e when the developing countries face a 2 m i l l i o n t o n fertilizer shortage t h a t is really critical, the U n i t e d States w i l l use some 3 m i l l i o n tons on lawns, cemeteries, and g o l f courses—fertilizer which is desperately needed by American farmers t o produce food at a time of w o r l d food shortage. A s I mentioned earlier, the o i l crisis has also greatly accelerated the power s h i f t . O n the one hand, i t has given the O P E C countries a much larger capital surplus, <and the issue o f what they do w i t h t h e i r capital surplus is now much more acute t h a n the slow accumulation we saw 6 months ago. T h i s creates a real problem w i t h the o i l countries, one I t h i n k warrants the attention of this subcommittee. There really has not been i n m y judgment, an effective dialog on this w i t h the O P E C countries. The focus o f the U.S. Government has been on the commendable objective o f t r y i n g t o reduce the price of o i l ; but the focus has been so heavy on this, t h a t u n t i l really only very recently, has there been serious attention i n a sustained major way by the U.S. Government to how one gets more contributions out of the o i l countries to meet, shall we call i t , damage control requirements. T h i s raises issues which really have not been discussed yet. W h a t is a f a i r share f r o m the O P E C countries? The U n i t e d Nations has a standard f o r assistance of .7 percent Q I G N P . I f we f o l l p w the .7 percent of G N P formula, the U n i t e d States is roughly one-h^lf of that. I t is clear t h a t t h i s would b r i n g out of the O P E C countries less than a b i l l i o n dollars—far less than is needed f o r damage control purposes. O n the other hand, i f , because o f their l i q u i d i t y , they should properly p u t u p a larger amount, the issue then is what is the larger amount and f o r how long. T h i s whole question of really what our f a i r share is, is very much at issue. F i n a l l y , I would say, looking at the elements of a solution, first and foremost is the need t o avoid a global recession. A s I indicate i n m y statement, we are considerably more worried about this, I t h i n k , t h a n Secretary Bennett's statements w o u l d indicate. A s p a r t of this, i t is clear t h a t an o i l price rollback w o u l d be valuable; b u t i n m y j u d g ment, the prospects o f a really m a j o r o i l price rollback are sufficiently slight t h a t we should not allow i t t o completely preoccupy our attent i o n at the expense of other damage control measures. O n the establishment o f recycling facilities, quite clearly^ as I i n d i cated earlier, f o r the advanced developing countries there is the need f o r an expansion o f the present special o i l f a c i l i t y , b u t also a very i m p o r t a n t need t o keep existing channels open—the E u r o d o l l a r , the supplier credit, the W o r l d B a n k channels. F o r the F o u r t h W o r l d , first and foremost, there is the need t o supplement I M F and W o r l d B a n k channels w i t h an emergency assistance of at least $3 b i l l i o n f o r the year t h a t lies ahead. 19 A s y o u know, the U n i t e d Nations Secretary-General has appealed f o r a special emergency fund, and has asked D r . R a u l Prebisch to be his agent i n r o u n d i n g this up. T h e European Economic Community has now volunteered a contribution of $500 m i l l i o n t o w a r d this f u n d i f the t o t a l reached is $3 b i l l i o n and i f the O P E C countries w i l l p u t u p h a l f , or $1.5 billion, of the amount. Canada has indicated a willingness to provide $100 m i l l i o n ; the Netherlands, $30 m i l l i o n . Reports are t h a t Venezuela and I r a n are prepared to provide $100 m i l l i o n each f o r this purpose. The Secretary-General of O P E C has stated, but without any substantiating detail, t h a t the O P E C countries as a whole w i l l provide 1 percent of G N P f o r assistance. A t this moment of time, the U n i t e d States has stated i t w i l l participate i n the f u n d ; but unlike the European Community, the Canadians and the Japanese, we have not indicated yet at what scale we m i g h t participate—at $100 m i l l i o n or a b i l l i o n or $1.4 billion. T h i s is badly overdue. M r . G O N Z A L E Z . M r . Grant, pardon me. I very reluctantly interject at this point the fact that Secretary Bennett is going t o have to leave us soon because he is going t o get sworn i n at about 12:30. I f i t is a l l r i g h t w i t h you, we w i l l insert at this point i n the record y o u r complete prepared statement, and we w i l l recognize members of the subcommittee f o r some brief questions. [ M r . Grant's prepared statement f o l l o w s : ] 20 Statement of James P . Grant* President, Overseas Development Council Submitted to the Subcommittee of the House Banking and Currency Committee on International Finance July 9, 1974 The International Petrodollar Crisis and the Developing Countries . M r . Chairman and Members of the Committee: I welcome this opportunity to testify at your Invitation before the House Banking and Currency Subcommittee on International Finance on the consequences and Implications of the International petrodollar crisis that the world recently has been experiencing and on its implications for the developing countries and for U.S. policies. My comments might be sum- marized briefly as follows: F i r s t , any meaningful assessments must take Into account the fact that although the oil and petrodollar crises took place earlier than anticipated as a result of major short-term factors such as drought and w a r , they nevertheless are primarily a consequence of the unparalleled economic growth of the past quarter century within the constraints of a largely finite physical system and of relatively inflexible political and economic structures. This long-term trend is shifting economic and political power toward commodity suppliers and creating a new International economic and political order; It requires the development of new International systems, structures, and rules. •The views expressed In this statement are those of the Individual, and do not necessarily represent those of the Overseas Development Council, or of its directors, officers, or staff. 21 - 2 - Second, better means must be found for recycling funds in adequate amounts from the foreign exchange surplus nations (notably the OPEC countries, the United States, Canada, Germany) to the most seriously injured industrial and developing nations. a. For those currently able to pay commercial rates, such as Italy and Korea, the Eurodollar market may serve this purpose in the short term. Over a several-year period, however, there is need for a greatly expanded version of the "oil facility" recently established by the I M F to assist hard-hit countries meet financial difficulties resulting from recent price increases, and for monetary and trade adjustments to enable the hard-hit countries to increase their earnings f r o m the surplus countries. b. The most severely affected developing countries require special help immediately on highly concessional terms in amounts totaling $4-$5 billion annually if they are not to go under and if they are to gradually regain their economic stability and growth. In addition to pressuring the richer, capital-surplus OPEC countries! for major contributions toward meeting these needs, the United States, whose higher food prices and fertilizer export restrictions are also a significant contributing cause of the current disastrous predicament of these poorest nations, should respond affirmatively to Secretary General Waldheim's appeal for emergency assistance by providing at least $1.25 billion of additional assistance. This can be in the form of food as recommended in House Resolution 1155, as w.ell as by making 22 -3available additional assistance for food production and r u r a l development, in response to President Nixon's request for an increased authorization under the Foreign Assistance Act for FY 1975. The Newly Emerging International Order The emergence of the new international order was symbolized in 1973 by a growing list of shortages, including fuels, and by jolting price increases and other developments on many different fronts. Food prices soared in the United States (wheat prices alone increased more than threefold) to the utter surprise of most American economists, who had failed to anticipate the acceleration of global interdependence in food. The quadrupling of oil prices by the oil-producing countries and the implementation of an A r a h oil embargo against the most powerful nation--the United States-- were an even greater surprise to many. Soaring prices for soybeans led the world's principal producer, the United States, to embargo their export, creating a major new crisis with Japan and dramatically undermining the major American effort to reduce the protectionist agricultural policies of the European Economic Community. F e r t i l i z e r shortages have led the fertilizer-exporting industrial nations to restrict shipments to the developing countries, leading already to dramatic reductions in some of their crops, with the threat of more to follow. These changes have already brought shifts, many not yet fully perceived, in economic power--and therefore political power--not only among the developed countries, and between developed and developing countries, but also among the developing countries themselves. 23 -4The changes the world has experienced in the past year, have resulted from two quite different sets of circumstances--short-term and cyclical factors on the one hand, and longer-term and more permanent ones on the other. With respect to the short-term circumstances, the early 1970s w i t - nessed an unprecedented business boom caused by the simultaneous expansion of a l l the industrial economies for the first time since World War II. Other major but short-term factors have included unprecedented droughts in the case of food, and the Middle East conflict in the case of oil. I believe, however, that, viewed from the perspective of ten years hence, the shortage crises of the past year—while of course accelerated by such short-term factors—will be seen as essentially the product of major long-term trends: continuing rapid economic growth taking place within the constraints of an often finite physical system and of inflexible political and economic structures. As the global scale of economic'activity has expanded--from roughly $1 trillion in global production in the late 1940s to some $4 trillion in 1974-it has begun to push the global system increasingly to the limits of its adaptive capacity. There was relatively little strain on the world system 25 years ago, but as the world approached the attainment of its third trillion dollars of global production in the late 1960s, signs of stress began to appear in many areas. We began experiencing an ecological overload, ranging from massive environmental pollution in cities everywhere to an over-harvesting of the world catch of table-grade fish, which appears to have led to a decline in the world fish catch oyer the past three years. Global increases in 24 -5population growth (averaging 2 per cent a year) as w e l l as increasing affluence (as measured by a 3 per cent average rise in per capita income a year) have doubled the annual increase in demand for food f r o m some 15 million tons each year in the mid-1950s to 30 million tons now, thereby straining the productive capacity of the world agricultural system. Even in the case of many commodities for which additional productive capacity exists, for example oil and coffee, soaring world demand is bringing about shifts from the buyers' market circumstances of the last 25 years to those of a new sellers' market. It bears remembering that the period since World War I I was characterized largely by material surpluses. The central economic i^sue of the period was producer access to the markets of consuming nations. The international rules developed under the General Agreement on Tariffs and Trade (GA.TT), the Kennedy Round of trade negotiations in the 1960s, the key resolutions by the developing countries at the past three UNCTAD conferences, and the proposed Trade Reform Act of 1973 have a l l taken place or been developed in this context of seeking to safeguard and to increase access to markets. Recent events indicate that an equally important, or even more important, set of issues is taking shape around the question of assuring consuming nations reasonable access to essential resources--such as energy, minerals, grain, fish, and soybeans--and on the associated need to develop global approaches to the new worldwide problems arising f r o m scarcity in the market place. The shift from traditional buyers' markets 25 -6- to global sellers' markets for an ever lengthening list of commodities is bringing a host of profound changes, many of which are still only remotely sensed. Economists and foreign offices (other than those in the OPEC world) have been slow to recognize the fundamental character of the change in progress, a change which in a period of less than 12 months has resulted in energy shortages throughout much.of the world, soaring food prices everywhere, a host of related shortages, and widespread speculation about the possibility of more OPEC-type situations in store ahead. At present the trend has been toward each country looking out for itself--the law of the jungle--rather than toward cooperation with pthers. As a result, many countries are suffering unduly, and the resourcepoor countries are suffering the most. A doubling or trebling of grain prices is for most Americans a bearable inconvenience, but for those in the cities and towns of South Asia or Northeast B r a z i l who have been spending 80 per cent of their income on food, it means more malnutrition and the prospect of an earlier death. As the world moves toward more than a $ 1 0 - t r i l l i o n gross global ..product by the end of the century, one can safely predict that: Competition among countries for the earth's limited resources will, intensify; A. linkage effect w i l l frequently set in, with shortages in one field limiting production elsewhere (as when energy shortages result in f e r t i l i z e r production cutbacks, which, in turn, l i m i t food production); 26 -7Product substitution w i l l become more difficult; Economic and, therefore, political power w i l l continue to shift markedly f r o m buyers to sellers. In retrospect, it can be said that these trends were w e l l advanced by early December 1973. The doubling of oil prices by the O P E C countries on December 22, 1973--which raised oil prices in 1974 to levels most economists had not anticipated until 1980--has introduced a "system overload" which may be beyond the capacity of the international order to absorb without major chaos. It has also accelerated and brought into stark relief other important trends which must now be taken into account. Four trends in particular merit special attention: the economic dislocations resulting f r o m the oil price rises; a worsening world food situation; a deepening of the global recession already in prospect; and major shifts in the economic and political power of nation states. Energy Shock The "energy shock" which many developing countries are experiencing u comes f r o m two quite different factors: (1) the increase in o i l prices, and (2) higher prices for essential food and f e r t i l i z e r f r o m developed countries. I f prices remain at current levels (which are four times those of 1972), the l_/ 1972 A l l oil imports f r o m OPEC (c. i . f . ) $20. 0 billion Developing country oil imports 3 . 7 billion O P E C governmental oil revenues 14. 5 billion (Of which Venezuela's share) 1. 9 billion OPEC current account surplus 1.6 billion 1973 $36. 0 5.2 22. 7 2. 8 6. 1 billion billion billion billion billion 1974 (est. ) $100. 0 billion 15.0 billion 85. 0 billion 10. 0 billion 66.0 billion 27 - 8 - non-oil-exporting developing countries w i l l have to pay $10 billion more for necessary oil Imports in 1974 than in 1973. Moreover, it is likely that most of this money w i l l be "recycled"—in the form of purchases and investments by countries--not into the economies of the hardest- hit jion-oil-exporting couiiLx Les,' but into tfc^i'j >2 developed countries. At the same time, the increased cost of the food and fertilizer impart* A the non-oil-exporting developing countries from the developed countries w i l l exceed $5 billion. With wheat and nitrogenous fertilizer prices more than double those of 1972, the increased import bill of the non-oil-exporting developing countries for these two commodities alone (both imported p r i m a r i l y from the United States) w i l l be over $3. 5 billion. As a consequence of these price rises, the developing countries w i l l need to pay some $15 billion more for essential Imports in 1974. The massive impact of these price increases is indicated by the fact that they are equivalent to nearly five times the total of net U. S. development assistance in 1972, and are almost double the $8 billion of a l l development assistance that the developing countries received from the industrial countries in the same year. Equally important, many developing countries would be further damaged if the present worldwide economic slowdown were allowed to drift into a major global recession, further reducing their export earnings. Those countries which depend heavily on workers' remittances and on revenues from tourism—for example Mexico and the Caribbean countries-would suffer additional harm. Whether a global depression can be avoided 28 -9depends on how the developed countries (notably the United States) react to the new situation. Effects of the Price Increases on Particular Developing Countries Beyond these general effects on a l l of the developing countries, however, the impact of price increases, as already indicated, varies greatly among individual developing countries. The major oil exporters are one category of developing countries which obviously benefits. These countries-- whose combined population of more than one quarter billion is greater than that of North America, the European Community, or Latin A m e r i c a — w i l l be in a greatly improved position to accelerate their economic .growth. However, as shown in Table I attached to this statement, the degree of benefit varies sharply among the countries within this group. Thus Venezuela's increased earnings from oil alone w i l l in 1974 more than triple its total imports of $2.4 billion in 1973. Indonesia, which is an extremely poor country within this category, now benefits only to the extent of $20 per capita from the oil price hikes; but even in this case, the additional oil earnings--in combination with the good prices it is getting for its other raw material exports--will remove foreign exchange as a major constraint on its development effort. It must be noted, however, that increased foreign exchange availability does not remove, although it may alleviate, other major development constraints--the many social problems faced by most oil-exporting countries. 29 -10- Thus in such disparate countries as V e n e z u e l a , N i g e r i a , A l g e r i a , and Indonesia-, the serious unemployment and income m a l d i s t r i b u t i o n p r o b l e m s w h i c h a r c l a r g e l y a consequence of their economic and s o c i a l s t r u c t u r e s and policies have not been solved, and m a y only be eased, by growing a v a i l a b i l i t y of f o r e i g n exchange. D j a k a r t a ' s vast u r b a n slums and its recent r i o t s a r c v i v i d r e m i n d e r s that growing s o c i a l p r o b l e m s can exist side by side w i t h a c c e l e r a t i n g economic growth and i n c r e a s e d f o r e i g n exchange •earnings. Saudi A r a b i a and the P e r s i a n Gulf E m i r a t e s also face m a j o r problems of transition f r o m feudal to m o d e r n structures. These countries, t h e r e f o r e , w i l l need continued technical cooperation in solving their development problems, although they c l e a r l y no longer r e q u i r e any capital financing on highly concessional t e r m s . A second category of developing countries consists of those nonO P E C countries which, on balance, either have not been significantly injured by the p r i c e trends of the past two years or appear to be net beneficiaries because their advantages in other areas w i l l l a r g e l y offset the net effect of the p r i c e changes of 1973 or their balance-of-payments. Some of these coun- t r i e s a r e n e a r l y self-sufficient in oil or a r e m i n o r o i l exporters; some benefit substantially f r o m their exports of other raw m a t e r i a l s whose prices a r e increasing (see Table I I I ) ; and some enjoy both of these advantages. 37-211 O - 74 - 3 30 - l i - y China, Colombia, Mexico, B o l i v i a - - a n d , shortly, P e r u as w e l l - - a r e in the f i r s t sub-group; while M a l a y s i a , Morocco, Z a m b i a , Z a i r e , and p r o bably also B r a z i l belong in the second. Tunisia because of its phosphates and Bolivia because of its tin a r e examples of m i n o r o i l - e x p o r t e r s benefiting under both headings. Mexico and T u n i s i a , however, also belong to a t h i r d c a t e g o r y of c o u n t r i e s - - t h o s e which w i l l suiler d i s p r o p o r t i o n a t e l y f r o m any economic slowdown in the i n d u s t r i a l countries bccause of t h e i r close linkages w i t h the m a j o r i n d u s t r i a l regions of the W e s t . T h e s e a r e nations w h i c h d u r i n g t h e past 15 years have successfully c a p i t a l i z e d on t h e i r p h y s i c a l p r o x i m i t y to the i n d u s t r i a l countries to increase t h e i r earnings f r o m t o u r i s m , r e m i t t a n c e s , and exports of a g r i c u l t u r a l p e r i s h a b l e s . Greece, workers1 Spain, T u r k e y , Yugoslavia, T u n i s i a , and A l g e r i a a r c a m o n g those who have benefited' greatly f r o m their p a r t i c i p a t i o n in W e s t e r n E u r o p e a n economic expansion. Thus in 1973, Yugoslavia and T u r k e y each earned m o r e than 2 / China became a m i n o r o i l e x p o r t e r in September 1973, and i n 1974 is expected to :•<hi.p some.3 m i l l i o n tons, valued at a p p r o x i m a t e l y $200 m i l l i o n . Its o i l exports may increase . g r a d u a l l y - - t o 5 m i l l i o n tons in 1975 o r 1976 - but a r e not oipcetod to increase g r e a t l y in the f o r e s e e a b l e f u t u r e . By the l a t e 1 970s, tho m a j o r expansion that is now under w a y in its p e t r o c h e m i c a l i n d u s t r y is -jxpftetod to r e q u i r e l a r g e amounts of d o m e s t i c oil production. Chi Aft wi.U however, f r o m the. present high g r a i n and f e r t i l i z e r p r i c e s . China r i v a l s QiOia as the w o r l d ' s l a r g e s t f e r t i l i s e r i m p o r t e r , and its g r a i n r i m p o r t s for 1 -7-1--which a r c unusually h i g h - - a r e expected to r e a c h at l e a s t 9 mi.Uion ton:;. In m o r e n o r m a l y e a r s China's grain i m p o r t s have ranged between 4 a no o raUlior; ions. In 197 Z the Chinese paid $345 m i l l i o n f o r t h e i r /;.rain import:; nt-lbo nmch l o w e r p r i c e s then p r e v a i l i n g ; in 1974 t h e i r g r a i n import bill, is expected to be w e l l o v e r $1 b i l l i o n . 31 -12- $1 billion from workers' remittances, and Yugoslavia earned an equivalent amount from tourism as well. Mexico and the Caribbean have been the most conspicuous gainers from proximity to the booming North American market. Mexico's tourism earnings, for example, exceeded $1 billion in 1973. A group of countries that are related to this third category, yet somewhat different, includes countries such as South Korea, Taiwan, Hong Kong, and Singapore. These countries are closely integrated with the world economy but almost entirely through the processing of goods. The energy component of their imports is very large, and they also are substantial food importers. The combined increase of South Korea's oil and food bills in 1974, for example, is likely to approximate $1 billion. These countries clearly are affected adversely by the greatly increased prices of the energy and raw materials they need. However, the crisis period for such countries may well be of relatively short duration, since—provided that there is no major global recession and the market .continues strong--they should be able to pass along much of the extra cost to the buyers of their manufactured exports. An added advantage of these countries is that in recent years, most of them have developed sizable foreign exchange reserves as well as established patterns of access to export credits and to the Wall Street and Eurodollar markets. Because of the inherent strength of their ties to the industrial economies, the problems of this third category of countries and its special sub-group in adapting to the new price structure should not prove impossible 32 -13unless the slowdown in the industrial countries is serious and long-lasting. In 1974 and 1975, many of these countries w i l l need access to funds of a type which should be relatively easy for the international economic community to provide if the Western nations wish to accommodate the needs of these countries. Many of the measures developed for assisting the OECD countries to adjust to the higher oil prices should be applicable to these countries as well. It also should be possible to ensure their continuous access to the 3/ Euro-currency markets and export credits despite their s h o r t - t e r m difficulties. The fourth category of countries consists of the hard core of seriously affected countries, totaling about forty in number. Most of these countries a r e in tropical A f r i c a , South A s i a , and the Central A m e r i c a n - C a r i b b e a n a r e a , but the category also includes Uruguay, and possibly Chile and the Philippines. It is important to realize that these countries together contain some 900 million people, or nearly half the population of the developing w o r l d exclusive of China. F o r this "Fourth W o r l d " group of countries, the consequences of the changes f r o m 1973 a r e overwhelmingly negative. Most of these countries not only a r e the poorest in the world at present, but also 3 / I n 1973, developing countries borrowed an estimated $10 billion in the E u r o - c u r r e n c y m a r k e t s , w e l l above the l e v e l of the preceding y e a r . (See Table I V ) Largsst known borrower:', w e r e O P E C countries in A s i a and A f r i c a , and B r a z i l , Mexico, Colombia., and P e r u in .Latin A m e r i c a . Many countries in the second and t h i r d categories described above borrowed r e l a t i v e l y s m a l l amounts. T h e impact of the high o i l prices orx E u r o - d o l l a r transactions w i t h developing count r i e s is uncertain, To the extent that A r a b deposits in E u r o - d o l l a r banks a r e m o r e than offset by European withdrawals to pay for o i l , t h e r e w i l l not be as much liquidity in Euro-ciii-rcncies, and that m a y deprive developing countries of an iimportant i ccvnt source, of finance. M o r e o v e r , much of the $10 b i l l i o n is c a D ' i H c on .short notice; by Hie lending banks, thus increasing the v u l n e r a b i l i t y of the developing countries.. Oa the other luuul, if A r a b deposits leave the E u r o - c u r r e n c y ij».:;rhcst m o r e liquid, 197-1 may yield additional l a r g e t r a n s f e r , to the u;:velopiu£ cou:il;rio.s-~chiefly the. m o r e advanced ones. 33 -14have the most dismal growth prospect^ for the future. Their net share of the identifiable adverse effects of the recent price increases amounts to some $3 billion. In addition, these countries face imponderables such as the cost of reduced direct private investtfnent in the wake of these economic disriptions or the decline in their export earnings due to the global economic slowdown in 1974. Finally, if the countries in this category are to maintain their development momentum, they w i l l need major additional investments either to increase their food, f e r t i l i z e r , and energy production to reduce their dependence on these high-priced imports or to establish new export industries to enable them to pay their vastly higher import b i l l s - or both. An additional $l-$2 billion annually is needed for these purposes. India, the Philippines, and Bangladesh, for example, probably could double their grain production in less than a decade with greatly increased research, more irrigation facilities, and wider availability of f a r m inputs and credit. Sri Lanka and Nepal have unexploited hydroelectric potential, and India--like the United States and several European countr ies--has large coal reserves which warrant development given the new high price level for energy. The poorest countries, however, always have had more difficulty than the industrial countries in shifting capital and technology from one sector to another, and this difference is even greater now because of the higher oil and food prices, which drain f r o m the poorest countries resources that might otherwise be available for investment. Extraordinary measures w i l l be needed to assist these countries, as most of the means suitable for helping the third category of countries 34 -15described above are not suitable for this Fourth World category. These poorer countries are unable to assume large additional amounts of shortt e r m or medium-term credits on near-commercial terms because of their already high debt burdens and limited foreign exchange earning capacity. The new I M F oil facility has, therefore, limited value for them. Worsening World Food Situation It has been apparent for approximately a year now that the current international scarcity of major agricultural commodities and the major drawdown of world food reserves reflect important long-term trends as well as the more temporary factor of lack of rainfall in the Soviet Union and large areas of Asia. We are witnessing what appears to be a funda- mental change in the world food economy f r o m two decades of relative global abundance to an era of more or less chronically tight supplies of essential foodstuffs. This is so despite the return to production of U.S. cropland idled in recent years. As noted earlier, a major reason behind this shift is the fact that growing affluence in rich countries has joined population growth in the poor countries as a major cause of increasing demand for fbodgrains. At the same time, overfishing has interrupted the long period of sustained growth in the world fish catch--thus limiting the supply of another important protein source. As a consequence of these fundamental changes, as well as of the additional temporary factor of drought, global food stocks have been dropping in recent years. Global reserves have dropped f r o m the equivalent of 69 35 -16- days of consumption in 1970 to some 36 days of reserves by last summer. Despite the highest grain production and the highest grain prices in history in the current crop year, global reserves are continuing to fall and had reached the equivalent of only 26 or 27 days' global supply by June, 1974. Food production prospects for the developing countries for the crop year that begins this month are even less hopeful than they were last fall. Most developing countries w i l l be even more short of foreign exchange as a result of last December's doubling of energy prices, and hence w i l l be unable to import energy, fertilizers, pesticides, and other essential f a r m inputs. In addition, the world is faced with a world fertilizer shortage which, w i l l last at least for several years. Barring some new governmental intervention, developing countries can expect their fertilizer supply to be cut back far more than w i l l be the case in the industrial countries. In the United States, the combination of new acreage being restored to production, the greater use of fertilizers because of the much higher prices for grains, and the increased use of urea for feed, has resulted in an unofficial "quasi-embargo" on U.S. fertilizer exports since last October. As a consequence of the energy crisis, Japan--in recent years the world's largest fertilizer exporter--has cut back its fertilizer production severely to the point where in recent months its output has been largely limited to meeting the demands of its politically important domestic market and to supplying Communist China. Developing countries are hurt the most, as evidenced by the shortfall of 750 thousand to 1 million tons in India's fertilizer imports during the 36 -17past crop year, which w i l l cause a production shortfall of 7 to 10 million tons of grain. It w i l l be at least several years before adequate new f e r - t i l i z e r capacity can be constructed, and under the present policies of the industrial countries the adverse consequences of this shortfall are borne principally by the developing countries. The FAO estimates the shortfall of these countries for the present crop year at 2 million tons, which w i l l necessitate their importing as much as an additional 16-20 million tons of grain at a foreign exchange cost of some $4 billion. The extent of global vulnerability is particularly underlined by examining the degree of global dependence on North America for exportable food supplies. Over the past three decades, North America--particularly the United States, which accounts for three-fourths of the continent's grain exports--has emerged as the world's breadbasket. Of the 95 million tons that moved in world grain trade between regions in 1973, 88 million were from North America. This contrasts with the mid-1930s, when North America provided only 5 million of the 25 million tons then moving in trade between regions. Exports of Australia, the only other net exporter of importance, are but a fraction of North America's. Moreover, the United States now is not only the world's major exporter of wheat and feedgrains but it is also the world's leading exporter of rice. Thus the United States and Canada together today control a larger share of the world's exportable surplus of grains than the Middle East does of oil. Having embargoed new fertilizer sales because of rising domestic demand and devoid of the food surpluses on which its food aid (PL 480) 37 -18- p r o g r a m so long depended, the United States--the food and f e r t i l i z e r center of the w o r l d - - n o longer is implementing even the semblance of a global food policy beyond that of m a x i m i z i n g profits for a g r i c u l t u r a l exports. U.S. food aid this year is o n e - t h i r d its volume of two years ago, and one-half of this greatly reduced amount goes to Indochina. A t the same t i m e , U.S. per capita food consumption continues to Trise--amounting to 1, 850 pounds of grain annually by 1972, as contrasted to 380 pounds per person in most of A f r i c a and South A s i a - - w h i l e scarce f e r t i l i z e r continues to be used for such n o n - f a r m purposes as lawns, golf courses, and c e m e t e r i e s in e v e r - i n c r e a s i n g amounts that already exceed the total f e r t i l i z e r s h o r t f a l l in the developing countries. T h e r e is an urgent need for the United States to develop an integrated global food policy. The new e r a of increasinly tight supplies brings w i t h it the need for greatly improved global management not only to avoid l a r g e scale famine but also to increase food availability so that two-digit inflation does not become a s e m i - p e r m a n e n t f i x t u r e . Now that idled cropland in the United States has been returned to production, the opportunity for easily expanding production in the developed countries has diminished sharply. As sources become scarce, the comparative advantage in additional food p r o duction shifts toward those areas w h e r e the resources can b r i n g the greatest gains. The increase in food output brought by a given additional amount of f e r t i l i z e r or energy is f a r higher in the developing countries than in the industrial countries. Since f e r t i l i z e r s a r e a l r e a d y applied v e r y heavily in 38 -19the a g r i c u l t u r a l l y advanced nations of Europe, in Japan, and in the United States, an additional pound of f e r t i l i z e r applied in these nations m a y not r e t u r n m o r e than 5 pounds additional grain. But in countries such as India, Indonesia, or B r a z i l , it w i l l yield at least an additional ten pounds of grain. Unfortunately and ironically, when w o r l d f e r t i l i z e r shortages emerged in 1973 the m o r e advanced nations acted to r e s t r i c t their f e r t i l i z e r exports to the poor nations, where the f e r t i l i z e r would have produced much m o r e food. In some ways, President Nixon's proposal to double U . S . assistance f o r increasing food production in the developing countries under the F Y 1975 F o r e i g n Assistance A c t m a y be described as one of the lowest cost means available to the United States for fighting inflation over the longer run. The w o r l d ' s principal unrealized potential for expanding food production is now concentrated in the developing countries. Soils in Bangladesh a r e fully equivalent to those in Japan, yet r i c e yields a r e only o n e - t h i r d of those in Japan. India's a r e a of cropland is roughly comparable to that of the United States, but it harvests only 105 m i l l i o n tons of grain while the United States harvests 250 m i l l i o n tons. C o r n yields in B r a z i l and Thailand a r e s t i l l only o n e - t h i r d those of the United States. Power Shifts The events of recent months have accelerated the shift of economic and p o l i t i c a l power to two power c e n t e r s - - N o r t h A m e r i c a and the O P E C c o u n t r i e s - whose leadership role in the months ahead is uncertain, at the same t i m e that they have weakened and d e m o r a l i z e d the European Economic Community and Japan, which in recent years had been providing increasing global leadership. 39 -20- The o i l - r i c h O P E C countries, w i t h a current account surplus of some $50-$65 billion annually, a r e an obvious source of new power. Given the new w e a l t h and the a r b i t r a r y manner in which these countries implemented t h e i r o i l price increases, it is understandable that many insist that these countries take the lead in meeting the aggravated financial problems of the poorest countries. The O P E C countries have tended to react defensively, however, and most developing countries have been reluctant to press them hard for a combination of reasons. These include some degree of self- identification w i t h the o i l producers as fellow developing countries, as w e l l as the same " p r a c t i c a l " politics that have led many industrial countries to seek b i l a t e r a l deals w i t h the o i l producers. No m a j o r dialogue, has developed as yet, t h e r e f o r e , between the oil countries and the industrial countries on the problems of the poor. The o i l producers in their defensive reactions have noted that the price of wheat had increased n e a r l y threefold before there was a p a r a l l e l o i l p r i c e increase, that most of them a r e not so r i c h per capita as the industrial countries (in 1974, Venezuela's per capita income w i l l approximate-$1, 500, N i g e r i a ' s $250, I r a n ' s $ 1 , 0 0 0 , and Saudi A r a b i a ' s $3, 000 versus $5, 000 for the United States, $8, 000 for Kuwait, and $43, 000 for Abu Dhabi), and that they, solely as newly r i c h , should not be asked to help the developing countries to a greater extent Ln t e r m s of per cent of G N P than the industrial countries. The dialogue initiated by the I M F and the W o r l d Bank w i t h these countries is useful, but f a r m o r e needs to be done. T h e r e should be p a r t i c u l a r opportunities for effective dialogue w i t h Venezuela, Saudi A r a b i a and I r a n . Venezuela has closer and longer established ties w i t h 40 - 2 1 - the other L a t i n A m e r i c a n countries than N i g e r i a has w i t h the countries of its region, or the Middle E a s t e r n countries have w i t h A s i a and A f r i c a . Saudi A r a b i a appears m o r e concerned than most of the r i c h e r O P E C count r i e s w i t h the potential adverse effects of high o i l p r i c e s . I r a n , the o r i g i n a l instigator of high o i l p r i c e s , has been conscious of the need to avoid undulyantagonizing the F o u r t h W o r l d countries. The second power center strengthened as a result of recent events is the United States and Canada. Canada, w i t h increased earnings f r o m its o i l exports to the United States to offset its o i l imports for E a s t e r n Canada, is a m u l t i - b i l l i o n - d o l l a r beneficiary of the recent trend toward higher prices for raw m a t e r i a l s . A less appreciated, but m a j o r result of r e c e n t events is the r e l a t i v e l y strengthened position of the United S t a t e s - - a s reflected in the increasing value of the dollar and the U . S . b a l a n c e - o f payments surplus "for 1973. This strengthening is the result of a combination of factors including high, s c a r c i t y - r e l a t e d prices for many of its m a j o r r a w m a t e r i a l exports; the at least t e m p o r a r i l y improved U . S . competitive position in manufactures resulting f r o m the c u r r e n c y realignments that began in late 1971; and, f i n a l l y , the r e l a t i v e l y m i n o r dependence of the United States on o i l imports compared to other m a j o r industrial countries. The o i l imports of the United States represent only some 13. 5 per cent of its t o t a l energy consumption. M o r e o v e r , the United States r e l i e s on imports f o r only 30 per c e n t - - c o m p a r e d , for example, to Japan's 9 9 . 6 per c e n t - - o f its o i l consumption. M o r e o v e r , vast r e s e r v e s of coal and shale ensure f o r the United States the option of substantial energy independence over the 41 -22- longer run. A s a consequence, the United States, despite the l i k e l y eco- nomic slowdown in 1974, is far m o r e a t t r a c t i v e for A r a b (and other) investment than a r e other countries and currencies and therefore can be expected to run a l a r g e balance-of-payments surplus in 1974. I n general, then, the r e s o u r c e - r i c h c o u n t r i e s - - s u c h as the United States, China, Canada, A u s t r a l i a , and the Soviet U n i o n - - s u f f e r less than do s m a l l e r , resource- dependent industrial or developing countries when wrenching changes weaken the international economic o r d e r . Elements of a Solution Possibly most important among the various measures required by the present situation is the need to avoid a serious global recession at a t i m e w h e n a l l m a j o r economies a r e simultaneously in an economic slowdown. Ways also must be found to recycle funds in adequate amounts f r o m the f o r e i g n exchange surplus nations (notably O P E C , the United States, and Canada) to the most seriously injured industrial and developing countries. F o r those c u r r e n t l y able to pay c o m m e r i c a l r a t e s , the Eurodollar m a r k e t m a y serve this purpose in the v e r y short t e r m , but over a s e v e r a l - y e a r period there is need for a greatly expanded I M F o i l f a c i l i t y and for monetary and trade adjustments which w i l l enable h a r d - h i t countries such as the United Kingdom, K o r e a , and Taiwan to increase their export earnings. Many developing countries, p a r t i c u l a r l y those of the F o u r t h W o r l d , w i l l r e q u i r e special help on concessional t e r m s . Considering the stakes involved, the amounts n e e d e d - - $ 4 - $ 5 billion annually f o r s e v e r a l years to 42 -23cover p r i c e rises' and accelerated energy and a g r i c u l t u r a l d e v e l o p m e n t - a r e not l a r g e . In addition to helping the most severely affected countries meet their immediate problems in maintaining the flow of essential I m p o r t s , a special worldwide effort should be launched to provide them w i t h the techn i c a l and financial assistance necessary to Increase their food production and to develop alternate sources of energy so that these countries do not r e m a i n indefinitely Impaired by these p r i c e r i s e s . The I M F ' s s h o r t - t e r m capabilities can be effectively employed to help the poorest, h a r d e s t - h i t countries only If they a r e part of a longer range package which r e s t o r e s the growth process In these countries. Without other action by the Industrial countries, the O P E C countries, and the International community In general, the contribution of the I M F ' s present f a c i l i t i e s Is at best l i m i t e d . The rollback of o i l prices is s t i l l an issue at the present moment. The significant price reduction being sought by the United States would c l e a r l y ease the global readjustment problem by reducing the danger of a serious economic recession and by lessening the severity of the trade deficits confronting the great m a j o r i t y of countries in 1974, thereby easing the task of r e c y c l i n g the trade surplus of the O P E C countries back to those in need. However, the m o r a l (and logical) position of the United States in pressing for an o i l p r i c e rollback would be greatly strengthened by a U . S . initiative to (1) ease the growing burden on the least developed countries resulting f r o m the skyrocketing prices of f e r t i l i z e r and grain, and (2) assure t h e m of access to v i t a l commodities, p a r t i c u l a r l y f e r t i l i z e r . Thus there is an urgent need for reducing the adverse impact of both sets of price r i s e s , and p a r t i c u l a r l y for reducing their impact on the poorest countries. 43 -24The resolution of the United Nations General Assembly Special Session on Raw M a t e r i a l s in A p r i l , 1974, is important in this context. It called on Secretary General Waldheim to r a i s e emergency assistance to help tide the most severely affected, or F o u r t h W o r l d , countries over the next 12 months, and outlined a procedure for developing a m u l t i - y e a r effort to help these countries regain their financial balance and development momentum. The Council of the European Economic Community has offered to increase its assistance by $500 m i l l i o n if the other r i c h countries w i l l r a i s e the balance for a fund of at least $3 billion, of which they would expect the O P E C nations to provide some $1. 5 billion. The United States Government has a f f i r m e d to Secretary- General W a l d h e i m that we w i l l participate in this emerging effort, but without specifying any amount or share. A f a i r share for the United States total should be at least one q u a r t e r , probably even a t h i r d , given the fact that we a r e much less hurt by the recent price dislocations than the Europeans or the Japanese. A U . S . contribution in the f o r m of increased food and a g r i c u l t u r a l production assistance totaling $1 billion w i l l be less than one-half of the m o r e than $2 billion we w i l l receive in 1974 f r o m the developing count r i e s as a result of our higher food p r i c e s . The Canadian and Japanese a r e each reported to have offered to put up $100 m i l l i o n , and the Netherlands $30 m i l l i o n . I r a n and Venezuela a r e also reported to have each promised $100 m i l l i o n or m o r e , and D r . Raul P r e b i s c h has been conducting a round of discussions w i t h the A r a b countries in the past two weeks on behalf of Secretary General W a l d h e i m . The 44 -25S e c r e t a r y General of O P E C has stated s e v e r a l times recently,, but without substantiating detail, that the O P E C countries w i l l provide assistance in 1974 in amounts greater than 1 per cent of their G N P , i. e . , m o r e than $1.5 billion. This includes, however, assistance to such countries as Jordan and Egypt which, like U . S. aid to V i e t n a m or Colombia, does not qualify as aid to F o u r t h W o r l d countries. I m m e d i a t e Next Steps The scale of the global problems brought on by the events of 1973 is such that they cannot be coped w i t h through, a series of belated, uncoo.rdinated, and ad hoc m e a s u r e s . The need is f o r a global cooperative effort to (1) counter the threats of a severe sustained economic slowdown by maintaining demand, and of inflationary supply shortages by increasing production; (2) enable the recycling of surplus funds f r o m O P E C investments to developed and developing countries In need; (3) help m a i n t a i n m o m e n t u m in the development efforts of the poorest developing countries d u r i n g these years of transition and adjustment to higher p r i c e s ; and (4) start evolving a new set of rules for access to supplies. S e c r e t a r y Kissinger acted w i t h foresight last f a l l in calling for a United Nations Food Conference (now set f o r November 1974) and in setting f o r t h general proposals in his w i d e - r a n g i n g speech to the U . N . General A s s e m b l y on A p r i l 15; however, the F o u r t h W o r l d countries r e q u i r e some $3 b i l l i o n of emergency assistance i m m e d i a t e l y , before governments and international agencies deliberate on m e d i u m - t e r m and l o n g e r - r a n g e proposals, and a specific U . S . response is now overdue. 45 -26- The Overseas Development Council in A p r i l proposed in its Agenda f o r Action, 1974, seven possible actions to address the urgent needs of the hardest-hit poor countries; (1) A g r e e m e n t by food-exporting countries to set aside a portion of their food exports for t r a n s f e r on concessional t e r m s to the poorest countries; (2) A p a r a l l e l agreement by c a p i t a l - s u r p l u s , o i l - e x p o r t i n g countries to set aside a portion of their o i l exports f o r t r a n s f e r to the poorest developing countries on concessional t e r m s , or to set aside a s m a l l portion of o i l revenues f o r development, or both; (3) A g r e e m e n t on a global system, of increased food r e s e r v e s to meet future shortages; (4) A joint effort by the capital-surplus o i l exporters and industrial countries to help the poorest developing countries w i t h t h e i r i m m e d i a t e and expanding needs for f e r t i l i z e r ; (5) A g r e e m e n t to launch a worldwide effort to expand low cost food production, w i t h particxilar emphasis on the poorest countries and e a r l y action on IDA replenishment. (6) A g r e e m e n t on a cooperative effort to help a l l countries find substitutes for oil, including a) an interchange of information on energy technology, and b) financing by capital-surplus countries; (7) A g r e e m e n t on such s h o r t - t e r m financial support for the p r i c e distressed poorest countries as debt postponement. These actions would be mutually r e i n f o r c i n g if a l l or most of them could be secured. 37-211 O - 74 - 4 T h e i r total impact would go w e l l beyond dealing w i t h 46 -27immediate problems of the current economic t u r m o i l to hold out the prospect of accelerated development. Conclusion I n many ways, the w o r l d in 1974 is at a watershed comparable to that of the m i d - 1 9 3 0 s , when the w o r l d chose the wrong direction and p r o ceeded on to W o r l d W a r I I , or to that of the mid-1940s when the decisions " taken led to a new cooperative w o r l d order which, for a l l its obvious i m perfections, has taken the w o r l d to unprecedented levels of cooperation and prosperity. The need in 1974 is for a sense of vision and cooperation c o m - parable to that of the late 1940s. The past year has c l e a r l y indicated what can lie ahead i f - - w h e t h e r by preference or lack of f o r e s i g h t - - t h e law of the jungle r a t h e r than cooperation remains the response of nations. Many of the new problems of global scarcity brought on by r i s i n g affluence and increasing populations c e r t a i n l y should be amenable to alleviation, and possibly even to solution, through cooperative international action. The United States, the w o r l d ' s b r e a d - basket and the m a j o r beneficiary (by over $6 billion) of s c a r c i t y - d e r i v e d higher prices for its food exports, has a special responsibility to help the hardest-hit countries at least on the food aspects of the w o r l d economic c r i s i s . By skillfully handling the w o r l d ' s most essential raw m a t e r i a l - - f o o d - - t h e supply of which it dominates, the United States might also begin to pioneer and f o r mulate new ."rules of the game" for access to supplies, for increasing p r o duction to meet demand, and for establishing global r e s e r v e s - - n e w rules that a r e needed for the benefit of a l l in managing the increasingly tight w o r l d supply of essential resources. Table I Estimated Oil Revenues, Per Capita GNP, Population, and Total Imports of Eleven OPEC Countries Country Estimated Government Oil Revenue ($ millions) .1972 1973 1974 Saudi Arabia Iran Kuwait Iraq Abu Dhabi Qatar Venezuela Libya Nigeria Algeria Indonesia 2,988 '2.423 1,600 802 538 247 1,933 1,705 1,200 680 480 8 4,915 3,8S5 2,130 1,465 1,035 360 2,800 2,210 1,950 1,095 830 19,400 14,930 7,945 5,900 4,800 1,425 10,010 7,990 6,960 3,700 2,150 Estimated Per Capita Government Oil Revenue ($) 1974" 1972 1973 393 79 1,758 80 11,700 1.941 176 820 21 45 4 630 123 2.131 141 22,565 2,575 250 1,005 33 71 7 2,456 461 7,223 551 43,636 9,500 870 3,631 114 233 17 Per Capita • Population GNP (millions) (S) 1971 1973 540 450 3,860 370 3,150 2,370 1,060 1,450 140 360 80 . 7.8 31.5 1.0 10.4 0.1 0.1 11\2 2.2 59.4 15.4 124.0 Total Imports ($ millions) 1971 1972 . 806 1,871 678 656 n.a. n.a. 2,301 712 1,506 1,221 1,174 1.229 2.410 797 713 n.a. n.a. 2.433 1.104 1,502 1,760 1.458 0DC estimate based on World Bank estimates for OPEC government oil revenues, population (mid-1971), and population growth rate*, SOURCES: Oil Revenue figures are informal World Bank staff estimates; GNP and Population figures are from World Bank Atlas, 1974 (Washington; O.C.: World Bank Group, 1974); import figures are based on International Trade, 1972 (Geneva: General Agreement on Tariffs and Trade, 1973), Publication Sales No. GATT 1973-3. • I Impact of Oil Pricc Rise on Sclcctcd Developing ^Countries, Ranked by GNP Per Capita Table H T . Primary Changa in Estimated Oil Import BiII Total Imports ($ millions) Country Bangladesh Sri Lanka 1972 1973 25 35 35 50 <$ millions) 1074* Estimated Total Debt Scrvice Reserves (S millions) ($ millions) 1972 1973 1974 95 929 807 n.a. 1 150 413 536 48 ; 1 1 • 1973 b 77 (per cent) 1972 79 1973° ^..n.a. . i n.s.. • Total Exports ($ millions) 1970-1973* 200°' Exports o: % of Total Total Reserves . 313 . Net O D A From OAC ' GN? 'Per Countries'* Capita Exports ($ million^ (S) 1967-1969 1972 1971 n.a. . . jute, 4 6 372® tea. 61 J 200 65 ...70. 100 606 110 . . rubber, 19 coconut. I d . India 265 415 1.350 3,196 4,048 1,403h 550 + 40 2.401 2,477 ' Jute. 2 3 tea. 12 Il Pakistan Kenya 65 85 260 1,144 1,455 278 ; 396 +118 737 25 40 115 698 854 30 j| 286 • 364 1 30 i I 1I II Thailand 125 180 510 1.616 1.737 52 Philippines 185 265 740 1*662 2,480 128 1,107; n.a. s • 1,063 1,503 rice. 2 7 .• rubber. 14 53 1,105 1,955 wood, 24 164 223 304* . .+284 +117 389 633 20 25 70 466 570 49 80 .216 1.057 1,336 102 ! I 205 '. 325 1.075 2.715 3.531 332 | 1.034 425 540 1,425 6,185 329 6.462 Korea. South Uruguay Chile 40 . n.a. 60 147 • 160 362 239 1,211' 7,109 369 n.o. 30 ' 312 . *T;-.c oi! import bill was calculated cn tho basis of the developing country's projected oil-import' corsurr.piion at approximately S3.C0 per barrel c.i.f. While'an oil import bill calculated in this fa:hlon may be unrealistic in terms of what many developing countries can afford to pay, it .nevertheless reflects the order of magnitude of the economic difficulties faced by these same countries. b As of September 1973, unless otherwise noted. c The. value of total exports in 1073 are those (or the second quarter of 1973 expressed In ar.rvja! rotes, unless otherwise noted. d Comp3icd of net bilateral OOA and concessional multilateral flows. * 'Total reserve position as of July 1973. 'Total reserve figure for Bangladesh obtained from U.S. Asency for International Development. •First quarter exports expressed in annual rates. -*--* j '{oil, 9 + 40 50 210 Vfca. ' 562* . 985 130 I +245 Morocco • • 160 tea. 15 867 Ghana 'Brazil 318 coffea. 24 1,267 i •; : Iron, 7 cotton, 11 • ( sugar. 17 . 'cocoa. 55' • phosphate, 2 4 " :'food, 17 210 j 240 i 60 9 7 ! ' j . 250 270 70 1,624 3,088 ' wood, 13 | fish, 6 361 j 290 +444 3.991 6.038 1 coffee, 39 cotton, 7 94 'j 460 wool, 4 2 21 ; • + 20 n.a. 197 I I 961 || 338 I j copper, 7 6 750 j _ meat, 3 0 962. 39 j 760 reserve position as of June 1973. 'Bas'jd on International Trofe, 1972 (Geneva: General Agreement on Tariffs and Trade, 19731. Publication Sales No. GATT 1973-3. SOURCES: Oil Import arid Total Import figures ere based on Informal World ftanlt staff estimates; Debt Scrvice- figures are from Bureau for Program and Policy Coordination, U.S. Agency for International Development; Total Reserves'and Total Export figures are from International Monetary Fund, International Fin»nci»l Statistics, December 1973; Net Official Development Assistance figures are based on Report by the Chairman of the Development Assistance Committee, Development Co operation, 1073 Review (Paris: OECD, 1973); GNP figures are from World D»nk A tits. 1974 (Washington, D.C.: World Bank Group. 1974). 49 Table I I I Pricc Changes in Major Commodity Exports of Developing Countries » ' Percentage Change in Price, 1972-1974" Per cent of Total World Trade, 1970 b 355 5.04 239 c 211 196 n.a. .48 1.00 Palm Oil Rice 147 138 .06 .36 Cotton 137 .76 Corn Sisal Sugar Cocoa Ground Nuts Copper 114 113° 105 103 91 90 .58 .02 .86 J27 .07 1.29 79* 72 .42 .21 Major Commodities Petroleum Urea . Rubber Wheat Principal Exporters' Shares of World Exports of . Commodity, 1970 „ Soybeans tin Iron ore* 46c £0 Coffee 36 " ~ .93 Tea 19 .21 JUte 17 .05 Saudi Arabia, 15% Iran, 13% n.a. Malaysia, 33% United States, 32% Canada, 21% Australia, 12% Argentina, 4% Malaysia, 44% United States, 27% Thailand, 11% United States, 16% Egypt. 14% United States, 45% Tanzania, 33% Philippines, 10% Ghana, 35% Nigeria, 29% Zambia, 24% Chile, 21% United States, 94% Malaysia, 50% Bolivia, 16% Venezuela. 7% Brazil. 32% Colombia, 16% India, 31% Sri Lanka, 29% Pakistan/Bangladesh, 50% f "Price change from 1972 (average) to 1974 (January), unless otherwise noted. bWortd trade equalled $280.4 billion in 1970, $371.7 billion in 1972, and $487.5 billion in 1973 (second quarter estimate). c Price change from 1972 (average) to 1973 (average). d . Prlce change from 1972 (average) to 1973 (October). I *Oata available for developing country exporters only. SOURCES: Based on International Monetary Fund, Internationa! Financial Statistics, Occember 1973, and World Bank staff estimates. 50 Table III Announced Euro-Currency Lending to Non-OPEC Developing Countries, 1972 and 1973 (S millions) Country of Borrower Argentina Bahamas Bahrain Bolivia Brazil Colombia Costa Rica Cuba Dominican Republic . Dubai Guinea Guyana Haiti Hong Kong India Ivory Coast Jamaica Kenya Korea, North Korea, South Lebanon Malawi Malaysia Mexico Nicaragua Oman Panama Peru Philippines Senegal Swaziland Trinidad and Tobago Zaire Zambia 1972 1973 236.0 87.3 30.0 15.0 6.0 789.0 115.0 11.0 30.0 15.0 120.0 - • - 577.4 90.0 - 23.3 4.0 18.3 40.0 - 20.0 - 15.0 - 30.0 - 76.1 490.4 15.0 - 40.0 210.0 61.3 - 3.2 - 12.5 10.0 72.6 10.0 • 95.0 35.6 4.5 51.6 106.0 20.0 5.3 1,247.5 102.0 35.0 251.0 633.6 178.5 90.0 - 90.0 25.0 38.0 346.9 150.0 Total, Non-OPEC Developing Countries 2.065.0 4,713.9 Total, OPEC Countries Total. Developed Countries 1,023.5 6,385.0 3,080.0 " "12,889.4 WORLD T O T A L 8.473.5 20,683.3 - NOTE: The interest rates vary. Maturities are largely three to eight years, with a six month rollover period. , SOURCE: International Economy Division, World Bank Group. 51 M r . G O N Z A L E Z . I n your statement you stated t h a t y o u anticipated a reduction or a decline i n the cost of petroleum, and I was wondering, this w i l l necessarily be predicated on the fact that we w o u l d have t o trust the A r a b producing countries that they would not reimpose an embargo. D o you see any danger or a possibility of a reimposition of the embargo ? M r . B E N N E T T . M r . Chairman, as you know, the embargo o f last year was imposed after the outbreak o f the war, and had an almost exclusively political content. O f course, I am not the expert butt i t is cert a i n l y m y hope t h a t there w i l l be continued progress t o w a r d a lasting peace i n the M i d d l e Bast, so t h a t the occasion f o r an embargo w i l l not reoccur. A general embargo f o r economic reasons seems t o me most unlikely. M r . G O N Z A L E Z . W i t h respect t o the possibilities t h a t you say the Secretary and others w i l l be exploring soon, w h a t mechanism or prog r a m caii be devised t o t r y t o absorb some o f this excess money t h r o u g h the issuance o f Government securities? C a n y o u t e l l us i f any k i n d of an agreement has been reached by now ? Whether or not some f i r m proposition was developed d u r i n g the occasion o f the President's visit t o tthe M i d d l e East? A n d whether or not, i n case such plans are i n the works, i t w o u l d be necessary f o r the administration t o come t o the Congress f o r legislation t o provide f o r t h a t t y p e o f mechanism, or whether or n o t i t could a l l be done w i t h i n the administrative processes ? M r . B E N N E T T . There have been no suc,h agreements t o m y knowledge w i t h foreign countries on new investments i n U.S. Treasury or Government securities. Y o u know, o f course, t h a t we do issue special securities. F o r example, we have about $26 b i l l i o n outstanding now, o f w h i c h the largest component is held by the German authorities. I t occurs t o us t h a t i t could be t o the mutual advantage o f the U n i t e d States. a,n<J t o some other countries t h a t w i l l be accumulating large government-held foreign investments t o consider similar special securities. There is no reason t h a t I know of w h y we should offer any o f these investors terms more favorable t h a n we offer other investors, includi n g U.S. citizens. B u t i t is, according t o our experience, l i k e l y that there w i l l be opportunities t o develop securities w i t h special features t h a t meet our respective needs. I f , f o r example, a M i d d l e Ea^t country could give us some assurance o f the dates over a coming period on which specific large amounts would be invested here, we i n t u r n could design government-to-government securities. These w o u l d be on terms comparable t o the private securities b u t w o u l d provide them the opp o r t u n i t y o f k n o w i n g i n advance they could invest on a specific day and t h a t those funds could be recovered by t h e m on the basis o f cert a i n periods of notice t o us, just as we have done w i t h the Germans. W e have h a d very p r e l i m i n a r y discussions o f t h i s sort o f t h i n g , f o r example, when the S a u d i A r a b i a n ministers were here recently. W e agreed to discuss the matter f u r t h e r w i t h them we go out there next week; but there are no agreements. M r . G O N Z A L E Z . T h a n k y o u very much. I n that connection, I am sure t h a t you would want to avoid the situat i o n I understand prevails now w i t h respect t o the W o r l d Bank, where a country such as I r a n lends to the Bank at a higher interest charge 52 t h a n w h a t the B a n k is lending out i n return. T h i s seems t o me t o be a questionable policy, and I t r u s t t h a t t h a t k i n d o f situation w i l l be very carefully studied by the U n i t e d States. M r . BENNETT. Yes, sir. M r . G O N Z A L E Z . I f you do not m i n d , M r . Johnson, I am going t o j u m p over y o u and recognize M r . Orane. H e has been here f r o m the beginn i n g and has anxiously been w a i t i n g to ask some questions. I recognize M r . Crane. M r . C R A N E . T h a n k you, M r . Chairman. F i r s t o f a l l , I would l i k e t o congratulate M r . Bennett upon reaching the position t o w h i c h he w i l l be confirmed very soon, and I appreciate his testimony before the subcommittee, as well as t h a t of M r . G r a n t . There is one question I w o u l d l i k e t o p u t t o you, M r . Secretary—it may be a premature designation, b u t I am sure i t w i l l be flawless i n another hour—and t h a t concerns the paragraph on page 5 o f your testimony i n w h i c h you indicate t h a t y o u do not feel t h a t the current situation is nearly as grave as some o f the remarks t h a t we had indicated i n a b r i e f prepared f o r the subcommittee b y the staff. I am t h i n k i n g specifically o f some o f the quotations i n H o b a r t Rowen's article on the deepening monetary crisis, as well as some o f M r . Levy's remarks. Y o u go on t o say, at the t o p of page 6, t h a t the problem you perceive now is t h a t the clear and present danger before us is not inadequate, but instead f a r too much monetary demand f a c i n g the existi n g capacity t o produce. O n the one hand, I can grasp this f r o m the testimony o f yourself and M r . Grant, b u t on the other hand, i t seems t o me t h a t w h a t we are t a l k i n g about, i n both your testimony and M r . Grant's, is t r y i n g t o come u p w i t h a whale o f a l o t o f money. I am not sure exactly who is g o i n g t o provide i t and h o w — p a r t i c u l a r l y t o help these least developed countries. T h a t does not strike me as surfeit of money chasing scarce resources, but rather a distinct lack o f money available, unless we simply crank u p the p r i n t i n g presses a n d aggravate a l l of the existing problems. I w o u l d appreciate i t i f you could dilate just a l i t t l e b i t on t h a t point. Mr. B E N N E T T . I n a time o f surplus monetary demand, i t w o u l d s t i l l be possible f o r the people o f Bangladesh t o be short o f the a b i l i t y t o buy imports. I may be wrong, but I understood you to say, M r . G r a n t , t h a t the U n i t e d States indicated t h a t i t w o u l d participate i n the U . N . fund. M r . G R A N T . Rig;ht. T h e emergency assistance effort, not i n the f u n d ; the emergency assistance efforts. M r . B E N N E T T . Yes, t h a t is the p o i n t I wish t o make. W e wish t o cooperate, b u t we have not made any commitment t o p u t money i n t o this U.N", operation. I t h i n k this also may be clarified. Y o u mentioned t h a t the Europeans said, conditionally, t h a t they m i g h t be able t o make some money available. B u t t h a t also is not t o the U . N . f u n d ; i t was t o assistance t o these most severely affected, i n response t o a U . N . appeal, b u t not necessarily t o any particular channel. B u t there is no U.S. commitment whatsoever to place any given amount i n t o this effort. I t may be i n t i m e t h a t t h a t w o u l d be appropriate or t h a t some f o r m of food loans m i g h t be, but there is no such commitment. I t is our hope t h a t a large p r o p o r t i o n o f this needed assistance w i l l come f r o m those who are today i n such a l i q u i d position. 53 M r . G r a n t mentioned an estimate of perhaps $3 b i l l i o n a year. I have a feeling t h a t f o r this calendar year the need w i l l probably not reach a b i l l i o n dollars. W h a t i t w i l l be i n later years, who knows. W h o knows w h a t the o i l price w i l l be—and i t is h a r d t o estimate a l l o f the commodity adjustments: the price of tea, the price o f beef, and estimates of t h a t type have t o be rather preliminary. M r . C R A N E . T h e t h i n g t h a t s t i l l concerns me is this point o f liquidi t y crunch. W e have unprecedented interest rates at home r i g h t now. I understand the balance o f payments deficit f o r I t a l y , i f i t continued to r u n at this rate t h r o u g h the year, w o u l d be $13 billion, which, even i f t h e i r gold is revalued u p w a r d t o market price, t h a t would totally wipe out t h e i r gold supply. E n g l a n d and France have these problems, though not of the same magnitude. Here are advanced industrial nations t h a t «are undergoing, I t h i n k , really severe wrenches, and then on the other hand, we have the underdeveloped countries w h i c h I do not know where they are going t o come up w i t h the money. I f the O P E C countries buy W o r l d B a n k bonds, what interest rates w i l l they be p a y i n g on those bonds ? M r . B E N N E T T . T h e bonds are i n t w o types lately—a p o r t i o n denominated i n their own currency, and a portion i n dollars. I believe the rates t h a t have been negotiated lately are mostly at 8 percent. M r . C R A N E . They are going t o have to lend long at low, very low, interest rates, w i l l they not, t o the least developed countries, t o t r y and get them t h r o u g h the present crunch ? M r . B E N N E T T . L e t me distinguish three things. The money that is going into the I M F f a c i l i t y to help buy o i l has been coming mainly f r o m the O P E C countries at 7 percent f o r relending at 4- to 7-year maturities. The W o r l d B a n k bonds w i l l be f o r long-term I B R D loans, and these are f o r development projects. I D A is financed f r o m governmental contributions, not f r o m the receipts of bonds. B u t let me get back to your basic question: Where is a l l of the money coming f r o m ? W e l l , I g^iess my answer is there is too much money i n t o t a l ; t h a t we are pushing up prices and pushing down the value of money. T h a t does not mean that there may not be a need t o help those who are p a r t i c u l a r l y h a r d h i t . I t does not mean t h a t some particular country cannot get into trouble w i t h an out-of-date exchange rate or by t r y i n g to hold prices that are not consistent w i t h the money supply. B u t take I t a l y . I t a l y has just p u t i n new measures t h a t w i l l substant i a l l y reduce that deficit forecast you mentioned, and i n fact, i n recent weeks, I t a l y may not even have had a deficit. They have begun to take measures. M r . C R A N E . T h a n k you. M r . G O N Z A L E Z . T h a n k you, M r . Crane. M r . Young. M r . Y O U N G . I y i e l d t o M r . Rees. M r . G O N Z A L E Z . M r . Rees, then. M r . R E E S . T h a n k you. Congratulations, M r . Bennett. I hope you enj o y traveling. I have been doing some work i n this field i n terms of the domestic and international monetary impact of the p r i c i n g of oil, and I noted that our balance-of-payments deficit f o r the month o f M a y was $776 million. I also notice that there had been a great deal o f overbuying of agricultural commodities over the past 6 or 7 months f r o m some of the 54 i m p o r t i n g countries, w h i c h actually m i g h t cut down the demand f o r U.S. f a r m products f o r the balance of the year. W e continue t o i m p o r t about 30 percent of our oil. W i l l this trade balance—of payments— continue throughout the year, do you believe ? M r . B E N N E T T . I t h i n k y o u probably p u t your finger on an i m p o r t a n t component of t h a t large deterioration i n M a y i n our trade position— the previous overbuying i n a g r i c u l t u r a l commodities and the drop i n a g r i c u l t u r a l prices. O f course, we do not know how much, b u t last year's $8 b i l l i o n i m p o r t b i l l f o r o i l is going to look p r e t t y small compared t o this year's i m p o r t b i l l . I t is also w o r t h n o t i n g t h a t the way or accounts are kept, these investments t h a t have been coming i n here increasingly i n recent weeks f r o m the o i l exporting countries—these investments i n U.S. Treasury securities or on deposit i n the U n i t e d States—are investments o f official institutions; they w i l l show u p i n our present method o f publ i s h i n g balance-of-payments statistics as an overall deficit o f the U n i t e d States. Maybe we ought to consider whether t h a t is not misleading. I t is really an investment; they are not so much f o r e i g n exchange reserves i n the usual sense but more investments o f the national p a t r i m o n y they w i l l be using down the road. They are not current balance-of-payments deficits i n the old-fashion sense. B u t I cannot at this point give you a specific prediction of what our trade balance w i l l be this year t h a t would be of much w o r t h to you. I t h i n k the i m p o r t a n t t h i n g is t h a t we have t o remain flexible to respond to what i t t u r n s out to be. A n y prediction I give you w i l l not be w o r t h much. M r . R E E S . W h a t bothers me, even i n l i g h t of our adverse balance o f payments and the possibility t h a t this m i g h t continue, is t h a t we are s t i l l i n better shape than most of the w o r l d because we produce so much of our energy. I t a l y , I understand, is b o r r o w i n g on the short t e r m E u r o d o l l a r market t o solve what is basically a long-term problem. M u c h of the E u r o d o l l a r market today is composed o f short-term money—most f r o m the o i l exporting countries. A l l of these various windows, whether you loan someone 8 percent money to purchase o i l o r whether you allow I t a l y t o revalue their gold so t h a t they can borrow more on the short t e r m E u r o d o l l a r market, a l l of these are j u s t solutions f o r 1974. W h a t worries me is 1975. Once a country uses a l l o f its reserves t o i m p o r t the bare m i n i m u m of t h e i r petroleum needs, t h a t is i t . They do not have any more reserves; they are broke. I t a l y has revalued t h e i r g o l d ; they cannot revalue i t again. They have already revalued i t u p t o where they can borrow. M r . C a r l i m i g h t be able t o do something to discipline the I t a l i a n economy—I tend t o doubt i t — b u t what is going to happen i n 1975? W e have taken the i n i t i a l shot, and we do not have a n y t h i n g to b a i l us out next year. M r . B E N N E T T . W e l l , let me take the case of I t a l y and illustrate some of the trends. F i r s t o f all, I t a l y has been b o r r o w i n g some short term, b u t i n fact, the b u l k of their E u r o d o l l a r b o r r o w i n g i n the first h a l f o f this year was long t e r m b o r r o w i n g and not short term. I n fact, they probably borrowed, i n the first h a l f of this year i n t o t a l more t h a n the entire increase f o r the whole year i n t h e i r o i l b i l l . Thus, obviously, there must be factors i n addition to o i l at w o r k here; factors h a v i n g t o do w i t h the domestic economy. So appropriate restraint on the domestic economy does provide hope f o r next year, and the intensity of the prob- 55 lem this year is more than just oil. O f course, they have taken additional measures—they just threw the other day another quarter-a-gallon t a x on the price of gasoline. Those to us would seem l i k e rattier draconian measures, so I t h i n k they do provide some hope t h a t next year w i l l be better than this year. M r . R E E S . Just one f u r t h e r question. A r e you going t o the M i d d l e East w i t h Secretary Simon ? M r . B E N N E T T , I es. W e are going not only to the M i d d l e E a s t ; we w i l l be t a l k i n g to some of the finance ministers i n Western Europe on the way back. Somehow I have some feeling t h a t some o f the subject matter w i l l be the same as we are discussing here. M r . R E E S . T h a n k y o u very much, sir. M r . G O N Z A L E Z . T h a n k you, M r . Rees. Before recognizing M r . Frenzel, I would like to report t h a t we have a t h i r d witness, V i c t o r K u r t z , f r o m New Y o r k , and we w i l l listen t o h i m after awhile. I recognize M r . Frenzel. M r . F R E N Z E L . T h a n k you, M r . Chairman. I do want to congratulate M r . Bennett and wish h i m a long and successful career. I t was indicated t h a t we had committed ourselves to the principle of some sort of emergency aid t h r o u g h the U.N., but you are c r i t i cized—or we are criticized, I guess—for not setting f o r t h some sum. I s i t not true t h a t we could w i n d up by p a y i n g the lion's share o f a l l of those emergency programs, M r . Bennett? M r . B E N N E T T . I would like to make clear t h a t we have not agreed i n principle to contribute to a U . N . fund. W e agreed to w o r k w i t h the U . N . t o study this problem and to t r y to see that this problem is appropriately recognized. W e have not agreed to make any contribution. I t is true i n the total postwar period we provided the lion's share. O f course, there are particular cases. W e have not provided the largest contribution to the Asian Development Bank, or the largest contribut i o n to the A f r i c a n Development Bank. There are exceptions. I t is our hope that this new Development Council w i l l be able to do an objective job of studying what is needed and what appropriate responses are and where i t should be possible to obtain appropriate help f o r those who are most seriously affected. M r . F R E N Z E L . T h a n k you. M r . G R A N T . M r . Congressman, may I just—since there is a l i t t l e play, apparently, here on words. M r . F R E N Z E L . I f you could do i t i n 30 seconds, because M r . Bennett has to leave, and you can stay, I t h i n k . M r . GRANT. Yes. The U n i t e d Nations is asked to w o r k on t w o fronts. One, the Secret a r y General is t r y i n g to raise approximately $3 b i l l i o n of emergency assistance f o r the most severely affected countries, which could be i n the f o r m of either contributions to a U . N . f u n d or directly, i n the f o r m of increased bilateral aid. The U.S. Government has stated t o the U n i t e d Nations t h a t i t w i l l participate affirmatively i n this effort. There is a second issue of a f u n d to be established next year that w i l l be designed to w o r k on a multiyear basis. T h a t is what we have said we would not participate in, i n its present f o r m , as I understand. M r . F R E N Z E L . Fine. I f either of you two want to a m p l i f y on these remarks f o r the record, I would be glad to have them. 56 M r . Bennett, you commented on the fact t h a t our a g r i c u l t u r a l sales abroad are d o w n considerably this year, and t h a t is m y experience, too. A p p a r e n t l y , our t r a d i n g partners are eating out of the pipeline, so t o speak, and t h a t leads me to believe t h a t w o r l d food supply figures are p r e t t y w i l d guesses, at best. I s this your estimate ? M r . B E N N E T T . W o r l d food prices have tended t o come down, as you know, since February. U n f o r t u n a t e l y , they have tended t o go u p the last few days, because some of these adverse weather reports t h a t M r . G r a n t mentioned have been coming i n , w h i c h is a clear i l l u s t r a t i o n o f how difficult i t is to forecast i n this area. M r . F R E N Z E L . W e have done t o w o r l d food prices w h a t we d i d t o the stock market. E v e r y time somebody says on television t h a t f o o d m i g h t be short, w o r l d food prices go up. I t may have no relationship t o growi n g conditions or what the anticipated crop is. I t h i n k W a l t e r Cronkite raised the price of wheat last year by at least a buck, and the market is getting a w f u l l y sensitive. B u t certainly, food prices are down considerably. Does t h a t mean we are going h u n g r y , or demand is off ? M r . B E N N E T T . The Russians, of course, are not expected t o be an importer this year. The Chinese are s t i l l expected to be a very large one. W h a t the Eastern Europeans and the Indians w i l l be is very much a difficult t h i n g to guess at this point. I do not want to pose as a food expert. A l l I would l i k e t o do is agree wholeheartedly w i t h your suggestion t h a t forecasting the food market ahead is a very difficult project. M r . F R E N Z E L . O K . T h e final point I wanted t o make is t h a t y o u r prime interest i n the t r i p t h a t is f o r t h c o m i n g and your p r i m e interest w i t h i n the Department has been to convince the o i l producers t h a t their prices have t o come down. I s t h a t true ? M r . B E N N E T T . I m i g h t c l a r i f y . T h i s t r i p t h a t I have the honor t o go on w i t h Secretary Simon is p r i m a r i l y to discuss economic collaboration i n trade and investment w i t h the Egyptians, w i t h the Israelis, and w i t h the Saudis. I n the case of the Saudis, the p r i m a r y concern w i l l be collaborating w i t h them i n the industrialization of Saudi A r a b i a , which, as M r . Hanna mentioned, is t h e i r No. 1 interest. W h i l e we are there, we w i l l take the o p p o r t u n i t y as bond salesmen also to t a l k to them on the other subject. M r . F R E N Z E L . I hope you t a l k about prices too, because i t seems to me there is not a n y t h i n g better than we can do, p a r t i c u l a r l y f o r the poorest of the poor, than t o t r y t o reduce those prices. W h i l e we have been criticized a l i t t l e b i t , i t seems to me t h a t when f o o d got short, we at least t r i e d to increase food supplies i n every way t h a t was available to us, while the producers of oil took the contrary course o f action. I do not t h i n k t h a t we are deserving the same criticism t h a t they do, and I believe i t is i n their interest to see t h a t those prices come down a l i t t l e bit. They may get bigger piles of money, b u t they are going t o spend the same way because of the inflation problem. I y i e l d the balance of m y time. M r . G O N Z A L E Z . M r . Young. M r . Y O U N G . Yes. M r . Secretary, before you r u n off, I wonder i f you m i g h t just say a w o r d about the consequences t o the U n i t e d States of any of the lesser developed countries actually going bankrupt. 57 M r . B E N N E T T . I have never thought the concept of bankruptcy was extremely useful i n t a l k i n g about the affairs of a government. Governments, of course, can always p r i n t money. They can default on their international obligations, and as a major creditor, that is a concern to us. B u t I t h i n k i t would be more appropriate to look at the u n d e r l y i n g situation. I f a government loses its ability to insure some degree o f economic v i a b i l i t y f o r an economy, what w i l l be the political consequences? W i l l the government be overthrown ? W i l l they take violent courses or t r y to make alliances t h a t under normal circumstances they would not contemplate ? I t h i n k , ultimately, we have to not only look at the humanitarian but also the political consequences of severe economic situations. M r . Grant, I am sure, could answer this better than I . M r . Y O U N G . I was really t h i n k i n g more along the lines of—well, we saw Jamaica begin t o raise the price of its bauxite i n an attempt to remain somewhat stable. T h a t government, f o r instance, where we have tremendous hotel travel and other kinds o f American investments; should t h a t government begin to totter, i t would not only have a political impact, i t would have a direct economic impact back on us. I was t h i n k i n g more i n those terms, because when we t a l k about the Congress going along w i t h more, or any k i n d of aid, i n view of our touchy experience last week w i t h I D A , that is what disturbs me about your somewhat optimistic approach. I t m i g h t be very good economically and i n terms of our whole w o r l d picture, but m terms of communicating any sense of urgency t o Members of this House of Representatives, i t does not quite do justice, I t h i n k , to the condition m which we f i n d ourselves, a condition which affects us economically and not f r o m just a humanitarian consideration f o r the rest of the world. M r . B E N N E T T . W e l l , there is no doubt that government i n extremis can take violent measures, not only w i t h respect t o foreign investments there, or exports, but i n other ways. O n the other hand, we have t o temper that w i t h the realization t h a t there has been an unusually large rash of expropriations and breaches of contract by governments that were not i n extremis. Y o u cannot say that they only occur i n those circumstances. M r . Y O U N G . M y colleague here passed a note t o me saying you can only legalize the purchase o f gold once. M r . R E E S . H O W are we going to get the next b i l l t h r o u g h ? M r . G O N Z A L E Z . W e m i g h t have special d r a w i n g rights, domestic special d r a w i n g rights. M r . Y O U N G . T h a n k you very much. M r . G O N Z A L E Z . M r . Burgener. M r . B U R G E N E R . I have no questions. M r . G O N Z A L E Z . M r . Johnson ? M r . J O H N S O N . I , too, M r . Bennett, want t o congratulate you on your appointment and hope you have a very lovely swearing i n ceremony today. I t certainly is a b i g h i g h l i g h t i n your career. M r . B E N N E T T . I look f o r w a r d t o a calm life. M r . J O H N S O N . Y O U t h i n k you w i l l survive i t a l l r i g h t ? I am quite interested i n one statement i n your speech where you said: Neither do I feel that current developments pose a serious threat of world depression. 58 Then M r . Gonzalez i n his statement quotes the respected Economist magazine, saying t h a t : The world's rich countries are digging the foundations for a major world depression. I realize those statements are contrary to each other, and first of a l l , w o u l d you comment on your statement t h a t you do not t h i n k i t poses a threat of depression? M r . B E N N E T T . W e l l , i t was w i t h statements such as t h a t o f the Economist i n m i n d that I thought i t was appropriate t o p u t i n such a phrase. E a r l i e r i n the statement, I had pointed out t h a t the o i l and other economic developments have led t o a cut i n our standard of l i v i n g and have led to a reduction i n our rate of g r o w t h . B u t t o refer t o t h a t as a recession tends to be misleading. T h a t is because of a shortage of something real. I t is not the type of recession we normally t h i n k of, since we a l l studied or grew u p i n the 1930's, i n which there was just p l a i n a lack of money to purchase the goods and to keep the plants working. T h a t type of recession just does not seem relevant to t h i n k o f at this time. Second, I see no evidence t h a t governments at this p o i n t are overdoing their fight against inflation to the extent t h a t they are unnecessarily restraining production, or t h a t one country is overdoing i t and t h a t w i l l reflect on and h a r m the next country. I n fact, i t is h a r d t o find a government that has been able t o p u l l itself together t o go f a r enough i n fighting inflation. T h a t is our problem, not the reverse, not t h a t governments are overdoing i t and t h a t is h u r t i n g us, or t h a t we are overdoing i t and that is h u r t i n g other governments. M r . J O H N S O N . I could ask you more questions, b u t I want t o get y o u downtown. I want t o get you to the church on time. T h a n k you very much. M r . G O N Z A L E Z . T h a n k you, M r . Bennett. W e wish you well. M r . B E N N E T T . I am sorry I cannot stay here ana argue w i t h M r . Grant, b u t I appreciate your consideration. M r . G O N Z A L E Z . I d i d want t o mention t o the subcommittee t h a t we had the t h i r d witness, V i c t o r K u r t z , here, and we w i l l allow M r . G r a n t t o finish his summation, because we interrupted h i m . B u t I do want to point out we have our t h i r d witness, and I would l i k e to see us remain here M r . K U R T Z . I am sorry I cannot question M r . Bennett, because I have accused the administration of terrible, basic errors, w h i c h are responsible f o r the crisis. M r . G O N Z A L E Z . W e l l , M r . K u r t z , what I was going to suggest is we allow M r . G r a n t to finish his summation, and then we w i l l recognize you f o r the presentation of whatever statement you have, and also have you introduce yourself to us and give us a l i t t l e background and the like. M a y I say by way of explanation t h a t M r . K u r t z has been i n touch w i t h us f o r more than a year and had wanted t o appear before the subcommittee a year ago out h a d t o go t o Europe at the time, and he could not make i t . So, M r . Grant, we indulge a l i t t l e b i t f u r t h e r on y o u r good kindness and w i l l come back t o you and leave i t u p to you how you wish t o sum up. Y o u were i n the process of sunmming up your presentation, and I 59 regret the interruption, but we d i d want to see M r . Bennett leave i n time f o r his swearing in. So you have the floor. M r . G R A N T . W e l l , M r . Chairman, I can be very brief, because I was at the end o f m y statement. I n essence, i t is that f o r the most severely ~ affected countries, the F o u r t h W o r l d , they clearly require major emergency assistance, f o r which the present mechanisms are not adequate. There has been an appeal by the Secretary General f o r an emergency effort over the next year, to be supplemented by a longer term arrangement. I would only say on this t h a t while i t is clear that the o i l countries need to play a very m a j o r role i n p r o v i d i n g the resource flow ? that so does the U n i t e d States. This is, i n part, because the financial crises t h a t the countries of the F o u r t h W o r l d are in, are i n p a r t due to the higher prices t h a t we ourselves are charging today f o r the goods t h a t we sell. W e w i l l earn more than $2 b i l l i o n extra f r o m the higher prices f o r food t h a t we are selling t o the developing countries this year. I f we would clearly move affirmatively i n p r o v i d i n g additional assistance to these countries to p a r t i a l l y compensate f o r the impact of the higher prices t h a t we are charging, i t w i l l then become vastly easier to get the O P E C countries to come t h r o u g h w i t h compensatory financi n g f o r the somewhat larger burden t h a t they are imposing. F i n a l l y , we do see, looking over the next 4 or 5 years, t h a t the countries which have a capital surplus are, i n the first instance, the O P E C countries, b u t i n the second instance, the O P E C countries are going to invest much of t h a t capital surplus i n countries like Canada and the U n i t e d States, w h i c h are much better investments t h a n ; let us say, I t a l y or the U n i t e d K i n g d o m , f o r their money; so t h a t u l t i m a t e l y p a r t of the recycling problem is not only how to get money f r o m the O P E C countries directly to the F o u r t h W o r l d and the developing countries, but also how do we get some of the capital surplus f r o m N o r t h A m e r ica and A u s t r a l i a to the countries t h a t are i n short supply. M r . G O N Z A L E Z . I n other words, would i t be correct and f a i r to say that what you are t e l l i n g us is that w i t h o u t America not only particip a t i n g but t a k i n g the leadership i n evolving a w o r l d approach, o r a cooperative venture, i n respect to helping these nations i n distress, that there is very l i t t l e optimistic outlook f o r a successful venture, either by the U . N . or by a combination of the other countries ? A s I gather i t , the thrust of what you are t e l l i n g us is t h a t American leadership is very essential, necessary, and t h a t w i t h o u t i t , really, i n effect, we may not solve this problem? M r . G R A N T . Y o u are absolutely r i g h t , M r . Chairman. T h e events of the last 2 years have i n many ways returned the U n i t e d States t o the sort of economic and political preeminence t h a t we had 10 or 12 years ago. The pattern that we have witnessed i n the late 1960's ana the early 1970's where the Europeans and the Japanese were t a k i n g an ever-larger share of the burden, they currently have had their stuffing knocked out of them much more than we have, and, really, looking over the next 10. years, we are relatively—as the world's largest raw material producer—we are i n a relatively much more advantaged position. The O P E C countries are raw, nouveaux riches. They do not know what to do w i t h their money yet. I t w i l l take, I t h i n k , several years to 60 get f u l l y responsible behavior out of them, at best. I f d u r i n g this period the U n i t e d States does not take a vigorous lead, then the fears o f a 1930's type situation t o me are very, very real. M r . G O N Z A L E Z . I was very much interested i n what y o u said on page 2 1 , 1 believe, of your statement, w i t h respect to Canada. T h i s is a very l i t t l e discussed subject matter, and you, I t h i n k , very wisely pointed out the fact that Canada has been one of the beneficiaries i n its exportation o f o i l t o the U n i t e d States, and also happens to be one of the great w o r l d g r a i n dealers. Could you explain a l i t t l e b i t f u r t h e r your reference to Canada's increased earnings and what you mean by offsetting t h a t w i t h the o i l imports f r o m eastern Canada ? M r . G R A N T . W e l l , M r . Chairman, Canada is both a m a j o r o i l exporter t o us and a major o i l importer i n eastern Canada to meet its requirements. M r . G O N Z A L E Z . W e l l , w h y is this not more developed i n our national consciousness? Seldom do you hear any mention about Canada i n this role, or what its politics has been, or whether there has been a change i n its politics w i t h respect to the U n i t e d States i n the recent months because of our added i m p o r t a t i o n of o i l f r o m Canada. D o you have any statistics on the increase, or what t h a t trade figure represents? M r . G R A N T . I do not have an exact figure. W h a t we do know is t h a t the substantially increased i m p o r t b i l l she pays f o r o i l she brings i n t o eastern Canada is offset by the very substantially increased export b i l l she gets f o r oil. She is then a major net gainer i n terms o f the much higher prices of grains, timber, ores, t h a t she exports. I f you look at the five or six countries i n the w o r l d t h a t have really gained f r o m the recent shifts, t w o or three of the A r a b countries, the O P E C countries, would be first, and then Canada comes i n there as the fifth or the s i x t h p r i n c i p a l beneficiary. M r . G O N Z A L E Z . Pardon me, M r . Grant. W e have a signal t h a t a quorum call is on. M a y I very respectfully and earnestly solicit m y colleagues to take this quorum call and, i f possible, r e t u r n so t h a t we can w i n d this u p by g i v i n g M r . G r a n t an o p p o r t u n i t y t o complete and also t o hear M r . K u r t z present his testimony. I am sure i t would not take long, and we could come back and w i n d i t up. I t h i n k we w i l l have t h a t o p p o r t u n i t y after this first quorum. I s there any objection to doing that? i f not, we w i l l t e m p o r a r i l y recess to take this quorum call, and return. [ A b r i e f recess was taken.] M r . G O N Z A L E Z . The subcommittee w i l l resume. I expect to have some additional members of the subcommittee comi n g back f r o m the quorum call, and I take this o p p o r t u n i t y t o t h a n k M r . H a n n a and M r . Y o u n g f o r being here, and M r . Grant, we were involved on this question of the role of Canada and its impact on the U n i t e d States and how much potential there is. I n other words, we like t o t h i n k i n terms o f Europe and distant nations, and we tend t o overlook our own neighbors. I wanted t o go over some o f the specifics. M r . G R A N T . W e do tend to underestimate—as one who was b o r n a Canadian, M r . Chairman, I am conscious of the fact t h a t we do tend to take our neighbor t o the N o r t h f o r granted. I t is not commonly recognized, f o r example, t h a t we have as much trade w i t h Canada as w i t h a l l of Europe and Japan p u t together. 61 M r . G O N Z A L E Z . N O ; t h a t is not known at all, I w o u l d say, t o the average American. I would say that is a fact t h a t is significant because of how i t has been overlooked. I f i t is a l l r i g h t w i t h you and i f i t is a l l r i g h t w i t h m y colleagues. I t h i n k we ought t o give M r . K u r t z an o p p o r t u n i t y to present his statement, and let me advise you M r . Y O U N G . Excuse me, may I just ask M r . Grant one point? M r . G O N Z A L E Z . Oh, absolutely, absolutely. Please feel free. M r . Y O U N G . I n the whole t a l k on agriculture, one t h i n g t h a t we ran into en route to A f r i c a was the presence of American agribusiness concerns moving into Senegal and Gambia. D o you have any indication t h a t there is an export of American agribusiness to the F o u r t h W o r l d , and would this i n any way help t o deal w i t h the problem y o u mentioned about balancing some o f the yields or u t i l i z i n g some of the more fertile land ? M r . G R A N T . There clearly has been quite a large degree of activity B Y American agribusiness i n the developing world. However, most of i t has been, u n t i l at least very recently, has been directed at producing products f o r export out into the industrial economy. I t has not tended to focus on the basic food crops t h a t are so indispensible to these economies t h a t have been lagging. I t is quite clear t o me that i f we are to seriously address this question of how the w o r l d gets another 400 m i l l i o n tons of increased agricultural food production a year w i t h i n 10 years f r o m now t h a t we need t o harness f a r more effectively than we have the skills of agribusiness, including their research facilities, t o go into the developing countries, because as I indicated i n m y testimony, the low cost potential food producing areas today are the developing world. W e can increase food here, but w i t h ever r a p i d l y increasing costs. F o r that, agribusiness corporations are a very i m p o r t a n t means of technology transfer. M r . H A N N A . M r . Chairman? M r . G O N Z A L E Z . M r . Hanna? M r . H A N N A . I t h i n k t h a t i t ought to be said here that i n considering this question of the petrodollars t h a t we m i g h t very well make the point t h a t the energy crisis which has brought the petrodollar t h i n g into focus is more properly seen i f we realize t h a t the energy crisis is t w o f o l d : One is the fuel f o r the human body and the other is the fuel f o r human activities. B u t i t is an energy problem and the crisis i n the w o r l d , I t h i n k , is t o take the increased volume o f money being produced b y the increased prices of o i l and seeing that a considerable portion of i t is directed t o w a r d the other face of the energy crisis, which is to increase food production, because i t occurs to me t h a t so long as a l l foods contain a considerable amount of sugar they also can be turned into fuel t h r o u g h the process of m a k i n g methanol or alcohol as a substitute f o r o i l and gasoline, and I do not t h i n k t h a t has been stressed sufficiently to make us see this t h i n g i n its t o t a l i t y . M r . G R A N T . R i g h t , and M r . Hanna, i t is not generally recognized, f o r example, how much energy i t takes today to produce food, and i t used to take 1 calorie of energy to produce a calorie of food i n this country, 50, 60 years ago. Now i t takes 10 calories of energy, and we are at a point of r a p i d l y diminishing returns i n this. T h i s is one more reason w h y , i f we want to get cheap food production over the next 10, 15 years, we have t o put more into the devloping countries which have not yet reached the point of diminishing returns. 37-211 O - 74 - 5 62 M r . H A N N A . T h a n k you, M r . Chairman. M r . G O N Z A L E Z . T h a n k you, M r . Hanna. M r . Burgener, do you have any questions ? M r . BURGENER. NO. M r . G O N Z A L E Z . I f there is no objection. I t h i n k i t w o u l d be proper t o recognize V i c t o r K u r t z , and I am going t o make a request, M r . K u r t z , t h a t vou give us a b r i e f autobiographical sketch. M y understanding is, f r o m correspondence w i t h y o u and the fact t h a t you were interested i n appearing before our subcommittee f o r more t h a n a year, t h a t you have intimate associations and dealings w i t h the internat i o n a l financial situation. So we iare interested i n h a v i n g a l i t t l e b i t of your background and i n hearing f r o m you. I f I may suggest a b r i e f summary o f your statement, though. I f y o u have a prepared t e x t y o u can introduce i t f o r the record o f the proceedings o f t h i s subcommittee, and I suggest this only because we cannot foretell when we w i l l have another vote since the House now is i n session. STATEMENT OF VICTOR KURTZ, ELVIC IMPORT CORP., NEW YORK, N.Y. M r . K U R T Z . T h a n k y o u very much M r . Chairman. I appreciate very much the courtesy you gave me f o r i n v i t i n g me t o appear before your committee. F o r many years I have been i n contact w i t h the administration, many Senators and Congressmen, b u t a l l I got were very polite letters b u t no action. I was born and brought u p i n Vienna and studied international economies a t the U n i v e r s i t y or Vienna. I have been interested i n geopolitics since my, y outh. I also lived i n Paris f o r many years. N a t u r a l l y I speak fluently French and German. I am a businessman and I have been going f o r more t h a n 25 years— at least once a year f o r 4 t o 6 weeks—to Western Europe where I have excellent connections and therefore I am well i n f o r m e d about the economical, political situations i n those countries. Furthermore, I get every week the most i m p o r t a n t French and German weekly magazines—24 hours a f t e r they appear i n Europe. I n J a n u a r y 1968 I had a meeting i n F r a n k f u r t w i t h one o f the highest officials o f the German Federal Reserve B o a r d (Bundesbank) about the gold crisis and discussed m y ideas w i t h h i m . F o l l o w i n g some correspondence, M r . Califano, special assistant to the President, i n v i t e d me i n February t o Washington, t o a meeting w i t h t h e i r g o l d expert. T h e student unrest i n France i n M a y 1968 and the flight of capital f r o m France solved the crisis f o r us at t h a t time. I n your statement, M r . Chairman, you speak about "potential f o r economical and political disaster as o f the 1930's." I t h i n k the danger is even greater. Before we discuss the causes o f our difficulties and ways t o solve them, we have t o ask: W h o is qualified t o speak and make decisions f o r us? I don't blame the managers o f A R A M C O — E X X O N f o r m e r l y 63 Standard O i l N.J., Standard O i l California, Texaco, M o b i l O i l — t o accept the order of their K i n g not to supply our A r m e d Forces w i t h o i l anywhere. B u t the managers o f the domestic companies who own A R A M C O have no r i g h t t o decide our policy because they have too many cont r a r y interests. T h e same concerns international bankers. M r . Chairman, you said the o i l producers w i l l have a surplus this year o f $65 b i l l i o n instead of $7 b i l l i o n last year. I t could even amount t o $100 b i l l i o n i f I r a n ' s pressure t o raise o i l prices prevails. T h i s means, by next year the foreign exchange reserves o f the Western World—about $165 b i l l i o n — w i l l be gone. T h i s is an intolerable situation. W e are not interested i n recycling o i l money. W e want private investments, not foreign government investments. O i l money is f o r eign government money. T h e o i l price has t o be broken. A possible new embargo danger cannot be tolerated. H o w d i d we come t o this situation? A s leading political, m i l i t a r y , and economical power, we must have a respected strong money. B u t somehow M r . M i l t o n F r i e d m a n and M r . Reuss decided t h a t only a devaluation could help our trade and payment balance. T h e t r u t h is t h a t our trade balance f o r the first t i m e was negative because o f the s h i p p i n g strike i n 1971. Because o f the shipping strike we could not export our grains, soybeans and heavy machinery, while goods came i n f r o m bonded warehouses and consumer goods b y air. B u t we had an active trade balance w i t h Europe. T h e 1971 trade deficit of $2 b i l l i o n was mainly w i t h Canada and Japan. B u t i n 1972 our trade deficit was 300 percent greater because our imports cost more and the exports received less. B u t h a l f of our trade is w i t h countries which d i d not want a cheaper d o l l a r : Canada, Mexico, Central America, nearly whole of South America, many countries i n A f r i c a , Israel, Pakistan, I n d i a , Philippines, Yugoslavia, Greece, T u r k e y stayed w i t h us. B u t because Germany introduced i n 1968 the value added tax, a b i g inflation started there, f o l l o w i n g the French example. There are i n France 3 m i l l i o n foreign workers: 1 m i l l i o n Algerians, 500,000 Portuguese, Spaniards, Italians. There are i n Germany 3 m i l l i o n foreign workers: 1 m i l l i o n Turks, 500,000 Yugoslavians, Italians, and Spaniards. A l l these foreign workers wanted higher wages and got i t , so European prices went u p a n d up, while i n spite of the V i e t n a m war, inflation here was extremely small. Because of our b i g investments i n Europe, there were many Eurodollars there, b u t according t o the U.S. T a r i f f Commission of M a r c h 1973: " U . S . f o r e i g n affiliates own about $190 b i l l i o n o f l i q u i d assets i n international markets." I t w o u l d 'have been possible t o use our foreign assets t o support our money i n an emergency—the same as the B r i t i s h d i d i n W o r l d W a r W h i l e i n 1971 our trade balance w i t h Europe was %iy 2 b i l l i o n i n our favor, i n 1972 i t was negative w i t h $140 million. F o r the whole year 1972, our trade deficit t r i p l e d f r o m $2 b i l l i o n to $6 billion. 64 O u r official position was, we bad not enough devaluated and the D o w J ones ticker reported the f o l l o w i n g : O n February 6,1973: Representative Reuss s a i d : The Monetary crisis i n Western Europe demonstrates t h a t the d o l l a r i s p a t e n t l y overvalued a g a i n a n d said the U n i t e d States can't expect the Smithsonian Agreement of December 1971 t o h o l d things together much longer. O n February 12,1973: W e are of t h e v i e w t h a t p a r i t y o f the d o l l a r should be fixed by t h e m a r k e t r a t h e r t h a n the fiat of central. A tremendous speculation on the foreign exchange market followed this news. The deutsch m a r k and Swiss franc went up and Chairman Stein reported on February 12, 1973 t o the President, we have to devaluate again. A g a i n , about 50 percent of our foreign trade—specially our neighbors Canada and Mexico—maintained the same relation w i t h our money t h a n before. Today we know the tremendous power of the speculation. A t a bankers convention i n San Diego, i n A p r i l of this year, the f o l l o w i n g was reported: I s the giant w o r l d w i d e m a r k e t f o r exchanging n a t i o n a l currencies being rigged ? B a n k s are d i s r u p t i n g the foreign exchange m a r k e t t h r o u g h excessive speculation. I f the German and Swiss banks f o r instance take a position of $500 m i l l i o n , there is no way you can go against it. F o l l o w i n g the oil embargo, as i t was f o u n d out t h a t we depend on much less oil imports than Europe, the dollar went up about 30 percent. T h a t was the reason that our trade balance i n the last 3 months of 1973 was i n our favor because of the higher value of our export dollar and the lower price f o r our imports. B u t as end of January 1974 a l l restrictions f o r capital outflow was l i f t e d , and the dollar was again under speculative pressure and went down 20 percent. The tremendous amount of speculation is proven by a German regul a t i o n t h a t starting June 1, 1974, all foreign exchange transactions i n " F o r w a r d T r a d i n g " have to be reported t o the authorities. The deutsche bank, the biggest, reported f o r 1973 foreign exchange transactions f o r over $300 billion—778 b i l l i o n D . M . T h a t was only one, the biggest bank. There are 350 other b a n k i n g institutions i n Germany. T h e foreign exchange t r a d i n g i n New Y o r k was about $5 b i l l i o n per day. The tremendous losses m foreign exchange speculation w h i c h one of the b i g three Swiss banks recently reported, and also the second biggest bank i n Germany followed now by the bankruptcy of one of the biggest private banks i n Germany ( H e r s t a t t ) , showed the extent of speculative t r a d i n g which involved here the F r a n k l i n National B a n k and others t i l l now unknown. I don't t h i n k more proof is necessary after the public knows now about the mystery of f o r w a r d foreign exchange speculation t h a t M r . M i l t o n F r i e d m a n is dead w r o n g i n saying i n Newsweek of A p r i l 23, 1973: The p r i v a t e speculation t h a t the governments deplored was socially useful and h a d desirable effects. The official speculation i n w h i c h the governments engaged was socially h a r m f u l and had undesirable effects. 65 The B a n k of E n g l a n d does not permit speculation against the pound. I t is imperative that we immediately stop p e r m i t t i n g to trade against the dollar. Since 1971 the German mark went up f r o m 25 cents (U.S.) t o about 40 cents (U.S.). I n J u l y o f last year, the m a r k was nearly double i n value but at the same time the German trade balance got better and better. The German export t o the U n i t e d States rose i n the first 3 months of this year by 18 percent—the imports only 9 percent. The next months were even better f o r German exports. B u t our export items are also wanted and w i l l be bought regardless of the value of the dollar. O n l y i f the dollar is strong, there w i l l be less commodity speculation, less flights f r o m the dollar, less inflation. O n l y recently German inflation is smaller than ours. I n general, Western Europe had overemployment, while we had underemployment; so the price pressure was greater there. W e cannot afford a budget deficit because we need international confidence i n our money. Because the oil producers received less money f o r the dollar they received f o r their products, they asked always compensation w i t h higher prices. The o i l importers d i d not fight i t , because their tax break got greater w i t h each price raise. The result, the arrogance of the oil producers showing their strength leading to an embargo and the attack of the Shah of I r a n to raise oil prices because he says the o i l companies make exhorbitant profits and his own imports went up tremendously i n price. I n the meantime, to stop dollars f r o m leaving our country interest rates going higher and higher. The stock market goes down, the b i g board alone shows a reduction i n value since last year of about $150 b i l l i o n to about $600 billion. T h i s means that the assets of our b i g public owned corporations can be picked up extremely cheap f r o m foreign oil governments. This has to change. F o l l o w i n g the Herstatt crisis, the German authorities to stop a market collapse offered money w i t h 9 percent per annum against stocks ( L o m b a r d C r e d i t ) , what we need here. Furthermore, our gold stock should be a weapon f o r us, not against us. The fact that t r a d i n g is $25 m i l l i o n a day against about $160 b i l l i o n i n official gold reserves at the market's price is true. T r a d i n g i n the key places i n F r a n k f u r t and Z u r i c h is even less. The B r i t i s h Finance Minister, M r . Denis Healey, thinks that additional demand f r o m American citizens would temper the possible price-depressing effects of new I M F sales of gold and—gold sales f r o m Central Banks—then the American public would just be p a y i n g a h i g h price. So Americans would just be the suckers to buy gold at $150 an ounce—maybe drive the price up to $200 then the speculation would unload and force the m a r g i n buyers to sell—and would buy back at h a l f the price or even lower. The French weekly magazine " L ' E x p r e s s " writes now i n its J u l y 8 edition: Gold i n d a n g e r : Gold stock correspond t o 30 years of difference between production and consumption. A t least 50 percent of it, is speculation. I f I t a l y starts to sell i t s gold stock, the m a r k e t could collapse. Our hope is t h a t American citizens w i l l now be able to buy gold. W h y should the Americans buy gold, i f i t is no more a secure investment? (ask L ' E x p r e s s ) . 66 So obviously a much higher gold price w o u l d again devaluate the dollar more tremendously and create a fantastic commodity speculation. The Commodity Exchange Inc., N . Y . , New Y o r k Mercantile Exchange, Chicago Mercantile Exchange, Chicago B o a r d of Trade are ready to trade i n gold and are w a i t i n g f o r the suckers. Now M r . Simon says, his first step is to fight inflation, but we cannot fight inflation i f we permit Americans to buy g o l d ; 75 countries do not permit their citizens to buy gold, i n c l u d i n g the U n i t e d K i n g dom, Australia, N o r w a y , and Denmark. The citizens of these countries do not lose their freedom because they don't have the r i g h t to buy gold. The French and German have the r i g h t , but we should not permit i t because the American is the most speculative. I f only a few m i l l i o n of Americans buy one ounce of gold, the gold price w i l l go up and then our commodities w i l l go up. Then I r a n w i l l again want to raise prices f o r their oil because the price they pay f o r soybeans and wheat, et cetera, w i l l go up. O n l y M r . Yamani, the oil minister of Saudi A r a b i a , sees the danger f o r the world's economy w i t h higher oil prices, but a l l the other o i l producers are more or less greedy. They want to give us a lesson t h a t we should reduce our standard of l i v i n g . B u t we feel we don't have to reduce our standard of l i v i n g — w e have to break this undeserved monopoly that ruins the Western W o r l d . W e have now an excellent foreign policy situation. W e have a f r i e n d l y relationship w i t h the most i m p o r t a n t o i l producer, Saudi Arabia. W e have the detente w i t h Russia and China. I r a n wanted to raise the price f o r natural gas to Russia. Russia buys this n a t u r a l gas and sells i t w i t h profit to Europe. A s Russia refused the higher price, I r a n doubled it. Russia is extremely dissatisfied, l i k e us, w i t h Iran's price policy. W e have now i n the key countries i n Europe, a change i n government, favorable to us. M r . Schmidt, the German Bundeskanzler w i l l make a more pro-American policy t h a n his predecessor. M r . Giscard D ' E s t a i n g , the smartest of the European politicians is not a French chauvenist. O n the contrary, he smashed the Gaullist P a r t y i n the shortest time since he came to power and is more pro-American than he admits to his people. W e should t e l l our European friends t h a t a break i n the price o f gold would have a long-range positive influence on their o i l imports, because the most important t h i n g now is t o break the oil price w h i c h went up about 400 percent since last year w i t h no end i n sight. Over 700 percent since 1970. I f we sell f r o m our gold stock—$111/0 billion—about $2 b i l l i o n — over $6 b i l l i o n at today's market price—it would s t i l l leave us w i t h a higher gold stock than France, Switzerland, England, and Japan. T h i s amount would break the gold price and would have a tremendous effect on the M i d d l e East countries which hoard gold. W h i l e France and Germany {nade b i g contracts w i t h I r a n , what France sold to I r a n w i l l take them 10 years to deliver, but the amount t h a t France w i l l sell to I r a n i n 10 years corresponds to a 1-year deficit i n their o i l imports. The new leaders i n Europe realize t h a t only a common policy w i t h the U n i t e d States can reestablish the situation and not g i v i n g i n to the oil producers i n every respect. 67 The underdeveloped countries are i n an extremely bad situation because o f the h i g h o i l price. They w i l l never be able t o pay f o r i t , and ask us f o r help. A l l these countries first supported the embargo of the o i l producers against us, ( but now they realize the damage t o their economy—they are most unhappy. I t is extremely important to help these countries, but before we can help them, they can help us w i t h strong moral pressure on the o i l producers, t o give up their greediness. I t is not satisfactory that the o i l producers offer t o loan them a trifle of their income. We, the U n i t e d States, w i t h our European allies and w i t h the underdeveloped countries have to force a showdown w i t h the greediness of the oil producers. O n l y recently A l g e r i a said, i f their new price f o r natural gas which is about three times the previous price, is not accepted, they w i l l start an embargo again, so France is most uphappy, and American companies which made contracts w i t h A l g e r i a do not have the slightest idea how these contracts w i l l be honored. I r a n wants to be the biggest power i n its area and place very b i g weapon contracts w i t h us. W e should, i n agreement w i t h our European allies, suspend all weapon deliveries to I r a n i f I r a n insist on higher oil prices. I n the meantime, weapon suppliers here should be paid by the Government, otherwise there w i l l be tremendous pressure not to suspend the deliveries, because of economic difficulties. I n the last analysis, i f the Shah of I r a n , whom the C I A brought back f r o m Rome to his throne, continues to be the leader i n asking f o r always higher oil prices and menacing to reduce production, we w i l l have to let h i m know that we can always make i n desperation, an agreement w i t h the Soviet Union. W e have to let h i m know that to save Western civilization and Western prosperity, i f he should continue i n his policy t h a t we w i l l have to remember the famous agreement of 1939. M r . Chairman, you took the leadership w i t h your committee t o look f o r solution i n our present crisis. I t would be i m p o r t a n t t h a t Congress does not permit i n the future, hysterical statements which are unfounded to go over the D o w Jones ticker and start a tremendous speculation which forces then policy decisions which are against our national interest. On February 6,1973 the D o w Jones ticker said: Monetary—Reuss—the dollar is patently overvalued again. O n February 9, M r . Reuss said: German export lobby likes the legalized dumping inherent in an undervalued mark. Washington had joined in this reckless process. Overstimulate German export which then fracture the jobs of American workers. On February 12,1973 the Dow Jones ticker said: Monetary—Reuss—we are of the view that parity of the dollar should be fixed by the market rather than the flat of central bankers. Since this time, all officials and private experts agreed that the February devaluation was unnecessary. There was never a German export lobby and there were no undervalued mark i n February 1973. B u t the result was that after our money was devaluated again, the oil producers started to raise their prices nearly every month to make up f o r their losses. O n l y the successive price capitulation o f the o i l 68 importers showed the o i l producers their political strength and started to give them the idea of the o i l embargo. I hope we w i l l not commit similar errors again. I hope you w i l l succeed t o b r i n g Congress to its senses and overturn the g o l d law which only play i n the hands of the o i l producers again 1 because of the new devaluation danger. O n l y w i t h strength can we break the o i l producers' unity. I n the last analysis, i f absolutely necessary, a cooperation w i t h Russia has to break Iran's o i l blackmail. [ T h e f o l l o w i n g articles, and letters were submitted by M r . K u r t z f o r inclusion i n the record:] [From the New York Times, January 17, 1974] P B I C I N G I M P A C T CALLED GLOBAL ENERGY E C O N O M I S T S A Y S R E S U L T M A Y BE DEPRESSION (By William D. Smith) Unless t h e s h a r p l y h i g h e r p r i c e s recently imposed by t h e o i l - p r o d u c i n g count r i e s a r e q u i c k l y cut t o a level t h a t t h e oil-consuming countries can a f f o r d t o pay, t h e e n d r e s u l t w o u l d be a g l o b a l depression, a c c o r d i n g t o W a l t e r J. L e v y , one of t h e w o r l d ' s l e a d i n g energy economists. M r . L e v y , a c o n s u l t a n t t o b o t h governments a n d companies, i s n o t p a r t i c u l a r l y sanguine a b o u t t h e possibilities o f s o l v i n g t h e problem. " T h e t i m e t o a c t w a s y e s t e r d a y , " he s a i d i n a n i n t e r v i e w . " T h e seriousness of t h e s i t u a t i o n c a n n o t be exaggerated." A p o i n t o f c r i t i c a l importance, he said, i s t h a t a reasonable balance be s t r u c k between t h e u l t i m a t e p r i c e f o r o i l a n d t h e i m m e d i a t e foreign-exchange cost t h a t w o u l d have t o be met. H e declined t o specify w h a t he t h o u g h t w o u l d be a f a i r price. P r o d u c e r n a t i o n s have q u a d r u p l e d prices i n t h e l a s t three m o n t h s . I f a n u n d e r s t a n d i n g can be w o r k e d o u t j o i n t l y between consumer a n d p r o d u c e r n a t i o n s i t s h o u l d be possible to a l l e v i a t e m a n y of adverse effects n o w a n t i c i p a t e d , M r . L e v y said. A s a first step, M r . L e v y calls f o r i n t e r n a t i o n a l cooperation a m o n g oil-consumi n g n a t i o n s , as he has been since November, 1972, w h e n i n a speech t o t h e A m e r i c a n P e t r o l e u m I n s t i t u t e he u r g e d a "concerted e f f o r t by t h e U n i t e d States a n d W e s t e r n E u r o p e a n governments a n d t h e i r i n d u s t r i e s t o t r y t o p r o t e c t as best they c a n t h e i r security a n d p r o s p e r i t y w h i c h depends so decisively on energy a v a i l a b i l i t y on acceptable p o l i t i c a l a n d economic t e r m s . " On P r e s i d e n t N i x o n ' s i n v i t a t i o n , a conference of oil-consuming n a t i o n s w i l l be h e l d Feb. 11 i n W a s h i n g t o n . Members of t h e E u r o p e a n Economic C o m m u n i t y have j o i n t l y accepted t h e i n v i t a t i o n , w h i c h w e n t also t o Canada, J a p a n a n d Norway. M r . L e v y asserted: " T h e h i g h prices t h a t t h e O r g a n i z a t i o n of P e t r o l e u m E x p o r t i n g C o u n t r i e s have been able t o e x t r a c t f o r t h e i r o i l m a y r e s u l t i n d i s r u p t i v e t r a d e a n d m o n e t a r y policies i n c l u d i n g c u r r e n c y r e s t r i c t i o n s as w e l l as social a n d p o l i t i c a l upheavals t h a t w i l l be most h a r m f u l t o b o t h o i l - p r o d u c i n g a n d oil-consuming c o u n t r i e s . " SPREADING CONSEQUENCES T h e strongest c a r d consumers have is t o m a k e t h e p r o d u c i n g n a t i o n s a w a r e t h a t t h e y w i l l suffer t h e same t e r r i b l e consequences as t h e i n d u s t r i a l i z e d n a t i o n s i f t h e w o r l d economic system crumbles, M r . L e v y said. Some believe t h a t t h i s is w h y S a u d i A r a b i a ' s O i l M i n i s t e r , Sheik A h m e d Z a k i a l - Y a m a n i is r e p o r t e d t o have s a i d recently t h a t the p r i c e of o i l is n o w too h i g h a n d t h a t t h e p r o d u c t i o n cutbacks o f t h e A r a b p r o d u c i n g n a t i o n s h a v e been too severe. M r . L e v y asserted t h a t t h e enormous increases i n w o r l d o i l prices since m i d October t h r e a t e n t o d i s r u p t t h e economic a n d m o n e t a r y s t r u c t u r e o f a l l o i l - i m p o r t i n g countries i n 1974 a n d t h a t because o f t h e w o r l d ' s economic interdependence, n o n a t i o n w o u l d be able t o escape t h e consequences. 69 COST L I M I T S T h e economist s a i d t h a t t h e r e w e r e r e a l l i m i t s on t h e a b i l i t y of c o n s u m i n g countries t o meet added costs o f o i l i m p o r t s o u t of c u r r e n t m o n e t a r y reserves or increased e x p o r t earnings. " T h e balance w o u l d h a v e t o be covered by c a p i t a l flow f r o m o i l - p r o d u c i n g countries r e s u l t i n g i n a b u i l d u p i n financial c l a i m s on t h e o i l - i m p o r t i n g countries, b u t t h i s w o u l d t a k e place over a r e l a t i v e l y s h o r t p e r i o d of t i m e a n d o n a n unprecedented scale," he continued. " T h e r e s u l t i n g s t r a i n s on i n t e r n a t i o n a l financ i a l m a r k e t s a n d i n s t i t u t i o n s w o u l d be e x t r e m e l y g r e a t " W h a t w o u l d r e a l l y be i n v o l v e d w o u l d be a massive t r a n s f e r of w e a l t h f r o m o i l - i m p o r t i n g t o o i l - e x p o r t i n g countries. T h e o i l - e x p o r t i n g countries w o u l d become owners of a r a p i d l y i n c r e a s i n g share of the economic resources of the rest of t h e w o r l d based on w h a t is f u n d a m e n t a l l y a monopolist r e n t f o r t h e i r o i l resources a m o u n t i n g t o some 50 t o 60 times the a c t u a l cost of p r o d u c i n g t h e i r oil. " M o r e o v e r , as revenues f r o m t h e governments of o i l - e x p o r t i n g countries, investments made w i t h these f u n d s i n o i l - i m p o r t i n g countries w o u l d be pred o m i n a n t l y owned a n d c o n t r o l l e d by f o r e i g n governments. I t is u n l i k e l y t h a t t h i s state of a f f a i r s could p r o v i d e a stable basis f o r the w o r l d economy or w o u l d prove acceptable to t h e i n d u s t r i a l i z e d countries." " R O L L B A C K " NEEDED M r . L e v y said t h a t i n order to c o n t a i n the serious, i f n o t disastrous, economic i m p a c t of the o i l cost explosion, i t w o u l d be necessary t o " r o l l b a c k " o i l prices to a level t h a t could be managed by the v a r i o u s i m p o r t i n g countries w i t h o u t severe economic dislocations a n d possibly even a w o r l d w i d e depression—"indeed a most d i f f i c u l t u n d e r t a k i n g , " he conceded. A p r i c e r o l l b a c k should be h a n d l e d on t w o l e v e l s — t h r o u g h the establishment of a c o o r d i n a t i n g policy among the m a j o r o i l - i m p o r t i n g countries a n d t h r o u g h discussions, r e v i e w a n d negotiations w i t h the i m p o r t a n t p r o d u c i n g nations. Some idea of the staggering increase i n costs to the c o n s u m i n g nations is given i n a s t u d y by M r . L e v y ' s c o n s u l t i n g firm. I t presents d a t a on the cost of o i l imports, exclusive of t r a n s p o r t a t i o n a n d r e l a t e d charges, f o r 1972 a n d shows t h a t costs i n 1974 f o r i m p o r t s a t t h e 1972 v o l u m e w o u l d be f o u r or more times higher. T h e figures, i n b i l l i o n s of dollars, f o l l o w : 1972 1974 U n i t e d States 5 21 Western Europe 11 51 Japan 4 16 On the same basis, government revenues of the o i l - p r o d u c i n g n a t i o n s i n the M i d d l e E a s t w o u l d increase f r o m $9-billion i n 1972 t o about $5.7-billion i n 1974. I r a n ' s income f r o m o i l w o u l d go f r o m $2.5-billion t o $16-billion a n d Venezuela's revenues w o u l d c l i m b f r o m under $2-billion to about $10-billion. T h e increased cost of o i l i m p o r t s w o u l d p l a y havoc w i t h balances of payments a n d reserves of f o r e i g n exchange. I n the case of the U n i t e d States, t h e i n d i c a t e d 1974 level of o i l i m p o r t s w o u l d be enough t o s w i n g the t r a d e balance f r o m surplus i n t o a $13-billion deficit, m o r e t h a n the n a t i o n ' s t o t a l gold a n d foreign-exchange holdings. T h e increased cost f o r J a p a n w o u l d almost equal her gold a n d foreignexchange holdings of $13-billion as of October, 1973. [From the Wall Street Journal, April 11, 1974] F O R E I G N E X C H A N G E A B U S E S BY S O M E B A N K S ALLEGED A T CONVENTION, SPURRING DEBATE ( B y Charles N. S t a b l e r ) San Diego, C a l i f . — I s t h e g i a n t , w o r l d - w i d e m a r k e t f o r e x c h a n g i n g n a t i o n a l currencies being rigged? Some i n t e r n a t i o n a l bankers here f o r t h e a n n u a l convention of t h e B a n k e r s Association f o r F o r e i g n T r a d e say, t h e a n s w e r is yes. I n a n unusual, l a s t - m i n u t e press b r i e f i n g c a l l e d by convention officials, several bankers w a r n e d t h a t c e r t a i n banks are d i s r u p t i n g t h e f o r e i g n exchange m a r k e t t h r o u g h excessive speculation. 70 "The abuses are picking up in speed, size and importance," warned George H . Chittenden, senior vice president of New York's Morgan Guaranty Trust Co. H e described some recent market activity, which has caused large and rapid changes in currency values, as "almost sinister." Mr. Chittenden and other bankers a t the press conference called for tighter self-policing of the market. I n private talks during the convention, some other bankers have cited what they refeT to as "combines" or "syndicates" of banks, mainly West German and Swiss, which apparently engage i n concerted attacks on the market "It's a kind of pooling operation, where they suddenly flood the market with orders, driving up the price of say, the German mark a few points—and there is no way you can go against it," complains one U.S. banker. A G B A I N OF ,$ALT But some other bankers here take such warnings with a grain of salt. For example, Arthur Meehan, an international executive of Boston's New England Merchants National Bank, discounts talk of market manipulation. H e describes the wide fluctuation in currency rates as a natural outgrowth of the floating rate system, in which currencies fluctuate largely, according to market forces. Mr. Meehan also noted that European bankers traditionally are willing to take big risks in the foreign exchange market, "American banks are much more conservative," he says. For example, a foreign exchange trader at a major U.S. bank would normally be restrained from taking a risk in a single currency of more than $20 million or so. For a German or Swiss bank, exposed positions of up to $500 million wouldn't be uncommon, bankers here say. One foreign banker here suggests that even for German banks this kind of risk taking is currently declining. Diether H . Hoffman, a director of a major Dusseldorf bank, says: " I would think i t isn't much of a problem now, because some sizable losses were taken by some banks late last year." I n addition, some executives of smaller U.S. banks here say they suspect that warnings of problems in the foreign exchange market by major banks may just be calculated to frighten off competitors. " I think the New York banks sometimes aren't above issuing pious warnings about possible dangers in this or that market just because they want to hang onto a good thing," says one Georgia banker. A t the press conference, neither Mr. Chittenden nor other participants suggested that possible abuses of trading were widespread. However, Robert F . Leclerc, vice president of Continental Bank International, an affiliate of Chicago's Continental Illinois Corp., said the speculating banks were taking positions large enough to artificially influence exchange rates. Mr. Leclerc is head of the Forex Association of North America, a professional association. Mr. Leclrec blamed the problem on top-level management of some banks rather than the traders themselves. H e said some banks are putting intense pressure on their trading departments in a search for "windfall profits." "When they expect a trader to make millions of dollars i n foreign exchange dealing, he can't do i t through normal business," he said. "You have got to go out and gamble." [From the Journal of Commerce, July 11,19741 CONTROLS P U T O N C U R R E N C Y M A R T T R A D E (By Jess Lukomski) Frankfurt—The Bundesbank evidently subscribing to the old tenet that "confidence is good but control is better" has moved to acquire from some 350 West German banking institutes full data on their foreign exchange transactions in forward trading. Compulsory registrations of such deals went into effect on July 1. This requirement provides the Bundesbank with full insight on the volume of forward trading in foreign exchanges and permits it to gauge the difference between delivery and purchase commitments made by the nation's banks. Moves i n this direction had been anticipated in the banking circles for some' time and came as no surprise. But a distinct possibility that the Bundesbank might take in the future even bolder and tougher steps to control foreign exchange activities is of considerable concern here. 71 REASONABLE LIMITS Since the Bundesbank feels r a t h e r strongly t h a t " t h e risks connected w i t h f o r w a r d t r a d i n g i n f o r e i g n exchanges must be kept w i t h i n reasonable l i m i t s , the extension of i t s new regulations to foreign subsidiaries of German b a n k i n g institutes cannot be r u l e d out—point out foreign exchange m a r k e t sources. The decision of the F r a n k f u r t monetary managers to supervise more closely foreign exchange dealings of commercial banks has been triggered by t h e i r enormously intensified involvements i n this field. German bankers have grasped early i n the floating game t h e i r d w i n d l i n g earnings i n the classical lending business suffering under the " b r u t a l l y restrict i v e credit policies pursued by t h e Bundesbank" could be compensated by highly l u c r a t i v e f o r e i g n exchange transactions. The 1973 business reports of the big German commercial banks show s t r i k i n g l y the enormous expansion of operations i n foreign exchange and they reveal to w h a t extent the handsome profits f r o m those dealings have enriched t h e i r overall earnings. 50 PERCENT G A I N The Deutsche B a n k transactions i n foreign currencies have reached last year DM778 billion, a sum w h i c h is equivalent to West German G N P i n 1971. I n the past t w o years the f o r e i g n exchange business registered a 50 percent gain w h i l e the number of people employed i n this field was increased by one-fifth. The Commerzbank w h i c h employs today nearly one-third more foreign exchange experts t h a n t w o years ago managed to expand its t u r n o v e r by 27 percent i n 1972 and another 20 percent i n 1978. A n d the Dresdner Bank's f o r e i g n exchange deals rose by 50 percent last year alone w i t h only a slight u p w a r d adjustment i n the number of employes w o r k i n g i n this field. T h i s development is not unique to the three big German commercial banks, the Girozentrale or savings banks, and the cooperative banking associations have plunged i n t o foreign exchange transactions to j o i n i n the biggest game i n the b a n k i n g business." W i t h most w o r l d currencies floating more or less cleanly the range f o r speculative transactions is almost u n l i m i t e d and temptations t o engage i n them often irresistible. German bankers insist t h a t "speculation i n foreign exchange t r a d i n g is taboo." There is no firm evidence suggesting t h a t this claim is exaggerated. Yet the very r i s k o f miscalculating the development on the foreign exchange m a r k e t is f o r m i d able and even decisions based allegedly on nonspeculative consideration can be extremely costly. PAINFUL MISTAKE The Westdeutsche Landesbank Girozentrale made a p a i n f u l mistake last year by miscalculating the f u t u r e development on the foreign exchange markets a n d had to pay a DM100 m i l l i o n penalty f o r its misjudgment. The f a i l u r e of the large p r i v a t e H e r s t a t t bank is another case i n point. I t was said t o have lost w e l l i n excess of any other bank here or elsewhere as a result of unauthorized dealings i n foreign exchange. I t seems t h a t German commercial banks have not overlooked the clear w a r n i n g t h a t the chance of m a k i n g a k i l l i n g on foreign exchange dealings is not any greater t h a n the r i s k of being caught short. I n days of fixed exchange rates w i t h the central banks pledged to support the parities both the chances of m a k i n g spectacular gains and risks of absorbing heavy losses were n a r r o w l y "defined" by the central banks obligation to intervene. Today this obligation applies to a h a n d f u l o f currencies floating j o i n t l y i n the European "mini-snake," and costly miscalculations i n t r a d i n g i n a l l other foreign currencies must be seriously considered. T h i s does not mean at a l l t h a t German commercial banks are abandoning foreign exchange dealings, but the developments i n the past several months suggest t h a t they have become more cautious even though t h e i r less hectic a c t i v i t y i n t h i s area has been strongly influenced by tapering off Euro-money m a r k e t business w h i c h i n the past has tended to trigger m u l t i c u r r e n c y transactions. Some German bankers suggest t h a t the decision of the Bundesbank t o supervise more closely banks' f o r w a r d t r a d i n g on the foreign exchange market m i g h t reinforce f u r t h e r this trend. 72 T H E W H I T E HOUSE, Washington, February 5,1968. M B . VICTOB K U R T Z Elvic Import Corp., 15 West 88th Street, New York, N.Y. D E A R M B . K U B T Z : Many thanks for your follow up note of January 3 0 . 1 think i t might be helpful if you would be willing to run down sometime and discuss your views with Ed Fried who is the Senior International Economist on the White House staff and who stays on top of the gold problem for us on a day-today basis. M r . Fried will await your call and set up an appointment with you. Sincerely, JOSEPH A . CALIFANO, Jr., Special Assistant to the President. CONGBESS OF T H E U N I T E D S T A T E S , H O U S E OF R E P B E S E N T A T I V E S , Washington, D.C., August 16,1969. M r . VICTOB K U B T Z , Elvic Import Corp., 15 West 88th Street, New York, N.Y. D E A B M B . K U B T Z : Thank you very much for your support of my position against the unnecessary increase in the prime lending rate. I hope you realize how much the support of the people means on an issue like this. High interest rates are a destructive force and they can be brought down only if the people are willing to take the time to make their voices heard against the special interests. I hope sincerely that you are letting other people know about your feelings on this very vital issue. Enclosed is a speech which I recently made on this prime rate increase. Sincerely, WBIGHT PATMAN. U N I T E D STATES SENATE, Washington, D.C., May 5,1911. M r . VICTOB K U B T Z , Elvic Import Corp., 15* West 88th Street, New York, N.Y. D E A B M B . K U B T Z : I certainly appreciated your recent message and I wanted to let you know that I value very much the points you made. I t is vital for me to get the thoughts and opinion of people like yourself. I t helps me make up my mind on the vital issues which the Senate must decide. Once again, thanks so much for letting me know what you think and I appreciate your taking the time and effort to write to me as you did. Best wishes. Sincerely, W I L L I A M PBOXMIBE, U . S . S . 73 CONGRESS OF T H E U N I T E D S T A T E S , JOINT ECONOMIC COMMITTEE, Washington, D.C., October 4,1971. M r . VICTOR K U R T Z , Elvic Import Corp., 15 West 38th Street, New York, N.Y. D E A R M R . K U R T Z : Thank you for your letter of the 23rd. I appreciate your including the detailed recommendations you have prepared on suggested ways for overcoming the present international monetary crisis. I have passed these recommendations on to the Joint Economic Committee staff for their review and appraisal. Sincerely, WILLIAM PROXMIRE, Chairman. M r . H A N N A [presiding]. I appreciate y o u r statement I t h i n k we need t o a d j o u r n n o w , subject t o t h e call o f the C h a i r . [ W h e r e u p o n , at 1:10 p.m., the subcommittee was adjourned, subject to the call of the Chair.] INTERNATIONAL PETRODOLLAR CRISIS TUESDAY, AUGUST 13, 1974 H O U S E OF R E P R E S E N T A T I V E S , SUBCOMMITTEE ON INTERNATIONAL FINANCE OF T H E C O M M I T T E E O N B A N K I N G A N D CURRENCY, Washington, D.C. T h e subcommittee met, pursuant t o notice, a t 10:15 a.m., i n r o o m 2128, R a y b u r n House Office B u i l d i n g , H o n . H e n r y B . Gonzalez (chairm a n o f the subcommittee), presiding. Present: Representatives Gonzalez, Reuss, F a u n t r o y , S t a r k , J o h n son, Crane, and Burgener. M r . G O N Z A L E Z . T h e subcommittee w i l l come t o order. I n order t o conserve t i m e , and I apologize f o r t h e lateness o f the hour i n g e t t i n g started—first, Governor W a l l i c h , m a y I t h a n k y o u f o r t a k i n g t i m e t o be w i t h us and f o r an obviously v e r y good statement. I m i g h t p o i n t out t o y o u t h a t at the latest count t h a t I made—and I could be a l i t t l e b i t m e r r o r on the conservative side—there were over 17 committees, subcommittees on C a p i t o l H i l l i n t h e Congress g o i n g i n t o some general aspects of the m a i n thesis t h a t we outlined t o y o u i n the letter when we i n v i t e d you. However, t h i s subcommittee has more of a direct relationship w i t h the aspects o f t h e problem, the o i l price increase, the concomitant problems a t t e n d i n g t h a t , because i t has been i n t h i s area o f o u r legisl a t i v e l i f e t h a t we have h a d t o deal w i t h such t h i n g s as the devaluation o f the dollar. W e w i l l have t o continue t o decide how we are g o i n g t o a r r i v e at a continuation o f our policy w i t h respect t o t h e internat i o n a l financial institutions t h a t we have c o m m i t t e d ourselves t o bel o n g i n g t o f o r some time. Recently, we h a d the I D A b i l l , and we w i l l have t o c o n f r o n t the question o f t h e A s i a n Development B a n k b i l l , w h i c h t h i s subcommittee approved and f o r w h i c h we obtained a rule last J a n u a r y t h a t is p e n d i n g before the House. However, i t may be t h a t we have reached a p o i n t where the Congress has got t o , i n the l i g h t o f developments, reevaluate a n d reappraise t h i s basic policy i n v o l v e d i n i t s belonging to these i n t e r n a t i o n a l financial institutions. Today's hearings are a continuation o f those t h a t we i n i t i a t e d earlier. T o d a y , i n continuance thereof, we are very p r o u d t o have y o u as an o u t s t a n d i n g witness. I n J u l y we pointed out t h a t some o f the i n t e r n a t i o n a l monetary and economic results o f t h i s f o u r f o l d increase i n w o r l d o i l prices, the accumulation o f massive amounts o f excess capital b y the members o f the O r g a n i z a t i o n o f Petroleum E x p o r t i n g Countries really poses a c o n t i n u i n g problem, i f not a threat, t o every one o f us. (75) 76 I , for one, since long before I thought I would be a chairman of the subcommittee, have been very much concerned about the fact t h a t the Congress seems t o have very l i t t l e role except as an after-the-event agent such as we d i d i n the case o f devaluation. W e were asked t o come i n and present on two different occasions a par-value modification b i l l . W e have been asked on diverse occasions to come i n w i t h these bills on the w o r l d financial international institutions, and each t i m e i t becomes increasingly difficult f o r us to assure the administration, which, i n t u r n , tells us t h a t these programs are a must f o r the basic national policy, to obtain an adequate congressional reception and approval. Since our last hearing we have had additional data t h a t has been presented t o us. W e have had very interesting material presented by various individuals who appear to be experts i n this area. They are a l l very disturbing and w i t h o u t any objection, I would like at this point to introduce into the record excerpts f r o m an article i n the Washington Post and one by W a l t e r J . Levy i n the J u l y F o r e i g n A f f a i r s , just very brief excerpts, not over t w o paragraphs. [ T h e excerpts f r o m the articles t h a t appeared i n the Washington Post and the J u l y edition of Foreign A f f a i r s , f o l l o w : ] [Excerpt from an article in the Washington Post] A n a r t i c l e i n The Washington Post said t h a t a W o r l d B a n k s t u d y estimates t h a t by 1980 the accumulated reserves of O P E C countries w i l l 'be $653 b i l l i o n ( c o m p a r e d w i t h $20 b i l l i o n i n 1973) a n d w i l l be $1.2 t r i l l i o n by 1985. T h e s t u d y s a i d t h a t t h e excess reserves of K u w a i t , Q a t a r , S a u d i A r a b i a a n d t h e U n i t e d A r a b E m i r a t e s w i l l be a b o u t $1 t r i l l i o n by 1985. [Excerpt from an article in the July edition of Foreign Affairs by Walter J. Levy] Today, governments are w a t c h i n g an erosion o f the w o r l d ' s o i l supply a n d financial systems, comparable i n i t s p o t e n t i a l f o r economic a n d p o l i t i c a l disaster t o the G r e a t Depression of the 1930's, as i f they were h y p n o t i z e d i n t o i n a c t i o n . T h e t i m e is late, the need f o r a c t i o n o v e r w h e l m i n g . I n sum, the short-to-medium t e r m i m p l i c a t i o n s of the present s i t u a t i o n are s i m p l y n o t bearable, either f o r the o i l - i m p o r t i n g countries—especially t h e n a t i o n s a l r e a d y needy—or f o r the w o r l d economy as a whole. . . . T h e f a c t is t h a t t h e w o r l d e c o n o m y — f o r the sake of everyone—cannot s u r v i v e i n a h e a l t h y or r e m o t e l y h e a l t h y c o n d i t i o n i f c a r t e l p r i c i n g a n d a c t u a l or t h r e a t e n e d supply r e s t r a i n t s o f o i l continue on the trends m a r k e d out by the new s i t u a t i o n . M r . 'GONZALEZ. Therefore, perhaps w i t h not a lot of ado and publ i c i t y , but nevertheless, w i t h a background of what I consider to be considerable importance and interest to those of us that serve on this level, we welcome our witness, Hon. H e n r y C. W a l l i c h , member of the B o a r d o f Governors of the Federal Reserve System, this morning. Once again, thank you f o r t a k i n g the time out. I am going to suggest t h a t M r . Johnson, who is our m i n o r i t y r a n k i n g member, make use of the mike i f he wishes, and then I w o u l d say t h a t you may proceed i n one of t w o ways. I t is up to you. Y o u have an excellently prepared statement. I f you wish to read i t , t h a t is fine. I f you wish to summarize i t , well, you use your discretion. M r . Johnson ? M r . J O H N S O N . Yes. I , too, want t o welcome you here this morning:, M r . Wallich. 77 I cannot help b u t compliment the Fed f o r the great cooperation we have received f r o m you people i n the last month. W e have had, I believe, practically every president of the Federal Reserve bank i n the U n i t e d States i n here to testify. O f course, D r . Burns has been here frequently and comes at the slightest request. W e are very glad t o welcome you here this morning. T h a n k you. M r . G O N Z A L E Z . Does any other member wish to make a prefatory remark? I f not, M r . W a l l i c h , you have the floor and we welcome you. STATEMENT OF HON. HENRY C. WALLICH, MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM M r . W A L L I C H . T h a n k you very much, M r . Chairman. I appreciate your remarks, and I also appreciate your offer t o let me summarize the statement. I t is perhaps unduly long, and so I would like to ease the task of going t h r o u g h i t f o r the subcommittee members, i f I may, by summarizing. The text I have submitted is, of course, m y official statement. M r . G O N Z A L E Z . Fine. F o r the record we w i l l just permit you to subm i t the entire statement, which w i l l appear i n the record as you prepared it. M r . W A L L I C H . T h a n k you very much, M r . Chairman. I t h i n k I do not need to go into much detail about the nature of the international balance-of-payments surplus of the oil-exporti n g "countries. I t is a subject t h a t has been widely discussed. These countries are likely t o have something like $100 b i l l i o n of revenues f r o m their o i l exports, an increase on the order of $80 billion. This leads to a surplus i n their transactions on the order of $50 b i l l i o n to $60 billion, because some of the exporting countries, at any rate, w i l l ntft be i n a position to increase their imports enough t o absorb the proceeds of their increased exports. This likewise leads, of course, to a very great increase i n the b i l l f o r oil of the o i l - i m p o r t i n g countries. W i t h some exceptions f o r a few countries whose o i l production and o i l needs are well balanced, this includes a l l countries t h a t are not net o i l exporters. T h i s situation leads almost necessarily to a deficit on trade account f o r these countries. Several types o f responses have been suggested to this unprecedented situation. One that is very important is our domestic supply response. W e have entered into Project Independence aimed to reduce, and hopef u l l y eliminate, our dependence on imported oil. This effort w i l l help us. I t w i l l help the rest of the world. A l t h o u g h I regard i t as a major policy response, I w i l l not focus on i t today because I do not t h i n k it, is germane to the discussion here. A second suggested response on the p a r t of the U n i t e d States and other i m p o r t i n g countries arises f r o m the concept that i n the increased prices f o r o i l they find themselves confronted w i t h what is very simi l a r to atn excise tax on oil. I f the current rise i n the cost of oil were due to the action of the government of an i m p o r t i n g country, i t would have the same effect as an excise tax. B u t i n the present case the proceeds go abroad. T h i s quasi-oil tax, first, has the effect of reducing aggregate demand. I n itself, i n a period of inflation, this effect is by no means a bad thing. 37-211 O - 74 - 6 78 B u t , as t i m e goes on inflationary forces are brought under better cont r o l , we w i l l need to watch the deflationary implications o f t h i s — I say i t i n quotation m a r k s — " o i l t a x . " B y reducing demand i n the economy, this quasi-tax w i l l make room f o r some substitute demand. T h i s could take the f o r m o f more investment. A d d i t i o n a l investment w i l l be both appropriate and needed, first t o take u p slack i n demand as w o r l d inflationary forces are brought under control, and second because i t is needed t o b r i n g about new o i l production. T h e problems o f g r o w t h also require i t . F i n a l l y , there is the tact t h a t inflation w i l l be better contained i f we have the larger capacity t o produce t h a t added investment can provide. There is, therefore, an o p p o r t u n i t y here as well as great risks. T h a t o p p o r t u n i t y is more investment and more growth. T h e risks I w i l l deal w i t h i n greater detail. T h e present situation concerns the O P E C countries as w e l l as the o i l i m p o r t i n g countries because both are interested i n w o r l d stability and the soundness o f our financial markets and institutions. B u t the o i l i m p o r t i n g countries have an unavoidable deficit i n the short run. A corollary of this unavoidable deficit is t h a t there is also automatic financing o f i t . T h i s has been much discussed. I n measure as the exp o r t i n g countries act t o create surpluses, they cannot avoid the necessity of p u t t i n g the proceeds of these surpluses somewhere. Wherever these proceeds go, they can be borrowed. B u t what is sometimes overlooked is t h a t they cannot be borrowed b y everybody. I t takes good credit standing i n order t o have access t o these funds. There is thus an automatic recycling i n the aggregate, t h a t is, f o r the o i l - i m p o r t i n g countries as a group. B u t this automatic financing of deficits is b y no means available t o every country, nor f o r every i n s t i t u t i o n t h a t wants t o participate i n the market. T h e unavoidability of a sizable aggregate deficit f o r the oilimporters has another implication. I f some countries t r y to reduce these deficits to zero, and do i t very aggressively, they are l i k e l y to reduce t h e i r own deficit by increasing t h a t of some other countries. T h i s is because the O P E C countries cannot, i n the short r u n , buy a great deal more t h a n they were already likely t o do. I f country A cuts down its deficit, i t probably does so at the expense of country B , b y policies t h a t c u r t a i l the exports, or drive u p the imports, of country B . So we may see a game of musical chairs played w i t h the deficit. T h a t does not mean the i m p o r t i n g countries should not watch t h e i r balance of payments. I n particular, they should t r y t o eliminate those payment deficits t h a t result f r o m payments f o r things other t h a n oil. There have been many balance-of-payment deficits i n recent years, before the cost of o i l became an unavoidable source of deficits. Some of these have been large deficits. B u t over and above elimination of non-oil deficits, the o i l deficits have to be accepted—by someone. There is a real problem where these deficits are g o i n g t o end up. Moreover, i t is not clear that this is a situation w h i c h can be smoothly adjusted to w i t h o u t a decrease i n the price of oil. A decrease w o u l d undoubtedly greatly ease a l l aspects of the situation. A m o n g the i m p o r t i n g countries there is a group t h a t is worse h i t t h a n others. Some of them are developing countries. Others are those of the i n d u s t r i a l countries t h a t have special difficulties i n dealing w i t h t h e i r deficits. These are problems t h a t give one pause. 79 The problems of the less developed countries exclude such questions as the question whether 1 they are going to have enough food. O i l leads to fertilizer, fertilizer leads to food. I f a country cannot i m p o r t enough o i l or i f i t cannot i m p o r t enough fertilizer instead of m a k i n g i t at home f r o m oil, there is a consequence f o r its food supply. T h i s affects the price of food throughout the world. W e are thus a l l involved i n the problems of the developing countries. I n d u s t r i a l countries, i n some cases, face very large deficits because their a b i l i t y to reduce their use o f o i l is limited. T h i s is the case when a country does not have a large automobile population, or i t does not use o i l f o r a number o f uses t h a t are compressible. I n such cases the problem of the increased cost o f o i l hits their industrial output and creates problems there. I w i l l come back t o some of those problems i n a minute. F i r s t , let me say a couple o f words about the U.S. balance o f payments, as a p a r t o f this overall picture. W e have done very well i n the improvement o f our balance o f trade. A f t e r the successive devaluations t h r o u g h the end o f 1973, we achieved a surplus at an annual rate of a l i t t l e over $4 billion. B u t that has now been converted into a deficit on the order of $7 b i l l i o n by the middle o f the present year. I f we eliminate f r o m this deficit the increased cost o f oil, and i f we also leave out of account the special advantages we have had f r o m h i g h prices on our agricultural exports, we see t h a t there has been a real underlying structural improvement i n our trade situation on the order o f $11 b i l l i o n per annum. I do not say this as an excuse f o r the deficit. T h e deficit is there. B u t i f we want to see the underlying structure o f our foreign trade, then we have to make this calculation, and i t does show a substantial u n d e r l y i n g improvement. A t the same time, we have seen significant fluctuations i n the rate of the dollar. T o some extent these fluctuations reflect trade and payment developments. T h e most h e l p f u l view is not the dollar's relationship to this or t h a t currency, but is, rather the so-called effective rate. This is the weighted average of our dollar exchange rate w i t h respect to many other currencies. T h a t is, I find the f a m i l i a r representation o f the exchange market— the dollar is down, the dollar is up, i t is d o w n again w i t h respect to one or only a few currencies—largely misleading. I f we look at the average, at the effective rate, we see t h a t the dollar's exchange value is d o w n about 17 percent compared to the period before the revision o f the whole exchange rate structure. T h a t 17 percent refers to the industrial countries. W h e n we look at the w o r l d as a whole—including both industrial and developing countries—the exchange rate o f the dollar is down only 12 percent. The reason, i n particular, is t h a t developing countries have acted to keep their currencies closer to the dollar. I t is m a i n l y the industrial countries t h a t have appreciated, especially Europe and Japan, t h a t have let their currencies appreciate w i t h respect to the dollar. T h e dollar was down severely f o r p a r t o f last year, then up quite sharply early this year; down a l i t t l e again, and has now been quite stable f o r some time. W e have been helped i n l i v i n g w i t h these fluctuations b y the system o f floating rates. I n fact, i t is h a r d to see how, w i t h o u t floating rates, 80 we would have handled the situation. O n the other hand, floating rates generate problems o f t h e i r own, and we cannot ignore them. T h e y are problems special to this new financial regime. Before floating exchange rates became general, one concern was t h a t i n a regime o f floating rate countries would t r y to gain export advantages by a l l o w i n g their currencies t o depreciate. B u t , i t is interesting t o observe t h a t this has not happened. O n the contrary, i f I read the record correctly, countries have been eager to see their exchange rates remain high. I believe t h a t the motivation is a conviction t h a t keeping the exchange rate h i g h is a means of helping to h o l d down inflation. T h e higher the exchange rate, the less is the cost o f imports, and the less imports affect the price level. T h i s has removed some of the concern about floating rates. O f course, we cannot be sure that the situation is going t o stay as i t is. I f w o r l d conditions change, i f demand i n w o r l d markets diminishes, countries m i g h t begin to adopt different policies. I t is fortunate, therefore, t h a t i n t h i s picture of floating rates the Committee of T w e n t y of the I M F has proposed a set of guidelines f o r floating. T h e aim is to help i n l i m i t i n g extreme fluctuations, and i n avoiding inappropriate intervention, or intervention at cross purposes. L e t me t u r n now t o the financial consequences of the o i l deficit and the capital flows associated w i t h i t . F o r e i g n direct investment i n the U n i t e d States has been high. P o r t f o l i o investment has been relatively quiescent. B a n k investment— both bank lending abroad and the i m p o r t of funds t h r o u g h our banks— have expanded. T h e t w o amounts come f a i r l y close t o offsetting each other. These developments reflect both the removal early this year of restrictions on international capital movements and effects of the o i l financing needs of other countries. I t is perhaps of some interest t o p o i n t out t h a t these international capital movements i n t o and out o f the U n i t e d States do not change the volume of dollars i n this country. N o d o l l a r creation occurs due to such capital movements. W h a t happens is t h a t the foreigner, w i s h i n g to b r i n g capital t o the U n i t e d States, buys dollars f r o m an American who wants t o own foreign currency. I f there are no ready sellers of dollars on the American side, the effect o f the foreigner t r y i n g to buy dollars is to raise the exchange rate, t h a t is, to raise the price of dollars w i t h respect t o other currencies. B u t the number of dollars, w i t h some exceptions, is always the same. A n o t h e r easily demonstrated feature of the capital movements we are observing arises f r o m the fact t h a t capital is very mobile. Except i n those countries where there are restrictions on capital flows, we have an international capital market t h a t is only s l i g h t l y compartmentalized. T h a t reduces the importance of any particular dollar amount or amount of any u n i t of currency t h a t lodges i n any particular p a r t o f this market. I f money flows into, say, the U.S. compartment of the international capital market, i t w i l l have the effect of displacing capital t h a t is already there, or of discouraging other capital f r o m coming in. Thus, capital tends to be rather evenly distributed over the whole range of the market. 81 However, capital w o u l d not go where i t feels exposed t o excessive risks. T h a t is, lack o f compartmentation of the international capital market does not mean t h a t capital w i l l go everywhere. T h a t leads me t o say something about the O P E C countries as capital exporters. These countries are quite different f r o m t r a d i t i o n a l capital exporting countries i n the degree of their financial experience, i n the degree t o w h i c h they are likely to accumulate reserves, and i n the reserves of wealth—oil reserves—they now have. A l l this makes, of course, f o r policies potentially different on their p a r t f r o m those we know. W h a t we have observed so f a r is t h a t they have employed very cautious investment methods. They choose h i g h l i q u i d i t y , and very low risk assets. Also, they have acted responsibly as investors. T h a t leads one to ask how things are going t o develop i f O P E C money piles UP f u r t h e r and f u r t h e r i n the same markets and i n the same financial instruments. I t is h e l p f u l , I t h i n k , to compare magnitudes. W e are t a l k i n g about an O P E C flow of perhaps $50 to $60 b i l l i o n a year. Some of this w i l l not go into the international capital markets but into bilateral and other aid to the less developed countries, or into other nonmarket channels. The amount t h a t is l e f t w i l l go into markets which annually raise something on the order of $400 to $600 billion. T h a t is the magnitude of the credit raised by the nonfinancial sectors of national capital markets. I n the U n i t e d States the amount o f credit raised b y nonfinancial borrowers is some $200 billion. So the $50 b i l l i o n or thereabouts is considerably smaller than the annual flow into these markets. This leads us to hope t h a t the petrodollar funds w i l l be manageable. A similar impression arises when you look at the E u r o d o l l a r market, which was expanded by some $50 b i l l i o n i n 1973. W h a t we have, therefore, is not an overall problem, so much as • problems relating to the effects o f petrodollar flows upon particular markets, institutions, and countries. B u t these problems are serious— i n some cases, very serious. One aspect of the problem t h a t arises i n particular markets is t h a t interest rates w i l l change. I f an investor wants to invest i n only the highest grade assets he w i l l drive down interest rates on those assets. One t h i n g is clear—as I said before, an inflow of capital does not change the money supply, except i n special circumstances. So this does not affect the Federal Reserve's ability t o maintain its overall monetary policy. I f the flow of funds into a particular market is larger t h a n the increased payments resulting' f r o m o i l there w i l l be an impact on the exchange rate. I t w i l l raise the value of the local currency unless that country decides to recycle t h r o u g h its market. Most of the so-called recycling we have seen has taken place t h r o u g h the E u r o d o l l a r market, but of course recycling could take place t h r o u g h national money markets, including the U.S. money markets. T h e effect, however, of such recycling is that i t leaves the recycler i n the position of intermediary. H e has borrowed and he has lent. H i s f u t u r e is therefore tied u p w i t h the future o f his creditor and his debtor. There are advantages to that situation. B u t there could be disadvantages to countries t h a t get less capital than their o i l b i l l amounts 82 to. These countries have a variety of adjustment possibilities. T h e y can borrow f r o m surplus countries provided their credit standing is good enough. T h e y could borrow f r o m the O P E C countries or international institutions i f they are of a m i n d to lend. I w o u l d t h i n k t h a t i n p a r t i c u l a r l y difficult situations the O P E C countries, inasmuch as they are the cause of the situation, would feel a responsibility t o help. I n addition t o borrowing, there is a possibility of balance-of-payment adjustments. These could r u n the gamut f r o m moderate measures to very drastic measures, and possibly we w o u l d ultimately be forced to accept the idea t h a t there is no measure t h a t w i l l produce any tolerable situation. F o r any one financial i n s t i t u t i o n problems arise when depositors insist upon very h i g h l i q u i d i t y . W h e n funds are p u t i n t o an instit u t i o n m a i n l y on an overnight basis, this poses f a m i l i a r problems i n m a k i n g use of the funds. However, such institutions do have means o f defending themselves. T h e y can cut down the interest rate t h a t they pay and thereby make short-term deposits less attractive. T h e y can adapt the nature of the investments they make w i t h such money t o its characteristics. They can ultimately stop accepting such funds. H o w ever, t h a t means leaving p a r t of the problem t o the rest o f the market or t o official institutions. I n this respect, i t should be noted that private markets may not be able to handle the whole problem. T h e monetary authorities have an obligation t o see to i t t h a t markets function. They have to safeguard the l i q u i d i t y of markets even though they do not necessarily b a i l out every i n d i v i d u a l institution t h a t may have trouble. Thus, i n t h a t area where the l i q u i d i t y of markets is tending to disappear, or where markets begin to malfunction, there is a place at which p r i v a t e markets may not be able t o handle this problem, and i t w o u l d have t o be l e f t to some k i n d of official action. L e t me conclude, M r . Chairman, by getting back t o the domestic area. A l l of these problems would be greatly eased, of course, b y a reduction i n the price of oil. I t is certain t h a t they w o u l d be eased b y successful action against domestic inflationary forces, t h a t is, those not arising f r o m the increased cost of oil. T h a t is a key problem everywhere. F i n a l l y the petrodollar problems w i l l be eased b y whatever we can do t o step up the rate of investment i n the means of substituting f o r oil, and i n the economy generally. T h a n k you very much. [ M r . WaUich's prepared statement f o l l o w s : ] 83 Prepared Statement by Henry C. W a l l i c h Member, Board of Governors of the F e d e r a l Reserve System b e f o r e the Subcommittee on I n t e r n a t i o n a l of Finance the Committee on Banking and Currency U . S . House of Representatives August 13, 1974 84 Mr. Chairman and Members of the Subcommittee: I welcome the opportunity to discuss with you some of the problems created by the enormous increase i n the price of o i l i n the past y e a r . As a r e s u l t of t h a t increase, oil-consuming nations w i l l be paying out over $100 b i l l i o n a year to the o i l - e x p o r t i n g (OPEC) countries a t current prices and volumes, an increase of some $80 b i l l i o n i n the revenues of these countries i n one y e a r . Even a f t e r allowing for a steep r i s e i n t h e i r expenditures for imported goods and services, the OPEC countries w i l l be l e f t with a surplus of funds a v a i l a b l e for investment of some $60 b i l l i o n . This surplus w i l l almost c e r t a i n l y diminish as time goes by, e i t h e r because the price of o i l i s reduced to l e v e l s more compatible w i t h a s t a b l e world economy, or because the OPEC countries w i l l use a greater share of t h e i r increases to buy c a p i t a l and consumer goods and services from other countries, and to provide assistance to countries most severely a f f e c t e d by r i s i n g costs of o i l . Nevertheless, without t r y i n g to project i n t o the more d i s t a n t f u t u r e , we must address our a t t e n t i o n to the l i k e l i h o o d t h a t the OPEC countries w i l l have huge surpluses for some time to come. I n analyzing the consequences of t h i s enormous new flow of funds i n the world i t i s h e l p f u l to look f i r s t a t the r e a l impact on income and investment i n the consuming countries and then to consider the f i n a n c i a l problems r e l a t e d to managing t h i s flow of funds. These 85 two aspects of the o i l s i t u a t i o n are i n t e r r e l a t e d , of course, and i f the f i n a n c i a l mechanism does not prove equal to the demands t h a t w i l l be placed upon i t the consequences w i l l enormously aggravate the already severe problems of the r e a l sector. E f f e c t s on Economic A c t i v i t y The f i r s t immediate and obvious e f f e c t of higher prices paid for OPEC o i l i s t h a t funds are pulled out of the income stream i n the consuming countries, and, since as a group the OPEC countries cannot for some time spend more than a f r a c t i o n of these funds on current output, there i s a r e l a t i v e reduction i n consumer demand. You w i l l r e c a l l t h a t l a s t October we also confronted a reduction i n supply, when we were faced w i t h a cut i n o i l imports, which would also have reduced production c a p a b i l i t i e s . This s i t u a t i o n set i n motion an e f f o r t a t planning i n i n d i v i d u a l countries, and m u l t i l a t e r a l l y through the follow-up on the energy conference held i n Washington i n February — to share research programs, to reduce dependence on imported petroleum and to share o i l i n the event of f u r t h e r embargoes. P r o j e c t Independence got underway. I n the U . S . , I would regard i t as a serious mistake i f we should allow the more relaxed supply s i t u a t i o n to cause us to slow down these e f f o r t s . For the United States i n p a r t i c u l a r , the most e f f e c t i v e way to deal with the energy problem i s to mount a strong n a t i o n a l program for holding down energy use and moving as quickly as possible to develop substitutes for imported o i l . 86 Not only w i l l t h i s give us some leverage i n dealing w i t h the present p r i c e and supply problems — i t w i l l move us i n the r i g h t direction f o r the long-run b e n e f i t of the country. I n some ways the e f f e c t of the jump i n payments for can be likened to an excise tax — c u t t i n g down consumption of oil oil i t s e l f as the price r i s e s , and c u t t i n g consumption of other goods to the extent more i s spent for o i l — d i r e c t l y and i n d i r e c t l y . there are important d i f f e r e n c e s : But the q u a s i - t a x i s levied by f o r e i g n governments rather than by a domestic government, and the use of the funds i s not under our c o n t r o l , although, as I s h a l l point out later, we can nevertheless guide the s h i f t s i n demand and output t h a t w i l l r e s u l t from the q u a s i - t a x . As I s h a l l point out, the d e s i r a b l e s h i f t of production i s i n the d i r e c t i o n of more i n v e s t ment. I t i s important to note t h a t while these payments to OPEC countries tend to dampen consumption demand i n the oil-consuming c o u n t r i e s , and may cause severe s e c t o r a l d i s l o c a t i o n s i n some c o u n t r i e s , they do not i n themselves reduce our o v e r - a l l productive capabilities. R e c a l l t h a t when the o i l price change was occurring the United States and other i n d u s t r i a l countries were approaching together the crest of a remarkable boom i n world demand — accompanied as you know by an explosion of world prices as our economies were being driven a t near to f u l l p r a c t i c a b l e c a p a c i t y . By the f a l l of 1973 87 nearly a l l over of governments were t r y i n g policies. concerned about for so t h a t In that the any advocacy of t h e m was c l e a r l y the fact activity, the in oil shift investment. supply up i n v e s t m e n t s financial thought to the I problems and s h a l l take oil there place. to of pay- compensate countries that has demands o f some This redress sector the is financing the caused some additional substitution imbalance especially these steps from consumption problem of are aware inflationary. situation is are depress - - we n e e d t o t a k e w h a t e v e r such v e n t u r e s between into demand inflation. important. Stepping The huge a n d we s h o u l d investments, give w h i c h we h a v e make. w o u l d now l i k e priorities countries, of to be oil t h a t were investment that underlies the energy capacity to will that requirements t h e economic domestic in is the our economic a c t i v i t y Such a s h i f t and p o t e n t i a l policies initially and i n take place more of of higher has c o n s e q u e n c e s the c o n t r a c t i o n elsewhere does n o t a u t o m a t i c a l l y we c a n t o prices on p e t r o l e u m , investment and t h e boom, we m u s t be i n c r e a s i n g l y consumer demands, depending room f o r of fiscal Now, a s we a n d o t h e r as t h o s e o b s e r v e d One r e s u l t sectors of boiling t h e r e was n o r e a s o n t o expansionary misplaced. rise as w e l l i n aggregate context, demand-depressing e f f e c t s e x p e r i e n c i n g an abatement of on t h i s demand, a n d w e r e a d o p t i n g more r e s t r i c t i v e monetary ments, to put a l i d to turn from questions t o t h e more g e n e r a l focus first problems upon t h o s e of reordering of a l l countries our oil-importing that are hardest 88 h i t , many of them less developed, but some also among the countries. industrial I f the less developed countries t h a t are severely a f f e c t e d cannot a f f o r d to buy the o i l they need, or the food and fertilizer they need, t h e i r present already low standards of living w i l l f a l l f u r t h e r , and t h e i r hopes of making some gains by i n d u s t r i a l i z i n g w i l l i n many cases have to be shelved. Unless adequate ways to help these countries are found, an important part of the r e a l cost of a d j u s t i n g standards of l i v i n g to pay for o i l w i l l f a l l on those l e a s t able to bear such a burden. countries Food prices are now r i s i n g g e n e r a l l y , and the added problems of paying for f u e l and f e r t i l i z e r may w e l l reach the point of depriving some countries of t h e i r minimal subsistence needs, posing very harsh a l t e r n a t i v e s . I t can cogently be argued t h a t the a d d i t i o n a l problems of these developing countries should be the r e s p o n s i b i l i t y of the o i l - e x p o r t i n g c o u n t r i e s . We can see how the burden of high o i l prices w i l l impact i f we look a t the way i n which the balances of payments of d i f f e r e n t groups of countries are l i k e l y to be a f f e c t e d unless these prices come down. The OPEC countries w i l l have a huge surplus i n t h e i r current account - - an export surplus - - amounting to perhaps $60 b i l l i o n or more per year a t current p r i c e s . They w i l l dispose of t h i s surplus i n various ways; some w i l l go i n t o b i l a t e r a l a i d programs, or i n t o the i n t e r n a t i o n a l i n s t i t u t i o n s , and t h i s can help take some of the s t r a i n o f f the poorer countries; but the bulk of the funds w i l l be 89 placed i n the c a p i t a l markets The i n d u s t r i a l account countries, deficit this w i l l with investment capital inflow that repay to their to their debts, replacement likely moment a g o . financed, It real true for not, through measures, of their those perhaps a f t e r This is not incomes need n o t be a b l e r u n down e x i s t i n g correct -- oil n o t have imports they w i l l until not that sort provided the oil deficits be much d i f f e r e n t an i n f l o w requirements. After of or that, oil be or price problems they would face they is not that will policy that w i l l can i n a c a n be through public These c o u n t r i e s begin oil from what capital to I mentioned countries the market, absorb be a b l e not as w e l l as d e v e l o p i n g of can their the will exporting the high say t h e r e w i l l oil and t h e OPEC c o u n t r i e s of in saying to, by the exhaustion of to by a a n o t h e r way o f But t h a t reserves. is however, about prices. to attract new i m p o r t is full countries the r i s e the workings the aggregate, energy sources d o e s mean t h a t , industrial current my p r e s u m p t i o n and i n d e e d industrial w o u l d have been w i t h o u t if countries. s u c h t i m e as t h e OPEC c o u n t r i e s a g a i n as a g r o u p , the In This their by a l t e r n a t i v e in have a l a r g e as a g r o u p w i l l exports; to encourage. of adaptation -- industrial t h e OPEC c o u n t r i e s pay f o r until run trade d e f i c i t s , its is equal of countries to goods and s e r v i c e s , imports financed f r o m OPEC c o u n t r i e s . be a b l e , will t h e OPEC c o u n t r i e s . plans these w e a l t h i e r indeed not the w e a l t h i e r as a g r o u p , be a u t o m a t i c a l l y capital of take some care cases drastic 90 adjustments unless they receive support. Taking these three groups of countries as aggregates, we f i n d one group, the OPEC c o u n t r i e s , very much b e t t e r o f f both i n terms of current incomes and i n terms of t h e i r claims on future world production; we f i n d a second group, the w e a l t h i e r countries w i t h a t t r a c t i v e c a p i t a l markets, or good capacity to borrow, t h a t are very uncomfortable perhaps about a r i s i n g debt to OPEC countries, but would be able to cope w i t h the r e l a t i v e l y small loss of r e a l incomes t h a t might occur; and we f i n d another group of countries — some counted as LDC's and some counted i n the ranks of i n d u s t r i a l countries - - who w i l l face serious difficulties. Their d i f f i c u l t i e s may i n t u r n react adversely upon the countries o r i g i n a l l y i n a more favorable p o s i t i o n . I remarked j u s t now t h a t some of the w e a l t h i e r countries may be increasingly uncomfortable about a r i s i n g debt to OPEC c o u n t r i e s . I n f a c t , some countries d i s l i k e the idea so strongly t h a t they may resolve to avoid i t by bringing t h e i r current account i n t o balance — t h a t i s , they may t r y r e a l l y to pay f o r o i l by^either increasing exports or decreasing other imports w e l l below the l e v e l s t h a t would otherwise be observed. This sounds very virtuous — we a l l f e e l t h a t going i n t o debt should be l i m i t e d and should be for some productive purpose. But the r e s t of the world happens to be i n a unique s i t u a t i o n v i s - a - v i s the OPEC countries — u n t i l those countries as a group buy more than they s e l l , they can only p i l e up f i n a n c i a l surpluses 91 abroad. Thus, if t o be a r a t i o n a l each consuming c o u n t r y fashion — c o u l d o n l y be a g r e a t e r countries. In real tried d e b t a c c u m u l a t i o n by o t h e r terms, the oil that trade balance being d r i v e n be t h e some c o u n t r i e s might do t h i s balance, taking currently, countries their otherwise case and t h a t while their into their some e x t r a m e a s u r e o f debt to independent countries if of experiencing i n the only inflation the o i l many c o u n t r i e s rise not curb price try d e b t w o u l d be countries deficit deficits controls exchange restraint would rate of more t h a n to a f f e c t their of a major them s h o u l d indeed e l i m i n a t e we w o u l d , setback a breakdown i n the r u l e s for us b a c k t o practices of the those d e f i c i t s I believe, fair the t r a d e among n a t i o n s or demand. arising now, and from serious the danger but also that the But resulting i n w o r l d economic a c t i v i t y trade desirable them. be i n They it, any payments d e f i c i t exist effect, rest. to depreciate Such d e f i c i t s would In upon t h e situation. oil, find t o h o l d down d o m e s t i c or e l i m i n a t e to eliminate there consuming The h o l d i n g down o f demand may i n many c a s e s be e n t i r e l y i n order appeared d e b t was i n c r e a s i n g . by u s i n g d i r e c t or m a n i p u l a t i n g avoiding other w o u l d be u n l o a d i n g t h e i r either i n what to avoid going into paying for their — acting of could take 1930's. We have not come near to such a state of turmoil i n the world trading system. I believe we can avoid i t . But i t i s d i f f i c u l t to predict the decisions of nations when they f i n d themselves confronted 92 w i t h major d i f f i c u l t i e s . Some countries may w e l l consider the problems confronting them insolvable a t the present price of o i l . I n the absence of a s u b s t a n t i a l reduction i n t h a t price unforeseeable conditions could develop t h a t could make the s i t u a t i o n d i f f i c u l t i f not impossible to manage. I would l i k e to t u r n now to the U.S. balance of payments, and to the e f f e c t s of the o i l c r i s i s on our i n t e r n a t i o n a l position. Our trade balance has already f e l t the weight of the sharply higher cost of imported f u e l — i n the second quarter of t h i s year we were paying $28 b i l l i o n a t an annual r a t e for f u e l imports - - about $20 b i l l i o n more a t an annual r a t e than we were paying a year ago. This i s almost e n t i r e l y a price e f f e c t - - i n volume terms imports of f u e l s were nearly unchanged. Mainly because of r i s i n g f u e l imports, our trade balance for a l l goods has worsened sharply from a surplus a t an annual r a t e of $4.2 b i l l i o n (balance-of-payments basis) i n the fourth quarter of l a s t year — when we reached the high point of recovery from the deep d e f i c i t i n 1972 — to a d e f i c i t a t an annual r a t e of nearly $7 b i l l i o n i n the second quarter of t h i s y e a r . How- ever, our underlying trade balance, that i s , abstracting from the a r b i t r a r y increase i n o i l prices and also leaving out the extraordinary jump i n a g r i c u l t u r a l exports, has shown considerable strength, moving s t e a d i l y from a d e f i c i t a t an annual r a t e of about $12 b i l l i o n i n the f i r s t quarter of l a s t year to a d e f i c i t of only about $1 b i l l i o n i n 93 the second quarter of t h i s year. I n volume terms we have done even b e t t e r , w i t h export volumes r i s i n g and import volumes no higher than they were e a r l y i n 1972. So f a r as our merchandise trade i s concerned, we seem to have made the kinds of gains i n competitive p o s i t i o n t h a t could be expected from the depreciation of the d o l l a r since 1970, and t h i s , together w i t h the extraordinary r i s e i n the value of a g r i c u l t u r a l exports, has helped to o f f s e t the huge jump i n o i l imports. However, l i k e other countries we must be concerned w i t h achieving an o v e r - a l l balance i n our accounts, including c a p i t a l movements, that w i l l underpin a stable d o l l a r i n exchange markets. The part of t h a t under- pinning t h a t must come from an appropriate net inflow of c a p i t a l from abroad could be s i g n i f i c a n t l y less than the e x t r a $20 b i l l i o n i n payments due to the higher .price of o i l , i f i t turns out that there are s u f f i c i e n t improvements i n the rest of our accounts. There have been considerable gyrations i n the exchange value of the d o l l a r since the second devaluation i n February l a s t year. But since about mid-May the d o l l a r has held f a i r l y stable against a weighted average of the currencies of the countries that are our major competitors i n world markets. As i t stands now, the d o l l a r has depreciated about 17 per cent against those currencies since May 1970, and has moved up s l i g h t l y i n recent months. On a broader measure, taking i n t o account the movement of the d o l l a r against a weighted i7_9ii r» 94 average of nearly a l l f o r e i g n currencies, the devaluation of the d o l l a r has been appreciably less — amounting to perhaps 12 per cent since 1970. The smaller d e p r e c i a t i o n measures the d o l l a r ' s " e f f e c t i v e r a t e , " against the world as a whole. so-called The reason for the d i f f e r e n c e between the two measures i s t h a t while the currencies of most of the major i n d u s t r i a l countries have appreciated quite sharply, against the d o l l a r , those of numerous other countries, including most of the developing world, have tended to stay w i t h or near the d o l l a r . I t i s the average r a t e r e l a t i o n s h i p t h a t comes closer to representing the longer run e f f e c t s on our balance of payments, r a t h e r than changes from time to time against p a r t i c u l a r f o r e i g n currencies. Recent r e l a t i v e s t a b i l i t y of the d o l l a r has of course been gratifying. I t has m a t e r i a l i z e d w i t h i n an environment of f l o a t i n g exchange r a t e s , i n which very wide swings had occurred during the 12 months following the breakdown of the f i x e d r a t e s system i n February-March 1973. Rate f l e x i b i l i t y has proved i t s usefulness times of severe disturbance. to new concerns. in I t has given r i s e , on the other hand, Among these has been the fear t h a t flexibility might be abused to engage i n competitive d e p r e c i a t i o n as a means of s t i m u l a t i n g exports. So f a r nothing of the kind, and indeed perhaps the very opposite, has happened. Faced w i t h strong demand for exports, and w i t h domestic i n f l a t i o n , most countries have had a motive to keep the value of t h e i r currencies high. That holds down the price of imports and helps r e s t r a i n domestic i n f l a t i o n . Downward 95 f l u c t u a t i o n s of the d o l l a r , such as occurred i n the middle of 1973 and i n the e a r l y months of t h i s year, must i n the l i g h t of t h i s nexus be regarded as harmful to our e f f o r t s to curb i n f l a t i o n i n the U.S. Of course one cannot a n t i c i p a t e t h a t n a t i o n a l preferences as regards exchange r a t e s w i l l always be the same and w i l l always favor a high r a t h e r than a low value for the l o c a l currency. If demand i n i n t e r n a t i o n a l trade should slacken, or i f some countries should begin to make strong e f f o r t s to eliminate t h e i r o i l deficits, n a t i o n a l preferences and the trend of f o r e i g n exchange rates may change. I t i s of considerable i n t e r e s t , t h e r e f o r e , t h a t as part of the e f f o r t to reform the i n t e r n a t i o n a l monetary system, guidelines for f l o a t i n g rates have been proposed. certain The reform e f f o r t has met w i t h only l i m i t e d success, which was to be expected once skyrocketing o i l prices and u n i v e r s a l i n f l a t i o n engulfed the world. No long-run reform has been agreed upon, although valuable preparatory work has been done. But among the immediate steps that were agreed upon by the Committee of Twenty of the I n t e r n a t i o n a l Monetary Fund, the proposal e s t a b l i s h i n g guidelines for provides some hope t h a t extreme and inappropriate r a t e floating fluctuations can be contained. The recent s t a b i l i t y of the d o l l a r i n the exchange market, w i t h i n a context of f l o a t i n g r a t e s , indicates that the net movement of c a p i t a l to the United States has increased s u f f i c i e n t l y to j u s t 96 about o f f s e t the d e t e r i o r a t i o n i n our balance on goods and s e r v i c e s . U n f o r t u n a t e l y , we do not yet have a c t u a l data i n d e t a i l to support t h i s i n f e r e n c e , but c e r t a i n patterns were showing up e a r l i e r . In the f i r s t q u a r t e r , U.S. d i r e c t investors' net outflows were q u i t e low, while there was a very large i n f l o w of c a p i t a l from f o r e i g n business concerns acquiring businesses i n the United S t a t e s . p a t t e r n of d i r e c t investment may w e l l be continuing. This Portfolio investments i n v o l v i n g i n t e r n a t i o n a l dealings i n s e c u r i t i e s seem to have dropped o f f sharply t h i s y e a r , w i t h Americans buying only a small volume of f o r e i g n s e c u r i t i e s even though the I n t e r e s t E q u a l i z a t i o n Tax on such purchases has been dropped, w h i l e foreign purchases of U.S. corporate stocks — an important type of i n f l o w i n the past few years — has also paused. Moreover, new issues of bonds i n the i n t e r n a t i o n a l markets outside the United States have been less t h i s year than i n any recent year. By c o n t r a s t , there has been an e x t r a o r d i n a r y surge so f a r t h i s year i n i n t e r n a t i o n a l c a p i t a l flows through banks i n both d i r e c tions — we see i t i n our own data and also i n terms of new loans arranged i n the Eurodollar market. U.S. banks, including the U.S. agencies and branches of f o r e i g n banks, increased t h e i r foreign assets by about $9 b i l l i o n i n the f i r s t f i v e months of t h i s y e a r , spread over many countries but e s p e c i a l l y d i r e c t e d toward Japan. A simultaneous massive r i s e i n l i a b i l i t i e s reduced the net outflow 97 — which measures the net impact on our i n t e r n a t i o n a l balance and on our domestic c r e d i t markets - - to only about $ 1 - 1 / 2 b i l l i o n . I would associate part of the increased international a c t i v i t y of U.S. banks w i t h the removal or reduction of b a r r i e r s to such transactions t h a t occurred both here and abroad e a r l y i n the year. At times, d i f f e r e n c e s i n r e l a t i v e i n t e r e s t rates have also been important, with U.S. rates moving up r e l a t i v e to foreign rates a f t e r the e a r l y part of the year. But I believe much of the heightened a c t i v i t y was a r e s u l t of the new o i l s i t u a t i o n , which generated a demand for loans by some countries to help meet the higher costs, and a t the same time resulted i n an added supply of l i q u i d loanable funds i n i n t e r n a t i o n a l markets as OPEC countries placed t h e i r revenues w i t h the Eurobanks. I n examining these manifold flows of c a p i t a l , i t must of course be borne i n mind t h a t an inflow or outflow of funds does not o r d i n a r i l y influence the amount of bank reserves i n the U.S. banking system or the American money supply. Foreign c a p i t a l does not bring any new d o l l a r s from abroad. Every d o l l a r of foreign c a p i t a l "flowing" to the U.S. was i n f a c t i n the U.S. before. I t simply s h i f t e d ownership. This s h i f t could have taken the form of an American s e l l i n g d o l l a r s to the f o r e i g n e r , i n which case the inflow was matched by an outflow as the American acquired whatever f o r e i g n currency or assets the buyer paid him w i t h . Or i t could have represented a s h i f t among 98 f o r e i g n holders, for instance i f the foreigner acquired d o l l a r s from a f o r e i g n c e n t r a l bank which had held them previously as p a r t of i t s reserves. What changes as a r e s u l t of changes i n c a p i t a l flows, under our present regime of f l e x i b l e exchange r a t e s , i s the exchange r a t e , as a r i s e i n the demand for d o l l a r s , i n the case of c a p i t a l inflows, or i n the supply i n case of outflows, s h i f t s the balance of the market i n favor or against the d o l l a r . Only i n s p e c i a l cases i s a d i f f e r e n t i n t e r p r e t a t i o n a p p r o p r i a t e . One f u r t h e r conclusion t h a t I would draw from the v a r i e t y of o f f s e t t i n g c a p i t a l flows t h a t have occurred i s that under today's conditions, c a p i t a l i s h i g h l y mobile. The w o r l d ' s n a t i o n a l money and c r e d i t markets are more open to s h i f t s among countries — sometimes v i a the Eunro-markets, than they have been since before the 1930's. Hence the system of n a t i o n a l and i n t e r n a t i o n a l c a p i t a l markets c o n s t i t u t e s i n e f f e c t something l i k e a large and only moderately compartmentalized pool, r a t h e r than many separate w a t e r t i g h t compartments. As a r e s u l t , any move of c a p i t a l i n one d i r e c t i o n i s q u i t e l i k e l y to be o f f s e t by movements i n the opposite d i r e c t i o n . A large outflow from the United States tends to d r i v e down i n t e r e s t r a t e s abroad, which makes American c a p i t a l markets r e l a t i v e l y more a t t r a c t i v e and causes other funds to come to the U . S . , and i n v e r s e l y . To pour c a p i t a l , whether owned by OPEC countries or others, i n t o any one p a r t of t h i s market does not mean t h a t the net supply i n that market i s 99 increased by the f u l l amount. C a p i t a l already present there tends to be pushed elsewhere, thus tending to even up the supply elsewhere. Of course, these equalizing movements w i l l take place only i f conditions are otherwise p r o p i t i o u s . When there are heavy r i s k s of a c r e d i t , exchange, or p o l i t i c a l s o r t , the movements w i l l not occur, or w i l l occur only i n response to severe declines of exchange rates or increases i n i n t e r e s t r a t e s , or both. The evidence t h a t i n today's markets c a p i t a l i s highly mobile should be kept i n mind i n examining the possible e f f e c t s of placement of OPEC money i n any one p a r t i c u l a r market. This leads me to some comments on the more s p e c i f i c aspects of the flows of funds derived from OPEC revenues, and t h e i r impact on f i n a n c i a l i n s t i t u t i o n s and structures. I believe i t i s worth emphasizing that there w i l l be great d i s p a r i t i e s among the OPEC countries i n t h e i r a b i l i t y to u t i l i z e t h i s new wealth to improve t h e i r own countries, and i n t h e i r plans for investment of t h i s huge cash flow i n f o r e i g n c a p i t a l markets. We see already t h a t I r a n has made plans for i n d u s t r i a l i z a t i o n and i s developing t i e s w i t h countries t h a t can be h e l p f u l i n t h a t process. We know that Kuwait, for instance, has been thinking through the requirements of an acceptable investment p o r t f o l i o for some time, and i s probably f a i r l y w e l l d i v e r s i f i e d . In the case of Saudi Arabia, the i n i t i a l r e a c t i o n , which was simply to l e t funds accumulate i n l i q u i d forms i n the Eurodollar market, seems 100 to be moving already i n the d i r e c t i o n of f i n d i n g more permanent lodging i n such investments, perhaps, as special issues of U.S. Treasury o b l i g a t i o n s . According to IMF data, the reported increase i n monetary reserves of the OPEC countries i n the f i r s t h a l f of 1974 was about $15 b i l l i o n , but the gains were a c c e l e r a t i n g , and were $3-4 b i l l i o n per month i n May and June, w i t h larger increases still to come. These funds should not be regarded as a monolithic mass of maneuver, poised to s h i f t t h i s way or t h a t for speculative or p o l i t i c a l reasons. There are many i n d i v i d u a l OPEC governments involved and there is no evidence t h a t they are taking any unnecessary r i s k s w i t h t h e i r funds. Working with t h e i r f i n a n c i a l advisers, these countries are l i k e l y to d i s t r i b u t e t h e i r funds over a wide range of investments, always mindful of the need for security and s t a b i l i t y . I n r e t u r n f o r continued r i s i n g l e v e l s of o i l output i n OPEC c o u n t r i e s , those countries understandably wish to be provided w i t h s u i t a b l e ways of holding t h e i r accumulating assets. I doubt t h a t there w i l l be attempts to a t t a i n dominance over p a r t i c u l a r large companies or economic sectors i n the i n d u s t r i a l c o u n t r i e s , since t h i s would expose them to considerable economic and p o l i t i c a l risks. At the same time, the amounts involved are formidable by any normal standards of i n t e r n a t i o n a l c a p i t a l flows. Questions n a t u r a l l y a r i s e about the a b i l i t y of c a p i t a l markets to absorb such flows without 101 suffering are severe justified, dislocations. but that of of, funds total say, in of $50 b i l l i o n countries By f a r the greater sectors other together of to part countries is these over-all for industrial three times of funds the flow effect years importance, is and i n t u r n w i l l i n national markets. has been c a p a b l e claims of of being deposited between domestic funds vis-a-vis of the Euro-currency The r e c o r d very rapid one b a n k o n a n o t h e r within forming "the market") part of to is, the eight after For in markets to have receipts in these borrowers the Euro-currency the past. (that the accounts g r o u p o f banks shows t h a t growth i n The E u r o - m a r k e t s in their be l o a n e d by t h i s the Euro-currency market c o n s i d e r e d as amount. i m p o r t a n c e a s a m e c h a n i s m t h r o u g h w h i c h f u n d s move t h e OPEC c o u n t r i e s of that on c a p i t a l m a r k e t s since a large size all is now t a k e n on i n c r e a s e d net the a year; markets. banks, flows States alone a n d f r o m n a t i o n a l money a n d c r e d i t of of credit times i n recent flow i n U.S. flows though a t Also, concerns sectors two t o can have a s i g n i f i c a n t countries. have grown i n I n the United $200 b i l l i o n of t h e economy, individual c a n be c o m p a r e d w i t h the t o t a l these exaggerated. r a i s e d by n o n f i n a n c i a l m a r k e t s a r e now c l o s e some o f o f ways i n w h i c h a n a n n u a l f i n a n c i a l markets. funds believe others are T h e r e a r e a number funds I market instance, the eliminating countries g r e w b y $25 b i l l i o n usually in 1972 a n d 102 b y $50 b i l l i o n in of $30 b i l l i o n has o c c u r r e d of the market of of several the assets preferences of of various levels, first would imply may r e s u l t I there would expect of liquid, say, mortgages. growth of size financing in it will not but investment the into existing of asset financial widely -- government a at institutions. o f OPEC g o v e r n m e n t s t h e m t o be m o r e interested traded both strongest nationally guarantees. on d i f f e r e n t kinds of on more l i q u i d I n the case o f inflow sectors. oil, the i n those countries t o major U.S. a s seems p o s s i b l e , i n those in handling for reflect reducing yields s h o u l d be a l a r g e on y i e l d s growth the net t h e amounts i n v o l v e d , preferences i n the yields obligations, net dislocations. and d e p o s i t s and backed by t h e on, bringing the normal stream of investment some s h i f t s the rate of potential are r e l a t i v e l y to yields if size payments debt and e q u i t y , the a further we h a v e p r o b l e m s and i n s t i t u t i o n s i n national markets, to Treasury that of place, different; that sheer mortgages, ana i n t e r n a t i o n a l l y , States, if in a given country w i l l hand, may b e q u i t e i n assets kinds corporate other the investors mixture relative to mid-May, funds associated w i t h higher financial assets year that billion. seems t o me t h a t In On t h e i s an e s t i m a t e this $185 be s o much b e c a u s e o f because There to about It flows 1973. the financial assets United banks some d o w n w a r d T h a t d o e s n o t mean the monetary aggregates w i l l That be and pressure necessarily significantly 103 affected, but some t i m e t o come. d e s i r e d degree it d o e s mean t h a t of Another some i s or c o u l d be c h a n g e d for The F e d e r a l R e s e r v e c o u l d e s t a b l i s h a n d m a i n t a i n any over-all kind of the Eurodollar irregularity is they w i l l the world. their sooner or later debt if deficits, t h e y do n o t it t h e OPEC c o u n t r i e s . and b r o a d c a p i t a l investments a number to borrow is, of of adjustments to cover liquidity recycling could allow strongest their deficits available Also, currencies to trouble- based directly economies and OPEC d e p o s i t s find the weaker it on t h e i r the could well First, w o u l d be a b l e i n these to attract limits which own strong surplus to countries deficits economies s h a r e o f OPEC be one o f to capacity. funds stronger other in private borrowing their them countries — needing take advantage countries — c o u l d do a c o n s i d e r a b l e receiving depreciate, inadequate so t h a t the countries difficult a disproportionate countries be t o governments and t o cover i n these c o u n t r i e s job. receive some o f are possible. their assets a few c o u n t r i e s w i t h markets a t t r a c t c a p i t a l markets the prefer policy. could succeed i n a t t r a c t i n g — and the U n i t e d S t a t e s the a d d i t i o n a l to place m u s t be t h a t If that burdens reach the a r e a t t r a c t i n g more t h a n enough f u n d s with flows the s h o u l d and p r o b a b l y w i l l However, cover in The p r o b l e m o f f r o m t h e m a r k e t as t h e i r the market likely m a r k e t and l e n d them out over — are ease i n m o n e t a r y So may t h e b a n k s t h a t borrowers a l l obvious relationships or on t h e c o u n t r i e s w i t h broadest markets. funds restraint t h a t OPEC c o u n t r i e s indirectly yield part of of that part financing the 104 adjustment a point, could come t h r o u g h c h a n g e s however, would not take some p o i n t of these accommodations care was r u n n i n g o u t of the problems o r who c o u l d n o t to relieve be l a r g e the be f o r through of adjust their relative the responsible to The t o t a l investment s h o u l d we e x p e c t countries parties amount o f i n terms oil to If of the t h e OPEC c o u n t r i e s those countries t o a c t as a t market t h e OPEC c o u n t r i e s of financial rates to contribute the contrary -- believe t h e economic but rather b u r d e n on t h e s e c o u n t r i e s donors. that capacity beyond logical t h e OPEC c o u n t r i e s financial of might the assets progress of that that should c a l l be the challenge, i n excess these assets of to cover cost terms? countries poorer not of b o r r o w i n g f r o m OPEC extending aid industrial -- world in do n o t m e e t t h i s r e c e i v e OPEC f u n d s t o emphasize that and i t stability borrow a t market the solution aid required would intermediaries, a r e sound, w h i l e because I to -- and w i t h a s s u r a n c e c o u n t r i e s who c a n n o t question not whose d e b t t h e m o u n t i n g OPEC r e s e r v e s , countries. needs After mechanism trade balance the most economy t h a n a c o n t i n u i n g a c c u m u l a t i o n o f their balance. the market countries such s i t u a t i o n s the burden. a more f r u i t f u l stronger trade necessity. To d e a l w i t h would c l e a r l y in I raise should countries there the -- this cease quite i s now a new f o r t h a new s e t of aid 105 T h e r e has a l r e a d y been a c o n s i d e r a b l e by t h e OPEC c o u n t r i e s some o f or the LDC's, institutions disbursement Nevertheless, but is of if quite mediary position, of these flows w o u l d be u n w i s e in the last t o meet information, resort m a r k e t s and t h e by a c t i o n these of that system. But g i v e n p r o p e r the actual particular countries. t o do t h e i r share w i t h an untenable inter- for the flow of on t h e petrodollars institutions untenable in that strains risks, develop liabilities this individual by o b t a i n i n g and would safeguard the financial problems sides, difficulties less question liquidity for — banks. providing r e g u l a t i o n and s u p e r v i s i o n , on a l l causing a r e u s u a l l y much c a n go w r o n g f o r from c r e a t i n g caution aiding world t h e payments mechanism by k e e p i n g o f a n y one i n s t i t u t i o n of how w e l l t o be c o m p l a c e n t a b o u t problems sometimes expressed funds available. outlets by c a r e f u l integrity new coming i n as v e r y s h o r t - t e r m find for for p r o v i d e mechanisms will b a d j u d g m e n t s may be made a n d t h i n g s up-to-date left to of In particular, o f OPEC f u n d s We m u s t be p r e p a r e d clear activity the burden proposals are w i l l i n g sources are not f o r w h i c h banks must q u i c k l y It not are not another aspect impact f i n a n c i a l markets. liquid? is we s h o u l d be a b l e Finally, from a flood it of relieve meet t h e needs o f countries c o u n t r i e s when m a r k e t the long, list t h e OPEC c o u n t r i e s industrial is though the funds w i l l and t h e concern t h a t may u l t i m a t e l y amount o f the and of possible entire I believe that fears are greatly exaggerated. 106 Banks and t h e i r rationalize side to the the m a t u r i t i e s funds: are countries asset side, practice the very this currency liquidity of in smoothly. large year, Countries sums i n for to express these does n o t mean t o say t h a t On t h e c o n t r a r y , if they are their risks. oil Given present the o i l -- to act prudently, prices, t h i s may l e a v e met t h r o u g h o t h e r c h a n n e l s . t h a t the problems, p a r t i c u l a r l y cut almost oil. first Euro- a s much institutions demands on t h e m . limits have t o of the investment importers at keep acceptable substantial of the borrowing countries of able year. T h e r e can be no a s s u r a n c e , i n the p r i c e it efficiently i n the they w i l l operations w i t h i n the at anticipating financial e x p o r t e r s and b o r r o w i n g n e e d s o f without a substantial flows — t h e y c a n m e e t a n y and a l l t h e s c a l e and k i n d o f So f a r , instance, i n our the the f u n d s have been $20 b i l l i o n faith on c a n be a d j u s t e d 1973 and f a r more t h a n i n a n y e a r l i e r Nevertheless, assisting by announced medium- and l o n g - t e r m t o t a l e d about enough funds; alleviated markets For deposit banks a r e the market. with the Eurodollar on t h e their rate i n need o f some t i m e a h e a d . publicly for is to are dropping assets; outlets changing conditions bank c r e d i t s as i n a l l needs of other begun that or y i e l d s l e a d i n g banks have d e a l t requirements of the problem of to reflect that raise half seek out f i n d more s u i t a b l e some o f and r e l a t i v e l y their out, reports o f m a k i n g t e r m l o a n s whose i n t e r e s t intervals appears to to have a l r e a d y there are stretching c a u s e OPEC g o v e r n m e n t s these to flow of OPEC c u s t o m e r s this to be time, c a n be m e t 107 W h e t h e r the p r o b l e m s I dollars become a c u t e on our a b i l i t y investment in make p r o g r e s s or n o t depends to get control the areas on t h o s e problems of adjustment strains, will not have d i s c u s s e d r e l a t i n g of shortages. we c a n be m o r e h o p e f u l to high o i l degenerate capacity into prices, serious petro- also i n f l a t i o n and g e n e r a t e of greatest fronts, i n good p a r t to or t o other impasses. more If that we c a n special unexpected 108 M r . G O N Z A L E Z . T h a n k you very much. I n your statement, on page 1 7 , you first discussed the question o f the investment flow of this money, excess money i f we want to call i t that, and t h a t perhaps some k i n d of special issues of U . S . Treasury obligations—you point out t h a t the I M F data shows a reported increase i n monetary reserves of the O P E C countries i n the first h a l f of 1974 of about $15 billion. Secretary Simon had t o l d us on the eve o f his departure to the M i d d l e East t h a t this was one o f the things t h a t probably would be discussed and t h a t is the attraction of some o f this money i n t o the U n i t e d States and t o official paper t h r o u g h some type of a special security. B u t then I t h i n k you reflect the fact t h a t since then an A r a b finance minister has stated t h a t one reason they have been slow i n doing t h a t is t h a t they want t o make sure t h a t i f they do i t w i l l be on some k i n d of paper t h a t is inflation proof. I t h i n k you reflect t h a t on page 19 by saying t h a t you w o u l d expect and I quote " t h e m t o be more interested i n assets t h a t are relat i v e l y liquid, widely traded both nationally and internationally and backed b y the strongest guarantees." W h a t k i n d of securities w o u l d t h a t be, M r . W a l l i c h ? W h a t would be an example ? M r . W A L L I C H . A S you know, M r . Chairman, the interest rate t o some extent inflation proofs a security. T h i s is p a r t i c u l a r l y so i n the case of a short t e r m security because i t has to be issued repeatedly. A t each reissue, the interest rate can be p u t at the level t h a t current market conditions require. T o the extent, then, t h a t interest rates move w i t h inflat i o n there is considerable protection i n the short-term instruments. M r . G O N Z A L E Z . S O an interest yield h i g h enough to make i t interesti n g would be one of the things? M r . WALLICH. Yes. M r . G O N Z A L E Z . O n page 2 0 you say the Federal Reserve could establish and m a i n t a i n any desired degree of overall restraint or ease i n monetary policy i n case the impact was such t h a t i t would have or tend to have an impact t h a t w o u l d have t o result i n some k i n d of a policy and you seem to be very confident about the a b i l i t y of the Federal Reserve t o develop t h a t strong policy i n the l i g h t of what D r . B u r n s said just last week, w h i c h was to a layman l i k e myself i t was u t t e r l y astonishing. I n case, he said, the current policies were to result i n a 6 percent unemployment, then as a must the Government w o u l d have to go into the public works arena but now this is what he and others have been saying has been the cause of the bad inflationary tendencies to begin w i t h so i t seems t o me rather tragic to say we are g o i n g to admit t o a policy t h a t is going to b r i n g about unemployment so i n case i t gets t o a p o l i t i c a l l y unbearable degree, well we w i l l get to the o l d nostrum and have public works. I s not t h a t a self-confession of contrad i c t o r y policies and results ? W o u l d not the same t h i n g happen here ? M r . W A L L I C H . Before t r y i n g to respond t o your question let me exp l a i n w h a t I meant to say i n t h a t p a r t o f m y prepared text to w h i c h you refer. I have heard i t said t h a t inflows of o i l money w o u l d affect the U.S. money supply and therefore monetary policy. I merely meant to explain t h a t technically t h a t is not so. T h e money supply does not change—it just changes hands. T h e Federal Reserve's a b i l i t y to control i t is not altered, broadly speaking. A s f a r as particular specific monet a r y policy such as Chairman B u r n s was t a l k i n g about, I t h i n k t h a t monetary policy has one p r i n c i p a l objective now, and t h a t is t o b r i n g 109 inflation under control. I t can do this job more effectively i f some of the undesirable byproducts of anti-inflation policy can be prevented. One such action would be to supply public service jobs so that the unemployment rate is kept down. M r . G O N Z A L E Z . O n page 22 i n mentioning one other aspect of this flow and some consequences i n case you have, as you very w e l l point out, O P E C funds coming i n as very short-term liabilities w h i c h would o f course create a problem f o r the institutions, the bank institutions. Y o u say i n t h a t case, we must be prepared f o r this risk by obtaining and p r o v i d i n g up-to-date information, by careful regulation and supervision and i n the last resort by action t h a t w o u l d safeguard the l i q u i d i t y markets and the i n t e g r i t y of the payments. M y question is, should we not now be anticipating t h a t as a very, very real possibility we could have this influx of short-term liabilities or capital and what is i t that we could be doing i n the meanwhile i n anticipation? W o u l d i t require legislation or is this something that would be an administrative policy now w i t h i n the confines of the regulatory agencies, or would they have to have some legislation f r o m us. M r . W A L L I C H . Insofar as I can foresee the problem, I belive that i t can be handled under existing powers. The problems raised by petrodollar flows relate not only to i n f o r m a t i o n about our domestic banking system, and the situation of our financial markets. I t relates to banking and t o financial markets worldwide, because the operations of banks and financial markets are worldwide. W e are i n the process of strengthening our i n f o r m a t i o n domestically and internationally, p a r t i c u l a r l y w i t h respect to the foreign exchange positions of banks. Thus, I t h i n k the w o r k that you suggest, M r . Chairman, is going f o r w a r d . M r . G O N Z A L E Z . O u r final question. I s there any possibility t h a t our country could develop any k i n d of muscle, any k i n d of pressure i f you want to use t h a t w o r d on the oil-producing nations to b r i n g about some reason ? There is no question they have been gouging us unmercifully. Y o u know, an increase of 400 percent is just not w i t h i n the realm of reasonable or justifiable, i n the normal sense t h a t we use that word. D o we have t o ? I s the country powerless ? I s the political situation such that our country does not exert pressures t h a t i t m i g h t otherwise be able to i n this area of o i l p r i c i n g ? M r . W A L L I C H . I w o u l d say our best bet is to go f o r w a r d i n developing our own sources of supply—developing an increased capability and thereby reducing our dependence on foreign sources. T h i s w i l l have t w o effects. One w i l l be the reduction o f demand f o r o i l i n w o r l d markets. T h a t w i l l tend, according to the laws of economics, t o b r i n g the prices down. The other effect, by m a k i n g us more independent i n our policies w i l l be to give us more leeway f o r action. M r . G O N Z A L E Z . I t seems though t h a t Project Independence i n the effort to make ourselves sort of fortress America is t h a t respect is not one of easy realization, or at least not i n the very near foreseeable future. A l l the experts seem to indicate t h a t there is this reliance on this M i d d l e East oil. W h a t I do not understand is f o r example, the reports that some of the countries i n the A r a b i a n producing w o r l d such as the Saudis w o u l d be amenable t o a reduction i n price but are kept so by such obdurate attitudes as those reflected by the Iranians, and there 37-211 O - 74 - 8 110 I am asking a question and perhaps i t is one t h a t really we should address to other officials and that is, is i t politics that is keeping us f r o m t a l k i n g t u r k e y to the Iranians ? M r . W A L L I C H . L e t me begin w i t h the first p a r t of your question. A s I have said, I t h i n k a reduction i n the price of o i l is necessary i n order to be sure the petrodollar problems are manageable. W i t h respect t o Project Independence, i t must be realized that, to a potential investor i n a substitute energy source, these plans may i m p l y t h a t possibly the price o f energy sources w i l l go down. I n t h a t case, his incentive t o make the investment w i l l be less. There are t w o sides t o the subject of the potential decline of o i l prices. I t may help on the O P E C side, but i t does not help on the side of domestic investment. A s f a r as the O P E C countries are concerned, I am not a specialist i n this area. M y impression is t h a t different countries are quite d i f ferently situated w i t h respect to the price of oil. Countries t h a t have reserves of only l i m i t e d size are more interested i n obtaining a h i g h price f o r their l i m i t e d supplies. F o r them, the flexbility lies i n decisions as t o whether the o i l should be brought above ground now or later. B u t , countries t h a t have v i r t u a l l y u n l i m i t e d reserves can be less concerned about price because i t applies to an unending flow. So there are v a r y i n g conditions here and i t is difficult to judge how an approach could be made and its effect. M r . G O N Z A L E Z . T h a n k you very much. M r . Johnson ? M r . J O H N S O N . T h a n k you, M r . W a l l i c h . I wish I had had time t o really read your statement. I t certainly is a very scholarly statement and has an a w f u l lot of meat i n i t as they say. I am t h i n k i n g of one o f the statements you have made t h a t this year our purchases of o i l abroad w i l l j u m p f r o m about $5 b i l l i o n to about $25 billion. T h a t is a $20 b i l l i o n increase i n cost and no doubt a great strain on our b a n k i n g system. These firms i n the U n i t e d States t h a t are b u y i n g this oil, how are they financing t h i s $20 b i l l i o n extra cost t h a t they are going t o be faced w i t h ? M r . W A L L I C H . U l t i m a t e l y , o f course, i t comes f r o m the consumer; we are a l l p a y i n g f o r i t . The o i l companies presently have t o carry higher inventories. A s they are very strong companies, I do not doubt t h a t they have good credit facilities. I am concerned about the fact t h a t when the o i l price goes up, i f they are on a first-in, first-out accounting basis, this gives them a very large visible profit which is not a real p r o f i t ; i t is just a capital gain on which they pay tax. A c t u a l l y , their l i q u i d i t y is reduced as a result o f h a v i n g had this r u n u p i n the price o f their inventory. B u t I have never heard t h a t the o i l companies have had any difficulty i n financing these inventories. M r . JOHNSON. I read over the weekend t h a t there is a greater demand f o r bank loans today than at any t i m e i n history. I s this huge demand f o r bank credit the result of a demand f o r o i l loans? A l l o f a sudden we need $20 b i l l i o n extra to buy o i l f r o m the Mideast? M r . W A L L I C H . I cannot say specifically w i t h respect t o the o i l inventories. W i t h respect to a l l inventories I t h i n k there is a very good case to be made t h a t w i t h the rise i n the price o f inventories, and the taxes levied on them, the l i q u i d i t y of corporations has been reduced. T h i s w o u l d force them i n t o the banks. M r . J O H N S O N . I was t r y i n g to t h i n k , as you have been delivering your statement, how the Federal Reserve banks can enter into this Ill picture and be h e l p f u l as f a r as financing the purchases o f the oil. Y o u can rediscount the notes f r o m a bank t h a t loans money to a b i g o i l company to buy oil, can you not ? M r . W A L L I C H . T h a t is r i g h t . There has been a very significant expansion o f credit, particularly commercial and industrial loans. There has also been a significant expansion o f the money supply, although currently at a lower rate. Consequently, I do not t h i n k there has been any lack of financing f o r the o i l companies. M r . J O H N S O N . N O W also, these O P E C countries are of course being the recipients o f large inflows of cash. Where w o u l d they deposit t h a t money? A r e they p a r t i a l to American banks over there like Chase Manhattan, and F i r s t National C i t y Bank, and Continental, and some of the b i g banks, or do they deposit i n their own local banks? M r . W A L L I C H . I t has been tending t o go into the E u r o d o l l a r market and to a lesser extent into banks i n the U n i t e d States. American banks have branches i n the Eurodollar market, which is m a i n l y but not exclusively situated i n London. They have a very i m p o r t a n t share of t h a t market. So i n those t w o senses money is going i n t o American banks f r o m O P E C countries. M r . J O H N S O N . The reason I asked t h a t is i t seems t o me that I read where Chase Manhattan B a n k was anticipating deposits maybe to the extent of $25 billion. O f course they would have t o i n some way handle, and as you mentioned i n your statement, provide l i q u i d i t y f o r i t because they are i n the nature o f very, very short-term deposits. M r . W A L L I C H . Yes, t h a t is a problem f o r banks. So f a r , they have been getting predominantly short-term deposits. T h a t puts a constraint on them regarding the m a t u r i t y of the use t h a t they can make o f these funds. M r . J O H N S O N . T h i s month Saudi A r a b i a very wisely agreed w i t h M r . Simon to hold an o i l auction and they have set the target date. They w i l l ask f o r bids f o r the sale of i y 2 m i l l i o n barrels of o i l a day f o r 16 months, and I t h i n k M r . Simon and everybody is hoping t h a t b y reason of the 2 b i l l i o n barrel a day g l u t r i g h t now i n o i l markets t h a t those bids m i g h t be as low as a reduction of $2 a barrel. D o you have any i n p u t on that? D o you t h i n k t h a t is possible under the present situation wherever there is a tremendous overproduction o f o i l i n the world? M r . W A L L I C H . There is certainly room f o r a decline i n the price of oil. Whether this particular mechanism is likely t o produce i t , I have no means of judging. I am no expert on this subject. One has t o bear i n m i n d of course t h a t an increased supply f r o m any one country could be offset by reduction i n the supply f r o m others. T h i s w o u l d be the case unless the country t h a t is expanding its production has such great productive capacity that its expansion would result i n an increase i n aggregate output even though others were c u t t i n g back. These are complexities t h a t we cannot see t h r o u g h very effectively at t h i s time. B u t actions designed to b r i n g down the price of o i l w i l l certainly bear exploring. M r . J O H N S O N . W e l l , is i t not true as M r . Gonzalez mentioned t h a t we have not used any political pressure as is nonexistent? A b o u t the only t h i n g t h a t is going to b r i n g down the price of o i l is the l a w of supply and demand and the i n a b i l i t y of the Arabians t o sell the oil. I understand the storage facilities are just jammed f u l l all over the w o r l d and 112 we may see a surprising drop i n the price of oil. I k n o w someone said they can c u r t a i l their production. I come f r o m the Pennsylvania oilfields and i f you curtail production of a prolific lease by reason o f pror a t i o n o r something, when you w a n t t o restore production back again, w h y paraffin has set i n t o the o i l sands and you don't get the production back. T h a t could well happen t o these people over there although I do not know the character of their o i l sands, whether a precipitous curtailment of production would cause the sands to fill up w i t h paraffin and asphalt. M r . W A L L I C H . I lack expertise here also. I always thought o f the m a i n pressure on the price of o i l as coming f r o m the development o f substitute sources of energy, not only of o i l b u t o f other sources. B u t conceivably, such a t h i n g as storage limitations may have a much greater impact. M r . J O H N S O N . T h a n k you. I believe m y t i m e has expired. M r . G O N Z A L E Z . M r . Reuss? M r . R E U S S . T h a n k you, M r . C h a i r m a n ; and M r . W a l l i c h , t h a n k you f o r a masterful paper. I have several hours of questions b u t I w i l l compress them i n t o 5 minutes. O n page 2, you say, t o w a r d the bottom o f the page, " f o r the U n i t e d States i n particular, the most effective way t o deal w i t h the energy problem is t o mount a strong national p r o g r a m f o r h o l d i n g down energy use, and m o v i n g as quickly as possible t o develop substitutes f o r imported o i l . " I certainly agree, and I want t o p u t t o y o u w h a t , t o me, is the most worrisome t h i n g about the o i l supply price i m p o r t situation; and let us see what your reaction is. I am not p r i m a r i l y worried—and I know you are not, either—about M i d d l e Easterners acquiring investment interest i n the U n i t e d States. I t h i n k we can protect our interests there, a l l r i g h t . N o r am I p r i m a r i l y worried about M i d d l e Easterners who now hold enormous reserves, and w i l l h o l d even greater reserves, b r i n g i n g the temple down by destructive dumpings o f dollars or some other currency; because f o r one t h i n g , they would h u r t themselves about as much as they w o u l d h u r t t h e i r intended victim. W h a t I am concerned about—and I wondered whether you share m y concern—is simply this r here we are, i n the U n i t e d States—we w i l l just t a l k about our country t h o u g h the same situation prevails i n most of the other industrial countries—here we are, on an essentially business-as-usual, o i l consumption-as-usual basis. W e are t r y i n g some conservation, but not much, as anybody who is d r i v i n g down the highway can p l a i n l y see; and meanwhile, the O P E C countries are accumulating horrendous reserves. Y o u gave us the arithmetic on that, and because they are not going t o spend them a l l currently, they are going to invest them. Those reserves are going t o grow. They are keeping t h e i r poker chips on the table, i n short, and t h e i r p i l e is g r o w i n g higher and higher. I f , i n 5 or 10 or 15 years, about the time we hope, i f we are l u c k y , i n reaching something like Operation Independence of our o w n — i f about t h a t time the A r a b countries decide t o spend f o r imports i n t o t h e i r country these fantastic accumulations; and p a r t i c u l a r l y i f t h a t t i m e coincides, as w e l l i t m i g h t , w i t h an increased scarcity o f materials worldwide, are we not l i k e l y t o have i n this country, w i t h really no option about i t , a serious d i m i n u t i o n i n our real income, because o f the 113 necessity to p a r t w i t h these resources which we ship overseas; a n d / o r a b o i l i n g inflation as domestic demand and foreign demand coincide? I n short, i t seems to me t h a t we are not i n the lucky situation we were i n i n the 1960's, when by and large we let the Germans and the Japanese m a i n t a i n an overvalued dollar exchange rate, and then supp l y us w i t h enormous quantities of Volkswagens and M i n o l t a cameras at cheap prices; and they d i d not know, u n t i l i t was a l l over, how they devaluations of the dollar, much deprewould be frustrated by ciation of the d o l l a r plus much inflation. I do not t h i n k the Arabs are going t o be t h a t shortsighted. W e are floating, so we cannot devalue. A n d i f we continue t o inflate, our creditors w i l l start b u y i n g while the b u y i n g is good. D o you share m y concern t h a t this is the real t h i n g we ought t o be concerned about, and t h a t unless we want t o impose o n the American people a no-choice alternative i n , say, 10 years, o f h a y i n g t o undergo a considerable d i m i n u t i o n i n national income and the i n d i v i d u a l standa r d of income, we should take more seriously the need t o conserve imported o i l now ? M r . W A L L I C H . Congressman Reuss, I have been very conscious of this problem, but w i t h a s l i g h t l y different emphasis. I have looked at i t i n the f o l l o w i n g terms. W e are i n c u r r i n g a great debt, which w i l l require service. Someday i t w i l l have to be repaid, presumably when the O P E C countries can accept trade deficits instead o f h a v i n g surpluses. T h e way t o p u t us i n position to service this debt, and ultimately repay i t , would be t o accumulate more capital i n the real sense. T h a t is, use the leeway created i n the economy now by this o i l " t a x , " the d r a i n i t creates on consumer demand, i n order to step up the rate o f capital formation. Then we w i l l have a bigger capital stock. The return on t h a t stock w i l l help t o pay interest on the debt that is outstanding. U l t i m a t e l y i t could serve, also—although I doubt t h a t would happen—to repay the debt. So, by d o i n g this, I t h i n k we would i n the main meet the problem that you are concerned about. However, since such a process never works completely smoothly, I t h i n k i t is certainly true t h a t whatever we can do to reduce the oil deficit i n the first place w i l l be a l l to the good. M r . R E U S S . O n t w o of the factors which are likely to keep things f r o m going as smoothly as you and I would like, the first one is that the O P E C countries are not l i k e l y to supply as much of the funds which they have skimmed off f r o m us i n higher prices back here i n the f o r m of investment and equipment as may be needed; and second, both the capital goods, the tools and equipment that you mean when you say capital investment, a n d the things they make, w i l l have an increasing proportion o f high-cost imported components—copper, bauxite; you know the whole list. W e l l , would you agree t h a t those are possible variables w h i c h may t h r o w off your nope a 1bit? M r . W A L L I C H . T h e y are definitely variables, and they present difficulties. I w o u l d add just one thing. Suppose the O P E C money should not come to the U n i t e d States—although i n fact there is no particular reason t o t h i n k t h a t we w i l l not get some reasonable share of i t , having good capital markets. B u t even i f t h a t should happen, so long as demand is reduced by the payment of h i g h prices f o r o i l and by the flow of money abroad, there is o f course a gap i n the economy, i n real terms. 114 T h i s can be filled b y some other f o r m o f demand. A n increase i n investment is just as good, or even a better way o f filling t h a t gap t h a n raising consumption spending. T h e market w i l l tend t o b r i n g i t about, although one cannot be sure t h a t i t w i l l b r i n g i t about completely. T h i s w i l l happen due to a f a l l i n interest rates and by other circumstances—such as the limitations placed upon industrial capacity. These factors w i l l encourage investment and b r i n g about the needed increase i n capital formation. M r . R E U S S . T h a n k you. O n another subject, you speak approvingly—and I surely j o i n you— i n what the Committee o f T w e n t y has done i n its recommendations w i t h respect to rules o f the road and guidelines on flexible exchange rates; so f a r , so good. I am concerned, however, about another recommendation of the Committee of T w e n t y ; namely, that despite a l l that we have learned, we should now, i n effect, p l a n a return to the stable b u t adjustable rates of B r e t t o n Woods days, and thus apparently deprive the U n i t e d States o f the o p p o r t u n i t y to float, as i t is now floating, when i n its sovereign judgment we determine t h a t i t is the t h i n g to do. Instead, i t w o u l d be up to the I M F to decide this question. I f I read the C - 2 0 r i g h t — a n d I t h i n k I do, because I have read i t again and again—shouldn't the Congress now serve notice t h a t i t simply w i l l not r a t i f y any amendment t o the I M F articles t h a t w o u l d envisage such an improvident impairment of our r i g h t t o make our currency flexible ? M r . W A L L I C H . T h e output of the Committee of T w e n t y is not a final agreed-upon report. I t is simply a report t h a t states the positions w h i c h the group had arrived at when i t dissolved. M r . R E U S S . A n d w i l l recommend t o the Governors? M r . W A L L I C H . Yes; b u t what i t recommends t o I M F ' s board is essentially a series o f short-run i n t e r i m steps. Those short-run objectives do not include a r e t u r n to stable b u t adjustable rates. T h a t is p a r t of the longrun perspective. I would be concerned about something t h a t compelled the U n i t e d States t o give u p a floating posture so l o n g as the U n i t e d States thought t h a t there was an advantage i n maint a i n i n g i t . O n the other hand. I see considerable advantages, over the l o n g run, i n stability o f exchange rates. I believe everybody does, and i f we can create conditions i n which stable rates are possible, then I w o u l d see a r e t u r n t o them as quite feasible. T h a t is, I can envision circumstances i n w h i c h stable rates w o u l d be i n our interests. B u t this is a conjectural matter. One cannot foresee how conditions w i l l develop, and t h a t is one reason the C-20 never settled this p o i n t i n reaching i n t e r i m agreement. M r . R E U S S . Then i t is your view, as you read the C-20 recommendations of June of t h i s year, t h a t they do not recommend a r e t u r n to stable but adjustable rates; t h a t they are simply t a l k i n g about the sweet by-and-by, and something that should be talked about, and t h a t Congress w i l l not be confronted w i t h new articles of the I M F f o r ratification w h i c h adhere to stable b u t adjustable rates? M r . W A L L I C H . N o t as a result of this negotiation. I t h i n k i t is f a i r to say t h a t there was a s p i r i t i n the committee approving the general idea of stable but adjustable rates, b u t t h a t the circumstances at the 115 time were so uncertain that no proposals of that k i n d are going t o be made to legislatures. M r . R E U S S . T h a n k you. I have not been told, but I suspect m y time is up. M r . G O N Z A L E Z . Yes; well, the Chair is being liberal w i t h the members. M r . Crane? M r . C R A N E . Yes; thank you, M r . Chairman. I w o u l d l i k e t o welcome M r . W a l l i c h before the subcommittee, too. M r . W a l l i c h , i n your testimony on page 2, you made reference t o a relative reduction m consumer demand, and t h a t this relative reduct i o n i n consumer demand could help to alleviate some o f our problems. B u t I am wondering about a reduction, say, i n demand f o r food, where we are faced w i t h the prospect of heightened demand worldwide because of shortages and increased food needs. T h i s summer, unfortunately, we are faced w i t h the prospect of a major drought. The last figures I saw contended t h a t we are going to be about 30 m i l l i o n tons of g r a i n short of our anticipated yield this year. W e also have other significant problems i n housing and, w i t h a g r o w i n g number of the young people who were a product of the post-World W a r I I baby boom i n the process of f a m i l y formation, i t seems to me that there are additional and inevitable strains there. There is the f u r t h e r problem of job creation to avoid rather significant unemployment rates—and I am t h i n k i n g again of that postW o r l d W a r I I baby boom population, and the need by industry to absorb almost twice as many people into the w o r k force today as they have been doing f o r the past 7 years. A s I understand i t , that is to continue f o r about another 7 years before we get back to normal job creation i n a h i g h l y industrialized society, where i t costs about $25,000 to create a job. The question I am wondering about is, how you achieve reduction i n consumer demand when you are stuck w i t h those givens. M r . W A L L I C H . L e t me say something about how I visualize the impact on demand. I t h i n k that i t would be very widely spread. People are very l i k e l y to cut back a l i t t l e here, a l i t t l e there. T h e y are going to cut back on what they spend on gasoline; perhaps not i n dollar terms, but i n terms of the amount of gasoline, and i n the other forms of o i l which they use. A reduction i n demand f o r food is not involved, I believe. Food is mainly a supply problem at this time. H o w does that fit into an overall aggregate demand policy ? I quite agree w i t h you, we need a proper balance. W e have h a d substantial excess demand, and t h a t has contributed to inflation. I t needs to be cured. O n the other hand, we have to be careful not t o develop an overall demand weakness which would make i t difficult to absorb g r o w t h i n the labor force. T h a t is a problem of the medium term, I w o u l d say. The demand trend has to be sufficiently u p w a r d t o absorb new entrants to the labor force. M r . C R A N E . Another question t h a t came to m y m i n d t h a t Congressman Reuss touched upon, concerns this necessity f o r developing substitutes f o r imported o i l ; and one of the concerns t h a t I have—and i n fact a number of m y colleagues do—is over the impact o f some of the environmental legislation that we have passed i n significantly in- 116 creasing demand f o r this product. Then, such delays as construction of the Alaskan pipeline, and so f o r t h — I am wondering i f , i n your judgment, there should be a continued effort at relaxing and extendi n g the timetable f o r implementation of some of our efforts at cont r o l l i n g p o l l u t i o n of the environment. M r . W A L L I C H . A S an economist, I like to see balanced adjustments. W e have had the misfortune at a time when we took what seemed to be desirable environmental action, we experienced an unforeseeable rise i n the cost of these policies. I t seems appropriate t h a t on the one hand we pay a l i t t l e more, and on the other, demand a l i t t l e less. T h a t way we w i l l bridge the gap. M r . C R A N E . W e l l , i t is the p a y i n g a l i t t l e more t h a t I t h i n k is a p a r t of the problem, too, at a time when there are such demands f o r money i n so many other sectors, whether i t is developing additional f u e l resources, or whether i t is job creation i n industry, and so f o r t h . L e t me t u r n t o another point. O n page 4 o f your testimony, where you made reference t o control o f b o i l i n g over of demand i n the f a l l of 1973, and you added t h a t nearly a l l governments were adopting more restrictive fiscal and monetary policies, f r o m late f a l l of 1973 t h r o u g h 1974 d o w n t o the present time, what has been the rate of expansion m the money supply ? M r . W A L L I C H . The rate o f expansion i n the n a r r o w l y defined money supply i n the U n i t e d States was of the order of 7.6 [6.8] 1 percent f o r the 6 months preceding, February t h r o u g h J u l y of this year. L e t us take the last 9 months, November 1973 t h r o u g l i J u l y 1974. O f those, the average of the last 3 months was 4.4[4.8] 1 percent, and the average of the 6 months preceding t h a t was about 6.8 [7.5] 1 percent. So, this averages 7.1 [6.6] 1 percent f o r the 9 months. M r . C R A N E . JBut most recently, i t has been i n the 8-percent range i n the preceding 6 months. M r . W A L L I C H . T h e last 3 months, i t has been at 4 . 4 [ 4 . 3 ] 1 percent rate, and before t h a t — i n other words, the aggregate o f 9 months—approximately 7.1 [6.6] 1 percent. M r . C R A N E . I see. W i t h respect to fiscal policy, there have been some proposals t h a t I t h i n k are i n line w i t h other recommendations t h a t you nave made, t h a t we m i g h t relax—or, i n fact, reduce—some of the taxes on capital investments, capital gains; even some relaxation or reduction o f corpor a t i o n taxes as a means of t r y i n g to stimulate increased investment, because of the expectation of a higher r e t u r n on investment; and i t w o u l d seem t o me that t h a t coincides w i t h some of the other recommendations i n your statement. W o u l d you recommend any specific changes i n our tax laws here, t o encourage more investment ? M r . W A L L I C H . I have a h a r d t i m e being very specific about these suggestions. I am aware o f the objective ana I am also aware t h a t they are t a x devices t h a t could be useful. I n t h a t respect, may I d r a w y o u r attention t o an aspect of the corporate-profits picture. Due t o the fact t h a t price rises have inflated inventory profits, the true profits o f business are currently very substantially overstated—in the economic sense, at least. I f you take into account the fact t h a t corporations must 1 Figures I n brackets indicate revisions made August 21, based on new data. 117 pay t a x on these inflated inventory valuations, the rate o f taxation on corporate income is really much higher than i t appears t o be. B u t that is an economic, not a legal, calculation. M r . C R A N E . F i n a l l y , you make reference also i n your statement t o the need t o take whatever steps we can t o s h i f t more o f our economic activity f r o m consumption into investment and I assume particularly you are concerned about return on investment and energy related fields, whether i t is o i l or what have you. D o you know what the r e t u r n on investment at the present time is f o r the m a j o r o i l companies i n this country ? M r . W A L L I C H . N O . I don't. I would have to look at the figures. I would guess t h a t because o f the profits on inventory d u r i n g the period when the price of o i l rose, i t would be necessary t o take a longer period i n order to get a meaningful figure. I t would be very h a r d t o p u t i t , say, i n terms of 1973 or i n terms of 1974 only. M r . C R A N E . T h e reason I raise t h a t point is because unfortunately i t seems t o me t h a t the o i l companies have come under undue criticism. There have been very dramatic headlines advertising the percentage of profit increase over say last year or the preceding 6-month period, when, i n fact, the r e t u r n on investment of the m a j o r o i l companies i n this country d u r i n g the preceding 5 years t o the time o f the o i l embargo was, relatively speaking, lower t h a n the r e t u r n on investment i n other forms o f industry i n this country. I t just seems t o me t h a t the o i l companies have taken something of an u n f a i r and unwarranted criticism i n this regard and that i f we are going t o stimulate t h a t investment then i t is necessary to develop a degree o f self-sufficiency, t h a t instead o f t a l k i n g about nationalization of American o i l companies we ought instead t o be applauding a return on investment t h a t finallv has exceeded a return t h r o u g h the p r i m e rate, and i t was below that t o r several years. M r . W A L L I C H . I would never accept a percentage w i t h o u t stating the base and w i t h o u t relating i t t o longer r u n data. M r . C R A N E . T h a n k you, M r . W a l l i c h . M y time has expired. M r . G O N Z A L E Z . T h a n k you. M r . Burgener. M r . B U R G E N E R . T h a n k you very much, M r . Chairman. Governor W a l l i c h , i t is a privilege t o have you here. I would l i k e to ask a few monetary policy questions and w o r k m y way t h r o u g h o i l and end u p i n Eurodollars maybe. Chairman B u r n s suggests t h a t monetary policy alone can certainly not solve inflation, although i t is an i m p o r t a n t part. H e says that fiscal restraint on the p a r t o f Government, on the p a r t of individuals, labor, management, and everybody is essential. H i g h e r p r o d u c t i v i t y , a l l of this combined w i t h monetary policy can tend to attack the problem. I s t h a t generally how you see his views? Governor W A L L I C H . Yes; t h a t is the way I see i t . Monetary policy should not be made t o carry the f u l l burden. M r . B U R G E N E R . A l l r i g h t . Now am I correct i n m y assumption t h a t i f the Federal Reserve dramatically reversed its field and eased money and made i t easy and i t is t i g h t at the moment, t h a t t w o things would happen. I recognize t h a t this is oversimplified. A m I correct i n assipiing, (a) t h a t interest rates would come d o w n ; and (b) t h a t prices would go up? 118 M r . W A L U C H . I f i n d i t difficult to generalize about monetary policy. B u t let me p u t i t this w a y : Over a period of time inflation and the movement o f prices reflect developments i n the money supply. I am not speaking t o the precise situation now, because there are always particular aspects that have t o be taken i n t o account. B u t speaking m general, i f at any one t i m e the central bank suddenly steps u p the rate of g r o w t h of the money supply and the money supply eases i n the sense y o u said, Congressman Burgener, the immediate effect w o u l d be a decline i n interest rates. Subsequently, however, prices w o u l d go up. R i s i n g prices tend t o p u l l up interest rates i n the long run. I do not know exactly what the t i m i n g w o u l d be. B u t the final result w o u l d be higher interest rates. M r . B U R G E N E R . The Federal Reserve most recently has a slower money supply g r o w t h rate o f about 4 percent as opposed t o last year's 8. W h a t do we know i n general terms about the g r o w t h o f money supply i n foreign countries, p a r t i c u l a r l y our t r a d i n g partners—Japan, Europe, the A r a b countries, and so on? H o w is t h e i r own currency g r o w i n g or is it? M r . W A L L I C H . Some of those countries have i n the past had very much higher rates of money growth. Some o f them, however, have been quite successful i n l o w e r i n g the rate of g r o w t h o f money. Japan, f o r instance, had a severe rate of increase i n the money supply i n 1972-73. T h e U n i t e d K i n g d o m d i d also. They have managed t o cope w i t h t h a t t o some extent. B r o a d l y speaking, one can trace these effects of monetary policy and price behavior. The countries I mentioned need to balance their payments. The rate of exchange o f t h e i r currency also has great significance w i t h respect to prices. I n addition interest rates have an international relationship. Thus, p a r t i c u l a r l y i n smaller countries, rates tend t o be influenced by rates abroad. A l l this makes i t harder t o follow the mechanisms, i f I understand you correctly, t h a t you are t r y i n g t o examine. B u t , broadly speaking, I t h i n k i t is validated. M r . B U R G E N E R . I s i t true, t h a t w i t h o u t passing judgment on whether i t is a good or bad idea, t h a t Japan moves very quickly i n terms o f allocating credit w i t h i n the nation t h a t we do not? M r . W A L L I C H . I n Japan they have had a system i n w h i c h the Government has had a great deal of control over the allocation o f credit. M y own impression is t h a t they feel the t i m e has come t o reduce t h a t degree of control. They have t r i e d to make their markets more responsive t o what we w o u l d call market forces. M r . B U R G E N E R . O n the O P E C countries, i f t h i s large reservoir is seeking h i g h l y l i q u i d or low-risk investments I assume t h a t h i g h r i s k brings h i g h returns and low risk generally low returns. Y o u state i n your testimony that that would have a tendency to force the rate of r e t u r n down. I s that what you are saying? I f they are seeking low risk w i l l not t h a t b r i n g their interest rates down ? M r . W A L L I C H . T h a t is correct. I meant t o say t h a t i f more money flows i n t o low-risk areas, such as short-term Government securities, the supply o f funds there w i l l be increased and t h a t w i l l necessarily tend to drive down rates. M r . B U R G E N E R . O f course, I guess currently our Government securities are quite h i g h r e t u r n or is t h a t just the short-term ones? 119 M r . W A L L I C H . I am a f r a i d that i n considering interest rate levels one always has to consider the rate of inflation, Congressman Burgener. M r . B U R G E N E R . I S 8 and 9 percent low return ? M r . W A L L I C H . T h e nominal rate, o f interest consists, economists would say, of the real rate, plus an inflation premium. I do not know what rate of inflation investors expect. B u t you could visualize an 8-percent interest rate that would contain a very sizable inflation premium. M r . B U R G E N E R . W e are p a y i n g about $20 b i l l i o n more f o r o i l and we are not getting more o i l and I take i t we are not getting less oil. The point is are we conserving energy or are we just t a l k i n g about i t , i n your opinion ? M r . W A L L I C H . I am not an energy expert, but m y overall impression is this. There is some conservation at the consumer level. Consumer conservation of energy was better d u r i n g the period of the boycott than i t is now. There is a significant effort at the business level, where conservation practices are based on precise calculations. There is a longrun effect but no one knows just what t h a t includes. There are structural factors such as a change i n the size of the average car, the insulation of the average house, and the way the factories are b u i l t , which w i l l take a long time t o become effective. B u t effort i n this area is proceeding. I t h i n k i t is probably the main part of this conservation effort. M r . B U R G E N E R . W o u l d i t be safe t o assume t h a t as of r i g h t now i t is more of an intention than a f a i t accompli ? M r . W A L L I C H . I would say i t is certainly not a f a i t accompli. I would add t h a t I t h i n k everybody has the best intentions. B u t , unless these intentions are backed by economic reality I do not t h i n k they are going to get us t o the desired result. I do see the reality of higher prices w o r k i n g on people, so that regardless o f intentions they are likely to be pushed i n the direction of conservation. M r . B U R G E N E R . A l l r i g h t . F i n a l l y then, I take i t a E u r o d o l l a r is an American dollar i n a European bank regardless of how i t got there or what the source. Y o u mentioned i n your testimony t h a t Eurodollars increased some 50 b i l l i o n last year. I s that roughly correct? M r . WALLICH. Yes, sir. M r . B U R G E N E R . Can you break down the source of t h a t increase i n any way? M r . W A L L I C H . I t certainly was not i n any major p a r t the U . S . balance of payments, although that is one possible area f r o m w h i c h the Eurodollar market can be fed. I believe there is some internal generation i n the creation of funds i n the Eurodollar market, proceeding i n the same way as i n any banking system. T o look at the detail, I w o u l d have to go back t o m y sources, and I am sorry to say t h a t m y informat i o n about t h a t market is not as precise as I w o u l d wish i t to be, because i t is an international market where many monetary systems, of many countries, come together. Y o u can perceive events over a given interval. B u t i t is quite difficult to go beyond t h a t and trace the fundamental causes of the events. M r . B U R G E N E R . A m I correct i n m y assumption that the immense b u i l d u p of Eurodollars tends to make all dollars worldwide less valuable, less desirable, devalued so to speak ? 120 M r . W A L L I C H . T h a t is an interesting hypothesis. I could not characterize i t as more t h a n that. G i v i n g you a very broad opinion, i n one sense the E u r o d o l l a r market increases the international availab i l i t y of dollars, but demand tends at the same time to press against i t . The U.S. dollar is being used a l l over the w o r l d f o r trade, f o r reserves—privately, and by official holders. The fact t h a t the dollar plays t h a t great a role is of course an i m p o r t a n t element i n the demand f o r dollars. T h e upshot is contradictory forces: possibly increased supply o f dollars, but also an institutional underpinning o f the dollar due to demand f o r i t . I do not know i n w h i c h way the net effect takes place. M r . B U R G E N E R . T h a n k you very much, M r . Chairman. M y t i m e has expired. M r . G O N Z A L E Z . T h a n k you. M r . Fauntroy? M r . F A U N T R O Y . T h a n k you M r . Chairman. M r . W a l l i c h I j u s t have one line o f questions and i t has t o do w i t h the possible use o f t a x ref o r m and its effect upon the whole o i l industry and upon prices. T o what extent w i l l a decrease i n the o i l depletion allowance affect the o i l investment picture ? M r . W A L L I C H . M r . Congressman, realizing t h a t I am not a t a x m a n p r i m a r i l y , m y reaction has been, w i t h respect to depletion, t h a t i t is a device t h a t encourages both the discovery and the production o f oil. W h e n the price of o i l became h i g h and i t suddenly became very i m p o r t a n t t o find more o i l I t h i n k a legitimate question was raised whether we should not g h i f t t o taxes t h a t would emphasize f i n d i n g and conservation, rather t h a n the l i f t i n g o f o i l above ground. T h a t , i t seems t o me, would be responsive to the economic needs. T h e second question is, what rate o f r e t u r n do the o i l companies need i n order to take on the admittedly h i g h risks of exploration and additional production ? Problems enter here such as: H o w assured are the markets? W h a t are the chances t h a t , after they have b u i l t refineries or d r i l l e d a well, o i l w i l l suddenly go down to a lower price and the investment w i l l lose its value ? A l l these things, I t h i n k , have to be considered j o i n t l y when you t a l k about o i l taxation. M r . F A U N T R O Y . T h a n k you, M r . Chairman. M r . G O N Z A L E Z . T h a n k you. One t h i n g has been pointed out. I t h i n k i t is well f o r the record t o c l a r i f y , M r . Burgener i n his colloquy w i t h you defined the Eurodollar, as an American dollar i n a European bank. More technically and correctly speaking, is t h a t not really a claim on a European bank denominated i n American dollars ? M r . W A L L I C H . Yes, I t h i n k one could call i t both. I f the d o l l a r is i n a European bank, then i t is a claim on a European bank. W h e n we say i t is a dollar, i t is a claim denominated i n dollars. There is not necessarily a dollar i n the U n i t e d States behind this Eurodollar. I t is necessary to make t h a t point, w h i c h I regard as a distinction. M r . B U R G E N E R . I f the chairman w o u l d y i e l d I t h i n k this is i m p o r t a n t and I certainly do not pretend to understand i t yet. I t h i n k i t was M r . W r i g h t the other day who set the example o f going i n t o a L o n d o n bank and opening an account and asking f o r the account t o be i n U.S. dollars f o r $100,000 and you give the banker a check on a New Y o r k bank f o r $100,000, we a l l understand t h a t transaction. 121 A different k i n d of a transaction would be to say I want t o open an account f o r 100,000 American dollars. I do not have the money, but I have collateral, so you loan me the $100,000 and w i l l open m y account and I t h i n k i t was M r . W r i g h t who said they opened your account w i t h nothing, w i t h no American dollars and w i t h no relationship t o any Federal Reserve requirements i n our country at all. H e alleged they just created out of t h i n air $100,000. N o w d i d they, or d i d they not? D o they have reserve requirements? T h a t is w h a t we are getting at. M r . W A L L I C H . E v e n the experts argue about this process, because i t is curiously h a r d to p i n down. M y own view is t h a t the market can create dollars, but that b y no means a l l of the dollars t h a t are i n i t have been so created. T h e y could have come out o f the U n i t e d States. Essentially i t is easiest t o t h i n k about the E u r o d o l l a r market as i f the whole market were a single bank. Just as a bank can make a loan to you i f you supply collateral and the 'bank w i l l w r i t e up its l i a b i l i t y the Eurodollar market can do likewise. There are no reserve requirements against deposits such as U.S. banks maintain. However, the " E u r o d o l l a r b a n k " — t a k i n g the whole E u r o d o l l a r market, f o r purposes of discussion, as a single bank—maintains, o f course, some l i q u i d i t y i n the U n i t e d States. I t does so because i t is called upon f r o m time to time to make a dollar payment, and then i t must be able to provide dollars i n the U n i t e d States. T o do that, i t must either have those dollars or must have short-term l i q u i d assets w h i c h can be sold to obtain dollars. M r . B U R G E N E R . I guess what we are finally, M r . Chairman, getting to is that while you, the Federal Reserve, makes a real effort t o restrain inflation by monetary policy, 4 percent, 8 percent, 6, and wherever you go, can you really come to grips w i t h i t w i t h no cont r o l really over the Eurodollar ? I do not know. M r . W A L L I C H . T h e E u r o d o l l a r market is somebody's money supply but no country's money supply—the Eurodollar does not enter into any country's statistics as money. The data appear to me t o indicate that this market has been g r o w i n g faster than money supplies around the w o r l d . T o the extent t h a t i t has the effect of stimulating demand, this may have contributed to generating excess demand i n the w o r l d . I do not t h i n k i t p a r t i c u l a r l y affects the U n i t e d States, because the impact o f the people who spend out o f Eurodollar l i q u i d i t y is worldwide. Thus, the impact on the U n i t e d States o f E u r o d o l l a r spending would at most be a small fraction of the total. B u t I t h i n k t h a t on a worldwide scale i t probably has been o f some effect i n increasing demand. M r . B U R G E N E R . T h a n k you. M r . G O N Z A L E Z . There is one final question, M r . W a l l i c h . I t looks as i f our U.S. commercial banks are going to have t o recycle some of these petrodollars and loan them i n t u r n to countries t h a t are, or possibly can be, very bad credit risks. I s that not a dangerous situation ? Isn't there a n y t h i n g t h a t we should t h i n k i n anticipatory action ? M r . W A L L I C H . I t h i n k the banks are conscious of these risks. A wellr u n bank w i l l have an idea of how much exposure i t can afford i n any particular country. Even so, accidents can happen, of course. The 122 obverse of this is t h a t countries t h a t are not strong credit risks may not be able t o get the money they need. Then a problem arises f o r other countries, s h o u l d they help this country? Should the international institutions enter the scene? Should the country make a desperate effort to adjust its balance of payments by some f o r m o f restriction or depreciation ? A l l these variables enter i n t o the matter. I f the banks act prudently they w i l l protect themselves, but they w i l l not protect each and every country t h a t is i n need of financing, and a problem is therefore l e f t to be dealt w i t h . M r . G O N Z A L E Z . W e l l , we h a d one gentleman witness who mentioned, and o f course I am just repeating, I am not an expert on this, t h a t we had the experience of the F r a n k l i n National B a n k , and his remarks were to the effect t h a t i n some countries, and I t h i n k he mentioned E n g l a n d and Germany, the governments had a flat prohibition, proh i b i t i n g the banks f r o m speculating against their own currency, and t h a t the U n i t e d States does not have this control. I s t h a t an accurate report? I s t h a t true? I s there such a t h i n g as that? M r . W A L L I C H . I t contains an element of t r u t h . Some countries cont r o l the degree t o w h i c h a bank may speculate and i n this group each country does t h i s to a different degree. Some countries p e r m i t no specul a t i o n against the home currency. Others impose no constraints at all. I note t h a t f o r the most p a r t restraints where they exist refer t o specul a t i o n only against the home currency. T h i s means the central bank is t r y i n g to protect the currency f o r which i t is responsible. Such restraints do not, by any means—even when they are extensive—protect banks because i t is s t i l l possible f o r a bank t o speculate i n currency B against currency C, leaving the home country out of i t . Risk arising f r o m t h a t k i n d o f speculation remains, and i t is i n f o r m a t i o n on t h a t problem t h a t we are now t r y i n g to get. M r . G O N Z A L E Z . I see. W e l l , thank you very much, M r . W a l l i c h . W e are deeply g r a t e f u l t o you. M r . W A L L I C H . T h a n k you very much, M r . Chairman. [Whereupon, at 11:55 a.m., the subcommittee recessed, subject t o the call of the chair.] [ T h e background material on the " I n t e r n a t i o n a l Petrodollar Crisis" prepared by the staff o f the subcommittee and referred t o b y Chairman Gonzalez on page 3, f o l l o w s : ] 123 HENRY B. GONZALEZ, TEX., CHAIRMAN ALBERT W. JOHNSON. PA. J. WILLIAM STANTON, OHIO PHIUP M. CRANE. ILL. FRENZEL, MINN. HENRY S. REUSS. WIS. WILLIAM S. MOORHEAO, PA. THOMAS M. REES. CALIF. waT™YPAS^RO^C. FORT^Y^^ET^tark. JR.. CAUF. B|i_|_ U.S. H O U S E O F REPRESENTATIVES SUBCOMMITTEE ON INTERNATIONAL FINANCE >. STEPHENS, JR.. GA. Q p j H £ COMMITTEE ON BANKING AND CURRENCY NINETY-THIRD CONGRESS W A S H I N G T O N , D.C. Background 20515 Information for Hearings on International Petrodollar Prepared by Subcommittee July 1974 Crisis St- 124 Hobart Rowen T H E WASHINGTON POST June 20, 1974 The Deepening Monetary Crisis A little more than a month ago in Basel, Switzerland, the rich nations' central bankers had one of their regular and secret sessions on the status of the world economy. This time, the subject was the deepening financial crisis occasioned by the high price of oil set by the producers' cartel, which is causing horrendous balance of payments problems for Italy, France and G r e a t Britain — as well as financial chaos for the hardpressed developing countries. But the most important financial men were far from the quaint little Swiss city. They were in Vienna, preparing for a meeting of the Organization of Petroleum Exporting Countries in Quito, Ecuador, where subsequently they would decide that the oil-consuming world would get no price relief. Last week, the IMF's Committee of Twenty met in Washington for a session which once had been targeted as the final "wrap-up" conference for international monetary reform. But as financial jitters spread, the best that the IMF could come up with was adoption of a few tentative steps attempting to ease the burdens placed on developing and developed countries alike by the high price of oil. , The plain fact is that there can be only postponement—not settlement— of the threatening international monetary crisis so long as the consuming nations must meet oppressive bills on a continuing basis. "For the first time, international financial men speak of a world-wide recession " For the first time, some prominent bankers and international financial men speak of a worldwide recession, with the remaining strong nations— the United States and Germany—being forced to bail out other countries. Writing in the July issue of Foreign Affairs, oil consultant Walter J. Levy warns that we are witnessing "an erosion of the world's oil 6upply and financial systems, comparable in its potential for economic and political disaster to the Great Depression of the 1930s." Italy has already been driven to the edge of bankruptcy by a deficit in her balance of payments running at an annual rate of $13 billion in the first four months of 1974. It is true that Italy has had other problems besides oil—a raging inflation, excessive imports of consumer goods, and a weak government. But it is oil that has pushed Italy to the brink, and reduced her credit-worthiness to almost zero. France and Great Britain could be close on Italy's heels. The British balance of payments deficit just for oil this year is likely to be $7 billion, or as much as the estimated 1980 value proposed it to.a surprised group of his colleagues at that meeting a month ago (in Basel. The Europeans for long have been urging that they be allowed to settle their debts with each other by the exchange of gold at real market prices. This would enable them, they held, to "unfreeze" that portion of their reserves consisting of gold—but which they obviously wouldn't' part with at $42.22 an ounce. The wily Burns reasoned that something had to be done for Italy in a hurry, but that an across-the-board inflation of total world gold reserves would not only be unnecessary, but dangerous. The gold "collateral" compromise, a concession by the United States, may buy time for Italy and other countries fortunate enough to own a gold stockpile. But how about the poor countries? The Trilateral Commission, a private of highly-trumpeted North Sea oil progroup of American, Japanese and Euduction. , ropean citizens, speaks eloquently of The tremors are being felt, as well, i the "economic disaster" that could in the huge, $150 billion Euro-dollar befall the 30 poorest nations if the market, where major companies as developed world and the suddenly well as nations have been borrowing wealthy OPEC nations fail to agree on money. This source could dry up quicka crash rescue program. ly, because it has been fed by Arab Everything done so far in the wake "petro-dollars," placed on deposit for of the oil crisis—for the industrial or very short periods of time. LDC countries—including the steps Recently, Chase Manhattan Bank taken at the C-20 session, is inadequate head David Rockefeller expressed pubor spineless. Untold hazards lie ahead lic concern about the Euro - dollar unless there is some alteration in the market. The best way for banks to vast shift of funds demanded by the get in trouble, he pointed out, is by OPEC nations. That requires lower oil borrowing for short periods of time prices. (from the Arabs) and lending for periods up to 7 years (to European countries in deficit). It is for this reason—in desperation —the major governments quietly got together in Washington, and over dinner at the Watergate Hotel agreed that Italy and others in the same boat should be allowed to pledge their gold reserves as loan collateral, not at the official $42.22 an ounce price, but at something "related" to the open market price of more than $150 an ounce. This clever, stop-gap device was the brainchild of Federal Reserve Board Chairman Arthur F. Burns, who first 125 Perils of Oil Complacency By THOMAS E. MULLANEY OME constructive developments In the international The New oil and energy situation during the three months Y o r k Times since the end of the Arab embargo—especially in S I recent days—have encouraged some economic analysts and seemingly eased the overwhelming pressures J u n e 2 3 , 1 9 7 4 that last fall's oil offensive suddenly created throughout the world. The real improvement, however, has been relatively minor and promises to be no more than a short-term palliative both for the United States and all the other nations that are so heavily dependent on the Middle East's, great resource now and for some time ahead. The real danger is that the recent abatement of the Oil-supply crisis will mask for a while the potentially catastrophic financial consequences that lie ahead as a result of the sudden and explosive rise in the cost of petroleum during the finarquarter of 1973. Equally worrisome is the possibility that the oilconsuming nations will become too complacent and fail to eMbrace a program of austerity and cooperation to mitigate the awesome economic and political problems that the recent startling changes in oil tupply-and-price conditions have created for every nation—even-the most advantaged and affluent in energy and other resources. • Perhaps the best recent news—though a email7 comfort—was the fact that the oil-producing nations, at their meeting last weekend in Quito, Ecuador, did not push through another increase in prices and Confined themselves instead to raising royalty payments from the oil companies by 2 per cent, which hopefully, will not be passed along to consumers. After a bruising intramural battle, Saudi Arabia successfully beat back the strong efforts of her producer colleagues to raise posted prices of oil at this time. What is needed now is an actual reduction in world oil prioes. That may come later on. It depends, probably, upon either the continued aggressive goodwill'of the Saudis or the ability of the United States to get Iran, the most militant of the oil producers, to accept the fact that the high level of oil prices is disastrous for all. Since mid-March, when the Persian Gulf states lifted their politically motivated embargo Against certain nations, it is true that there has been some improvement in the over-ail oil picture and other problems related to it, but the specter of new and even darker troubles remains ominous. * The supply situation is better because of increased production and reduced consumption. And the cost of the liquid gold, which snot from 90 cents a barrel in 1970 to $3 last October and then to $7 at the end of 1973, has since stabilized at that high and unbearable level. • : Moreover, much thought and some effort have been devoted to various ways to reduce dependence on Middle East oil as well as viable solutions for recycling the vast new monetary wealth that has been flowing into the producing nations. • In addition, some steps have been taken to ease the financial burden of nations most affected by the disruptive influences created by the huge increases in their food costs, though these have been mostly pledges that •till have to be redeemed—things such as promises not to engage in trade policies that would further aggravate payments positions, improvements in trade preference systems for the poorer nations and some additional monetary aid for the developing world. But not nearly enough has been done so far. There is evidence, at the same time, that there has not been sufficient effort so far m many nations to reduce consumption of this vital resource and to push the creation of additional sources of energy. While American industry, for instance, did achieve considerable conservation of energy in the period of greatest stringency and high prices test winter, there is a conviction among many analysts, both in Government and elsewhere, that greater opportunities in that area are still available. To that end, the United States Federal Energy Office is planning discussions with several of the nation's largest energy consumers to seek ways to cut their consumption. Walter Sawhill, the new director of that office, has already visited some of the auto companies with a view toward exploring ways for developing cars tljat use less gasolaie. As any one who has motored along some of the major highways in recent weeks has noted, the public is out on the roads again in much greater volume and driving at faster speeds than they were when the gasoline shortage was so severe last winter. Traffic has not yet returned to pie-embargo levels in most states, but there are signs that there will be mora summer driving than was expected a few months ago. .Highway traffic in Michigan, for instance, came within 2 per cent of last year's volume over the Manorial Day weekend after being down 10 per cent in the early part of this year. And parkways in New Jersey and Ntrw, York, which showed'declines of 17 per oent or more as recently as February, have seen the drop narrow to 3 or 4 per cent in recent weeks. The prospective increases in highway traffic and other uses of energy may soon turn demand for petroleum products shaiply upward again after significant declines in the early months of 1974. Total demand was down about 7 per cent in January from * year before, off 12 per cent in February and 6 per cent in March md do#n less than 2 per cent ki April, when the country's con-v sumption of all petroleum products ran about 16 million barrels a day. For the four weeks ended June 7, total demand wail still around that level, but in that last week, the figure, jumped to 16.7 million barrets a day, up about 10 per oent in that period from the previous one and about 3 per cent above the same week of 1973. The greater availability of gasoline and other petroleum products, combfhed with the disappearance of the irritation of waiting in lines to get to gasoline pumps, may weaken the earlier public support for programs to bolster the nation's independence of foreign sources of energy. There may be a greater tendency to defer the hard choices that must be made if the nation is to commit financial resources to the necessary research and development of alternative sources of supply. And it is clear that the United States and the rest of the world do have some hard choices to make. It is unrealistic to believe that, this country can become completely independent of foreign energy by 1980, but it could sharply reduce that dependence if it pushes forward with a number of proposed high-coat programs. . Hie job ahead for all nations in the energy area was cogently outlined by a respected international oil economist, Walter J. Levy, in the July issue of Foreign Affairs. After setting down the grim prospects for every one of the present realities in international oil supply trends and prices, he stressed the importance of extreme austerity in consumption. He suggests reducing the growth of consumption to a 3.3 per cent annual rate from the 5.6 per cent level that prevailed duping the 1968-72 period and a "wideranging coordinated program among all importing countries" to achieve. "sOme downward adjustment of foreign crude oil prices to all consumers." In a concise sum-up of his perceptive analysis, Mr. Levy commented: "Four elements are essential to move to a reasonable adjustment: far-reaching cooperation among the oilimporting nations; an understanding by the importing nations of the interests and aspirations of the producing countries; a clear-cut (and painful) program of energy austerity by the oil-importing countries, and a recognition by the producing, countries that even in an austerity situation any attempt to hold prices high must result in worldwide dangers to which they could not be immune. "Only with far-reaching consumer cooperation can it be expected that the producing countries will come to this necessary conclusion. At the same time, cooperation without austerity will not do the job; Both are needed, and a large new dose of political will, not yet in sight, will be required to achieve them." In this whole* effort the United States will obviously have to play a pivotal role of leadership. The world cannot afford to bear the tragic consequences that it surely faces if some dramatic steps are not taken to counteract actions by ttye Arab and other oil-producing states that have increased their cost of such a vital resource to the staggering total of $100-billion this year. 126 THE NEW YORK TIMES Bus i n e s s / F i n a n e e J u n e 17, 197^ R I S I N G O I L PRICES CREATING DISMAY E c o n o m i e s o f B i g Consumer N a t i o n s A r e C o n f r o n t e d . byHuge Payments D e f i c i t s REMEDIAL PLANS HAZY E x p e r t s F e a r a W o r l d Slump May Come B e f o r e A c t i o n I s T a k e n on P r o b l e m s By C l y d e H . Farnsworth PARIS, J u n e 15 — I t ' s h a p p e n i n g f a s t e r e v e n t h a n t h e experts thought. The m a j o r o i l c o n s u m i n g n a t i o n s — F r a n c e , B r i t a i n a n d I t a l y — a r e p i l i n g up h u g e d e f i c i t s i n e x t e r n a l a c c o u n t s , a n d t h e c o n c e r n i s m o u n t i n g a b o u t how t h e s e d e f i c i t s w i l l be f i n a n c e d . A b a n k e r i n F r a n k f u r t , West Germany, c o m m e n t s : "The m o n e t a r y w o r l d h a s c h a n g e d r a d i c a l l y a n d f o r g o o d as a r e s u l t o f t h e e x plosion in o i l prices." A b a n k e r f r o m New Y o r k s p e a k s o f h i g h e r o i l p r i c e s as t h e " f i n a n c i a l monkey w r e n c h " i n t h e w o r l d e c o n o m y . L o o m i n g i n t h e c a l c u l a t i o n s o f many f i n a n c i a l men o n b o t h s i d e s o f t h e A t l a n t i c i s t h e s p e c t e r o f a n o t h e r w o r l d economic s l u m p . A l t h o u g h t h e f i r s t s i g n s h a v e a p p e a r e d o f more c o o p e r a t i v e p o l i c i e s b y t h e m a i n o i l i m p o r t i n g n a t i o n s , many e x p e r t s a r e s t i l l w o r r i e d t h a t nations w i l l act too l a t e t o stop the d r a i n of w e a l t h and j o b s r e p r e s e n t e d by h i g h e r o i l payments. Discouraging Trends The s e c r e t a r i a t o f t h e O r g a n i z a t i o n f o r E c o n o m i c C o o p e r a t i o n and Development i n P a r i s , t h e N a t i o n a l I n s t i t u t e i n London, t h e F i r s t N a t i o n a l C i t y Bank i n New Y o r k , t h e D r e s d n e r Bank i n F r a n k f u r t , G e r a l d A . P o l l a c k , s e n i o r economic a d v i s e r t o t h e Exxon C o r p o r a t i o n , a n d W a l t e r L e v y , a p e t r o l e u m c o n s u l t a n t who h a s t h e e a r o f S e c r e t a r y o f S t a t e K i s s i n g e r a r e among t h o s e who a r e m o s t d i s c o u r a g e d by t h e l a t e s t t r e n d s . The o i l money i s a c c u m u l a t e d b y a h a n d f u l o f p r o d u c e r g o v e r n m e n t s . I t does n o t d i s a p p e a r f r o m t h e s y s t e m . Some o f t h e f u n d s go i n t o good and s e r v i c e s f r o m t h e i n d u s t r i a l c o u n t r i e s . Some a r e i n v e s t e d i n t h e money m a r k e t s o f t h e W e s t . A c c e l e r a t i n g r a t e s o f i n f l a t i o n h a v e meant t h a t much o f t h e money i s k e p t o n s h o r t t e r m d e p o s i t . So s h o r t t e r m i n f a c t t h a t a b a n k e r f r o m London snapped, s e v e n days n o t h i n g , we w i s h we c o u l d h o l d t h e money f o r more t h a n 2 b h o u r s . " 127 THE NEW YORK TIMES June 17, 197^ The q u e s t i o n i s w h e t h e r t h e s e s a v i n g s o f t h e o i l p r o d u c e r s c a n be t r a n s f e r r e d i n t o t h e c a p i t s l t h a t c r e a t e s j o b s . And as M r . P o l l a c k o f E x x o n o b s e r v e s , " u n l e s s g o v e r n m e n t s a d o p t suitable r e f l a t i o n a r y p o l i t i c s , c a p i t a l formation could actually fall." The g o v e r n B u t w h a t i s h a p p e n i n g now i s j u s t t h e r e v e r s e . ments w i t h t h e b i g g e s t d e f i c i t s a r e d e f l a t i n g i n e f f o r t s t o improve t h e i r f o r e i g n t r a d e . The c r i t i c a l d a n g e r , as t h e O . E . C . D . s e c r e t a r i a t p o i n t s o u t , i s on c o m p e t i t i v e d e f l a t i o n as c o u n t r i e s f i g h t f o r s m a l l e r a n d s m a l l e r e x p o r t m a r k e t s . H i g h i n t e r e s t r a t e s h a v e a l r e a d y s l o w e d c o n s u m p t i o n i n many c o u n t r i e s , i n c l u d i n g t h e two b i g g e s t markets f o r t h e w o r l d ' s e x p o r t s , t h e U n i t e d S t a t e s a n d West Germany. I t a l y ' s G o v e r n m e n t f e l l l a s t Monday when t h e t r a d e u n i o n s a n d s o c i a l i s t s r e f u s e d t o a c c e p t a s t r i n g e n t f i s c a l package on t o p o f t h e s e v e r e c r e d i t squeeze imposed by t h e bank o f I t a l y . They f e a r e d a sharp r i s e i n unemployment i n t h e f a l l . Y e t , I t a l y ' s desperate f i n a n c i a l p o s i t i o n s — c a u s e d by h i g h e r o i l p r i c e s s u p e r i m p o s e d o n a n i n f l a t i o n w e a k e n e d economy—made some s o r t o f s t r i n g e n c y a c o n d i t i o n f o r t h e i n t e r n a t i o n a l l o a n s i t has t o have t o pay i t s b i l l s . " T h e I t a l i a n s i t u a t i o n i s b a d , b u t i t i s l e s s w o r s e now b e c a u s e o f t h e g o l d a g r e e m e n t , " a b a n k e r i n Z u r i c h commented l a s t week. He was r e f e r r i n g t o t h e a c c o r d i n W a s h i n g t o n t h a t p e r m i t s c e n t r a l b a n k s t o p l e d g e g o l d a t m a r k e t r e l a t e d p r i c e s as c o l l a t e r a l for loans. $12-Billion in Gold The 2 , 5 0 0 t o n s o f g o l d i n t h e v a u l t s o f t h e Bank o f I t a l y a r e w o r t h some $ 1 2 - b i l l i o n , when v a l u e d a t n e a r t h e p r i c e f o r g o l d i n t h e f r e e m a r k e t , as o p p o s e d t o t h e $ 3 . 5 - b i H i o n when v a l u e d a t the o f f i c i a l price of gold. This gives I t a l y a l i t t l e time — A " b r e a t h o f a i r " as t h e Common M a r k e t ' s e n e r g y c h i e f H e n r i S i m o n e t p u t s i t . But i n t h e f i r s t f o u r m o n t h s o f t h i s y e a r t h e I t a l i a n t r a d e d e f i c i t was r u n n i n g a t an a n n u a l r a t e o f $ 1 3 - b i l l i o n . So t h a t g o l d c o u l d go pretty fast. N o t o n l y o i l , b u t f o o d i m p o r t s h a v e s w o l l e n t h e b i l l s . Many e x p e r t s o n t h e I t a l i a n economy s a y t h e c o u n t r y s h o u l d be p r o d u c i n g more o f i t s own f o o d . B u t t h i s i n t u r n w o u l d t a k e away m a r k e t s f r o m some o f t h e p r i n c i p a l s u p p l i e r s s u c h as F r a n c e , Y u g o s l a v i a and. t h e U n i t e d S t a t e s . Petroleum c o n s u l t a n t W a l t e r Levy observed t h a t a t t h e p r e s e n t p r i c e s f o r o i l , I t a l y s i m p l y cannot pay i t s b i l l s and w i l l have t o be b a i l e d o u t — e v e n t u a l l y b y W a s h i n g t o n . M r . L e v y r e a s o n s t h a t much o f t h e o i l p r o d u c e r s ' f u n d s w i l l f l o w i n t o t h e U n i t e d S t a t e s , a n d t h a t i n t h e l o n g r u n i t w i l l be 128 THE NEW YORK TIMES June 1 7 , 197^ t h e U n i t e d . S t a t e s t h a t w i l l have t o r e c y c l e money t o t h e debtors, accepting the debtors' ever d e p r e c i a t i n g promissory notes. S o , i n t h e end., t h i s p r o c e s s w i l l mean a l o s s o f r e a l r e s o u r c e s f o r t h e United. S t a t e s . W i l l the American people accept t h i s , M r . L e v y a s k e d l a s t week i n a n i n t e r v i e w . He s a i d h e d o u b t s i t , e s p e c i a l l y i f i t w o u l d lead, t o more u n e m p l o y m e n t i n t h e U n i t e d . States. Y e t , t h e a l t e r n a t i v e c o u l d be I t a l i a n b a n k r u p t c y a n d c r a s h i n g f i n a n c i a l m a r k e t s , s i n c e i f I t a l y cannot pay i t s b i l l s t h e banks t h a t h a v e a l r e a d y l e n t i t m o n e y — i t has b o r r o w e d i n t e r n a t i o n a l l y some 1 0 - b i l l i o n o v e r t h e l a s t t w o y e a r s — w i l l be i n deep t r o u b l e . West Germany i s t h e b i g s u r p l u s c o u n t r y i n E u r o p e a n d w i l l p r o b a b l y be t h e f i r s t t o b e c a l l e d , o n t o h e l p p a y I t a l y ' s b i l l s . A l t h o u g h , t h e German a c c o u n t s l o o k g o o d o n p a p e r , t h a t c o u n t r y , t o o , f a c e s enormous i n c r e a s e s i n i t s e n e r g y c o s t s . And i f markets a r e s h r i n k i n g f o r i t s e x p o r t s , i t can a l s o r u n i n t o trouble. Recard. T r a d e Deficits L a s t week, b o t h France and B r i t a i n reported, r e c o r d t r a d e d e f i c i t s , s i g n s t h a t I t a l y may be j u s t t h e f i r s t o f many d o m i n o e s . The F r e n c h d e f i c i t — a t 6 0 0 - m i l l i o n i n May—was e v e n h i g h e r t h a n t h a t f o r e s h a d o w e d , b y F i n a n c e M i n i s t e r J e a n - P i e r r e Fourcad.e when h e announced a s e r i e s o f a n t i - i n f l a t i o n measures on Wednesday. The F r e n c h a c t i o n i s aimed, a t c u t t i n g t w o - t h i r d s f r o m t h e 17 p e r c e n t i n f l a t i o n r a t e a n d g e t t i n g t h e i n t e r n a t i o n a l a c c o u n t s b a c k i n t o e q u i l i b r i u m w i t h i n 18 m o n t h s . The F r e n c h a r e c h i e f l y c o u n t i n g o n West G e r m a r y b u y i n g o f a l o t more F r e n c h - m a d e c a r s , machine t o o l s , f a r m p r o d u c t s and p e r f u m e s . B u t t h a t means some German r e f l a t i o n , w h i c h has y e t t o be s e e n . 129 T H E WASHINGTON POST June 30, 1974 Joseph R. Slevin Threat of Worldwide Recession Grows m THfi THREAT of a worldwide recession is causing mounting concern among «gnomic forecasters. It's only a cloud on the hwrizontoutit looms larger than it did a month or two ago. A sampling of government and private forecasters discloses that few are willing to predict that a worldwide slump actually will occur. Many are quick to warn, however, that it is a very •real possibility that must be reckoned with. The experts see two main weaknesses in the international economic scene. One is the serious, impact that the steeip Arab oil prices may have, on the capacity of oil consumers to buy other goods. Jr„..The second is the restrictive effect of the increasingly rigorous anti-inflation programs that industrial nations are pursuing. Federal Reserve Board Chairman Arthur Burns and his West German opposite number, Bundesbank President Karl Klasen, three weeks ago joined at the International Monetary Conference in flatly declaring there will be no world recession. WHILE THE central bankers clearly were anxious to bolster public confidence and undoubtedly would take the same upper approach today, the economics of the' major countries have a weaker look than they did. "Check them out," a top federal forecaster urges. "There isnt one important country that's expanding rapidly, not one." The government expert stresses that most countries seem to be chalking up impressive gains because their nominal output volume is being swollen by inflationary price increases. Real production, however, is changing little, with small increases or small declines being typical. Germany is the envy of most other countries for it has the lowest inflation rate and best international payments performance but German industrial production is only 1 per cent above a year ago and is lower than it was during the winter. The huge U.S. economy is struggling to grow again after having slumped sharply but the consensus judgment is that it will post only tiny gains at most during the rest of this year— and that it could sink into a deepening recession if that is the way the world is going. TIGHT MONEY is causing even greater housing weakness than seemed likely when Burns issued his "no recession" forecast. Consumers are behaving like reluctant spenders and busi- nessmen are showing signs of pulling in their horns, too. French President Valery Giscard d'Estaing has announced new austerity measures to curt) inflationary spending and the Bank of France recently boosted its discount rate to a record 13 per cent. Germany is holding to its tight money policy as are the British and the inflationridden Japanese., Italy has resolved its cabinet crisis with an agreement to carry out firm fiscal antiinflation measures to bolster the Bank of Italy's restrictive credit program. All the major Free World governments are consciously seeking sluggish economies to break their inflation spirals. It would not take much to push them over the line and into the worldwide recession that Burns and Klasen said won't happen. 130 T H E UNDER SECRETARY OF T H E TREASURY WASHINGTON. D.C. 20220 JUN 6 1974 Dear Mr. Chairman: You wrote to Paul Volcker on May 30, following your meeting with Congressmen Reuss and Johnson, about three areas i n which you desired follow-up information i n connection with reconsideration of IDA replenishment legislation. The f i r s t area concerned the Administration's p o s i t i o n on l e g a l i z a t i o n of p r i v a t e gold ownership, w i t h p a r t i c u l a r reference to the Dominick Amendment. I have attached, as Appendix I , a memorandum s e t t i n g f o r t h our views on t h i s t o p i c . I have also attached, ag Appendix I I , a memorandum on another area you mentioned, i . e . , the status of negotiations concerning the valuation of SDR's, and the r e l a t i o n of the "basket" approach to U.S. maintenance of value obligations i n the i n t e r n a t i o n a l f i n a n c i a l i n s t i t u tions . F i n a l l y , you asked what steps the OPEC countries are taking — other than the purchase of World Bank bonds — to help a l l e v i a t e the problems of IDA c l i e n t countries. I would l i k e to point out by way of introduction that the sharp increase i n revenues of the o i l producers occurred only w i t h i n the l a s t eight months, a r e l a t i v e l y b r i e f time for the o i l producing countries to r e a l i z e the extent of t h e i r new wealth and then to begin to accept the i n t e r n a t i o n a l r e s p o n s i b i l i t i e s that go with i t . Viewing the matter i n perspective, I believe the o i l producers have made a good s t a r t - - perhaps b e t t e r than we might have expected l a s t January - - but they must be encouraged to do more, p a r t i c u l a r l y , as you point out, i n the area of t r u l y concessional financing. Some concrete actions which we are aware have been taken by the OPEC countries are as follows: 131 - 2 - Six OPEC countries have pledged over $3 b i l l i o n to a special f a c i l i t y i n the IMF to provide supplementary financing for o i l importing countries. Four more OPEC countries are considering contributions. I t is contemplated that t h i s f a c i l i t y would be somewhat below market r a t e s , but not i n the concessional area, ana would help both developing countries and developed countries with balance of payments problems a r i s i n g from increased o i l costs. Kuwait i s expanding i t s Economic Development Fund from approximately $600 m i l l i o n to over $3 b i l l i o n . Assistance from the Fund w i l l no longer be confined to Arab nations, and the new funds are to be l e n t on a concessional basis. Expansion of operations from current levels may be r e l a t i v e l y slow because of the Fund's shortage of q u a l i f i e d technical personnel, but the World Bank has o f f e r e d technical assistance to overcome t h i s s t a f f i n g problem. I r a n i s extending over $1 b i l l i o n i n b i l a t e r a l project assistance on favorable terms to Middle East and South Asian countries in addition to providing special price and financing arrangements f o r c e r t a i n of i t s o i l exports. Saudi Arabia and I r a q are extending s i m i l a r project and/or o i l financing f a c i l i t i e s i n the region. Venezuela is a c t i v e l y negotiating the establishment of a $500 m i l l i o n t r u s t fund with the I n t e r American Bank for concessional lending. Venezuela i s also making a further $30 m i l l i o n a v a i l a b l e to the Caribbean Development Bank. Negotiations were completed i n May on a charter for a 24-member Islamic Development Bank, with an i n i t i a l c a p i t a l i n excess of $1 b i l l i o n . Formal approval is expected i n July, with an operational target of end-1974. On the basis of .less d e f i n i t e information, Middle East OPEC countries appear to be considering special funds for A f r i c a t o t a l l i n g perhaps 132 - 2 - $500 m i l l i o n , including a $200 m i l l i o n fund, which would i n i t i a l l y help w i t h financing o i l imports and then be recycled into longer term projects. While we do not have complete and d e t a i l e d informat i o n on a l l the f i n a n c i a l i n i t i a t i v e s , I think the preceding l i s t amply indicates that o i l producers are channelling a portion of t h e i r resources to the poorer countries, that a t least a p a r t of these resources i s being made a v a i l a b l e on the favorable terms that the s i t u a t i o n requires, and that we can a n t i c i p a t e s t i l l more constructive steps i n the f u t u r e . Mr. Volcker w i l l return to Washington by next Monday. I know he i s looking forward to accompanying Secretary Simon for his testimony before your Subcommittee i n support of IDA next Tuesday, and he hopes Committee approval and Floor action can then follow i n short order. / The Honorable Henry B. Gonzalez Chairman, Subcommittee on I n t e r n a t i o n a l Finance Committee on Banking and Currency House of Representatives Washington, D.C. 20515 Enclosures ^(or-V: MdEMY FUND; 4/1 r / ? ^ - Monetary Accord Reached guidelines tor manaiinP Anv arm=• n d m e n t. that are h | igreed ip r\ fl ii ^ hii V r -ite uld ha e t f William F Simon haifed the re- he | r Ih M i l 1 rx-s would submitted to Congress -<ind sults a-; i-omprehensr.-e and nhli h h lid t Kde of other natior1 a 1 legislatures. 1 he WorM Financial Harmony] r HI till H aid ih n < i ! 11 h i ,hm' f 11 f mi ndiner t ill b- le.ai d Should1 or shouM no r n i r nid lull i f de p 1 in, nt and Aid for Poor PUtlens j n ^ mi r h d J m[ li ned in riai, - , 1 r' eri •• ridm directors ol tne uti the 1 • nfl.-enee hangc roe. I.M I- betwf *en now and Fenr.o Set in Interim Agreement nd nierna'i IM ft if Th | in ^ the i n M' J Permanent Reform Sought 1 111 a, r ME,it HE aid r , B* L. DAUE Jr. I teps t r tional crm.l'i. I'»dav s meeting was the last • >1 I r-1 ti l««**l wn» mv Tort Tt*W greater stability/ in mone'ai . id I us ting urplu ps hn d d f 1 the 1 mmitt e >f \ hi h in the balance 01 payments relatJ n among the nations WASHINGTON, June IS —I i ahl hed in Septenih r the t r mn luri^f r r i h i n t I lie.se to irv to negotiate permaThe 20 nations negotiating that rial inns hold. the p,u" k. 1 > • e nent reform of the monetary world monetary reform a j m e d <1 ^ n nl r l 1 n t 1 1 svstem following the collapse «' [fr it t i pn- nl ti ! today on an eight-potrvt pack- impo he, ' in the Internaof'the old svstem when the U n I e - the lage of "interrm'' arrangements ^no'n l \ n i r Find t-irtii^ e1 ised t c pit itl in r to promote financiai harmony imnM HIte|' I--- mike loan to h 1 liar nt „ Id in! e • v. hose balance of pavin the world and help the less hanee rales he^an to tloat. 1 m-nt-. i m hall mt The eommittee. though taildeveloped c o u n t r y pending an H1 f huher il IL t r I h IGR t-ment n M m eventual return to more stable In h l| s uld h orr es 1 n) runt 1 u had nnd^ currency-exchange rates. a 1 HI 1 r r tn in lu mi 1 onsiderahle prepress h>\ last ! In a major gesture that the monetar.' fund, September But then the huge OIJ iltriec id r a n a hi red memnereased the way to the unanih h ill m t r guhrl = 1 1 i el (nM u air ii me rl- f m netai mous a^reecwTit, the United y , in'o dr-arra'. The committee j S t a t e i a^re«d to "reconsider" •i h ^ df. 'ded m pome last Jar>uarv 11 t r p Ml T ra ink, F i«,hts jits lonj-standiftf oppewition to enal crrmmittee based on 1 f l kw t ll- 1 ad I a "link" between ft+d for the 1 the World Ban nk, irr TM |P'S and bearing, for 1 poorer countries and future isthe transfer the tune hem? an interest rate suance of the new international t I I pi t p< r 11 Th 4 1 ni d reserve money C-allod Special •v 11 h speo I atten- The outiine of what has been hange ill mal-e r> F — D r a w i n g Rights. The less-develr,e h |e t n t rt-ns m'r s ^arde t ^ H,,-i , L igr d t r th 1 nl1 a lal" [ 1 Id— 1 ah' t b\ the e.\pl,,siuii of oil, t,»<i shape ol the permanent svstem oped countries had made this "1 ^ till r pri e ,n t "vm rr< -.ettlements among namfl 1 r u N l an absolute precondition f o r a Amendment of Agreement 1 n „.,n o.nn th* h^w .a t7 n n M general agreement. negotiations, though no Most of the elements in the [ > t q.-xerr. u 'nt ? fnn'ipl hut 11 the ;elf. 1 im ed package had been previously 1 hr I 1 ' I '.e| n 1 r nl 1 tahl h f disclosed in general outline, but -rill are • I her new monetarv irti I deadline ot i ind len 1 ti today's c o m m u n i q u e p r o v i d e d , 1 tin r^^^f" ^ is in thi additional details. ni d n Secretary of the Treasury T 1- 1 I the 1 h fei floating IMF e market pn- t Guidelines 134 The Wall Street Journal June; 1 1 , 1974 9 World s '74 Oil Costs Seem'Manageable' Bank for International Settlements Says By RlCHAKD F. JANSSEN deposits on which the banks have based meitaff Reporter of TH* WALL STMKT JOURNALdium and long-term loans of Eurodollars, BASEL—The world's oil-related financial which are dollars held outside the U.S. problems appear likely to be "manageable" Arabs Move. Funds this year, but just barely so, the Bank for In response to tlifct concern, private International Settlements indicated in its bankers here said, Arab countries are startannual report. . ing to move money into the biggest and preAlthough highly hedged, the finding is sumably safest banks from those with deapt to be received in financial centers as re-posits of under $1 billion. And to mlmlmlze assuring. As the central bank for European the danger of overdependence on volatile central banks, the BIS has a reputation for deposits, they say, some large U.S. and forsilent shrewdness most of the time but for eign banks are starting to insist that Arab often-pesadmistic candor vin its annual re- countries commit their deposits for terms longer than the one-month maturities the ports. Despite an estimated 160 billion of extra Arabs prefer. Even before much Arab oil money beoiMmport costs this year, the evidence so far suggests "that the payments problems came available, "the London-centered Euroin 1974 should generally be manageable, dollar market continued growing" vigorthough individual Countries are likely to en- ously, the BIS said. Net loans outstanding of counter serious, difficulties," the BIS dollars and other currencies deposited outside their home countries rose to (170 billion summed up. The world might be much less able to at the end of March from $1^5 billion at the cope with the huge outflow of money to a end of 1973 and from $105 billion a year befew oil producer nations if an overall deep fore, the bank said in its yearly analysis of slump were developing, the bank observed. the Eurodollar market. In an "I-told-you-so" tone, the BIS said But the early 1974 worry of a "significant recession" in Industrial nations has faded onthe floating of currencies since March 1973 "more Tecent indications that the setback has on balance "complicated the problem of attaining and maintaining monetary stabilwon't be prolonged," it said. ity." The breakdown of fixed exchange Although there aren't any indications of rates has spared countries such as West a general rebound in economic output, over- Germany from the need "to expand domesall activity in the quarter ending June 30 tic money supply by purchasing foreign exdoesn't seem "much changed" from the change at rates declared in advance to the first quarter, Rene Larre, the BIS general market," it conceded, thus ending one manager, said in a signed conclusion. And source of inflation. while inflation rates are generally the fastest since the end of World War n, "the ex- But "far from providing a policy-making treme pessimism of some observers doesn't nirvana," floating rates haven't freed other countries from tough decisions on supportseem Justified," Mr. Larre said. ing their. currencies or lessening steep declines that worsen their inflation by making, Most countries are seeking to keep over- imports more costly. Currency market par! all demand from "heating up again," and ticipants too often drove rates of some cur! the boom in commodity prices "can reason-rencies sharply lower instead of stabilizing ably be expected to taper off" so that the them at realistic levels, it complained, with | speed with which wage increases are the large swings worsening the "inflation' granted again could become the main rea- ary atmosphere" by contributing "to a lack son for varying rates of Inflation in differentof confidence in money." • countries, Mr. Larre said. Nevertheless, the BIS view is optimistic only against the background of fears of a sharp recession or even an economic coli lapse akin to that of the 1930s. That cata| strophic view wasn't mentioned in the re[ port, although it was verbalized in the inforv mal conversations of central bankers at the f BIS annual meeting. Mr. Larre did warn {• that "problems loom ahead which may pose f a real threat to the world economy and test } the strength of Intergovernmental cooperaj tion." While the oil countries' surplus ''could in principle be recycled to deficit countries by private financial intermediation, the need for prudence by both financial institutions and the borrowing countries will present obstacles," Mr. Larre cautioned. In effect, this puts the BIS on the side of those who worry that even the biggest banks could be endani gered if Arabs pull out the very short-term 655 France and Iran Sign $4-Billion Accord; Shah Will Receive Five Nuclear Reactors Paris Payments Expected Problem to Be Eased Rider Sees Saudi Switchj for Higher Oil Prices i Lze Joint negotaatiani among! PARIS, June 27—Franc* end oil-coniurnirtg and oil-prxiu-j cing countries, with a rtarw t o I r a n signed a massive 10-ye*r lowering prices. | development agreement today, The Shah of Iran has betn! i n c l u d i n g provision foe the u l < proMing for itiH higher price*, to Iran of five 1,000-megawatt against the reaiatanoe o< K l n g | nuclear reactors worth $ l . l - b i l Faisal of Saudi Arabia, w h o ha«| lion. been sympathetic t o A m e r i c a n The over-all value of cocarguments that continued rlaei etracts and i n d u s t r i a l plans w a i endanger the fur>ctk*itn| at j estimated at 54 b i l l i o n , m a k i n g the world's economy. France Iran's leading industrial Nonetheless, the Shah Mid 1 partner. at a news conference in Th»- deal w i l l go a long w a y Grand Trianon palace at VerThe Shah of Iran d l i c u m t o w a r d easing France's acute ing a f r * * n » « n t y a s t M d a y . sailles today that "Saudi Arabia balarn_e- of -payments problem• w i l l have joined our camp" p r o v o k e d p a r t l y by the rise in The agreements, aigned at the when it reache* 100 per c m t oil prices. Far f r o m seeking conclunor ot a Jtate visit by take-over of the foreign-owned credits, as is usual in vast in- the Shah of Iran and his' Em- oil companies, a re«uJt, he said d u s t r i a l purchases, Iran has presa, represent the f i r s t vast he hoped current Saudi negoagreed to make a_n advance de- iuccew of the French effort to tiations with tha companiei p..,Mt of $1-billion i n the Bank oope independently with the oil- w o u l d effect. <»f France and to pay for three- price crisis through huge sales. The nuclear rtactori, each quarters of the nuclear installa-j France has refused to join on a giant »cale, represent the tion cost in five years. Delivery the cooperative approach lrutiis to be completed by 1985. ! ated by Washington to organ-; Continued 136 THE NEW YORK TIMES FRIDAY, JUNE 28, 1974 France and Iran Sign $4-Billion Pact for more than five years Iran estimates of the total value. had declared herself '"ready to Other projects ace also being largest part of the French- turn our area into a nonnudear Siscussed. Iranian deal. Other aspects Of tone, that is, an area where no According to the doriununithe deal include the electrifica- nuclear weapons should be used qu€, the agreement pledges tion of Iranian railways and all or stored. And 1we stick to this additional quantities of Iranian railway construction, the crea- policy." Oil to France, and. will toake tion of a petrochemical Indus- The French-Iranian deal also France the leader of an enry, building a subway system involved military sales. But the n Teheran and perhaps other Shah said he could not give devSop Iranj^natural gas and cities and construction of a gas details at this time, beyond transport it to Europe. France liquefaction plant and pipeline. mentioning the purchase of a will also engage in further oil exploration m Iran. The nuclear deal includes the group of nst motor boats, training of Iranian scientists to Assure Passage Shah Favors Nationalization and technicians and the estab- Iran's purpose, he said, was lishment of a nuclear-research not to become policeman of the, The Shah saiid at his news nter. <«m Persian Gulf, as has been conference that he would like There was no public mentkm charged, but to assure open to see the whole oil business of safeguards against using the passage through the Gulf and nationalized and then have inreactors as a base for making the Straits of Hormuz, which ternational transactions conductedon attate-to-statebasis. nuclear weapons. The French control the southern entry. Since,that does not seem feasij Foreign Office spokesman said the agreemnt had implied safe- *lfcis is a matter of life and ble, however, he said, it is death fqr us," he add, adding necessary to limit the comguards. that Western Europfc and Japan panies" excessive profits. Other ItMtles Signed also had a vital interest in free He defended the dramatic , The agreement provides that navigation in that area. rise in oil prices, saying it was both parties will respect President Valfcy Giscard no larger than in other comDTEstaing bailed the agreements modities such ad steel, cement France has signed the as a sign that "in international or wheat and had been made Treaty, which prohibits dis- affairs, Iran and France have inevitably by inflation In indus[ semination of weapons or parallel attitude* since both in- trial states. weapon-making capacity to tend to maintain their bide- "We're trying to defend ournon-nuclear powers, and Iran selves against your rampant inhas signed and ratified the to cooperate in the advent of a flation," he said. "You tare Nuclear Nonproliferation Treaty, new international order." going to blow up, and youte 1 which calls for the safeguard Finance Minister Jean-Pierre going to blow Us up with ytota." system of the International Fourcade, said the accords Paris put on a grand show for Atomic Energy Agecny. would mean "fabulous" earn- the three-day imperial visit The Canada, however, is believed ings for French cojnpanies, highlight was a fete at Verto have hpposed these safe- notably Creuzot-Loire, which sailles, With dinner, ballet and guards when selling reactors to will be tile prime supplier of fireworks to which, for the first India and India has since con- the nuclear plants and of a time/ the public was admitted. ducted an underground nuclear steel $30-mHlioti plant The Shah and his Empress, test. President Giscard's spokes- who have visited two French The Shah was questioned man M d oply contracts already nuclear centers, are remaining about his intentions at the news signed or far-advanced" in in France for two more days , | conference. He assested that negotiation were included in as "private visitoift^. . 137 From t h e W a l l Street Journal, June 17, 1974 OPEC Talks Suggest Oil-Price Postings Won't Change Much; Saudis Back a Cut B y JAMES C. TANNER Staff Reporter I of THB W A L L STREET JOURNAL QUITO, Ecuador—The Organization of Petroleum Exporting Countries will continue deliberations today in an effort to reach a compromise on petroleum prices for the next three months. Late last night, after OPEC delegates completed a second day of deliberations, there was little indication of what those prices might be except that they aren't likely to vary much from' the postings that have been frozen at current levels since Jan. 1. ' Most of the 12 oil-producing countries that make up OPEC and account for mqre than 80% of the world's oil exports pushed for an increase in petroleum postings for the third quarter or, alternatively, higher taxes on the oil companies operating within their borders. •/ ' But While OPEC delegates attending the secret sessions denied a split had developed over prices, Saudi Arabia is known to have recommended a reduction In postings rather than an increase. In an interview, Sheikh Ahmed Zaki Ya< mani, Saudi Arabia's influential oil minister, pledged: "We won't Join them in increasing prices or taxes." Posted prices aren't true market prices but are used by the producing country governments to circulate taxes paid them by the oil companies. An increase in postings means an increase in taxes. This, in turn, is passed on by the oil companies to consumers. Thus, a change in postings is directly reflected in prices paid by the world's oil consumers. To resolve their differences over postings, the OPEC delegates continued their talks into last night. But Indications we^e that the thorny issue soon would be settled through a compromise. Iran's interior minister, Jamshid Amouzegar, suggested p. decision was near. And Saudi Arabia's Mr. Yamani w^s, planning to leave today before the end of the meeting. Many of the other OPEC delegates, however, plan to 'remain in Ecuador for the week after concluding their deliberations. The deliberations began Saturday in Ecuador's legislative palace, little used except for international functions under the country's military government. Because Ec- t uador is the newest member of OPEC and 1 host for the meeting, delegates named Ecuador's minister of natural resources, Navy, Capt. Gustavo Jarrin, as president. Replacing Mr. Amouzegar of Iran, Capt. Jarrin will serve ail president until the next OPEC meeting. In other actions over the weekend, the OPEC delegates: —Appointed a seven-member commission to study, a restructuring of the OPEC secretariat and statutes. -Listened politely to pleas of representatives of Guyana, Liberia, Sri Lanka and Nepal for more assistance to developing countries burdened by the tripling of oil prices within the past year. -Turned down applications of the Congo and Trinidad and Tobago for membership to OPEC. The countries, however, were granted "observer" status at the Quito meeting along with Bolivia, Colombia and Pefru. After the price deliberations, the OPEC delegates will take up further discussions today of an OPEC development fund and' an OPEC bank. 138 FROM THE CONGRESSIONAL RECORD, JUNE ?4, F I N A N C I A L ASPECTS O » T SITUATION (By David Rockefeller) I n the final quarter of last yew the Organization of Petroleum Exporting Countries (OPEC) Increased the price of oil fourfold. Given these price* and present level* of production. they will receive more than •100 billion yearly for their <41 exports. Of this •100 billion, the oil-producing nations will spend some HO billion for goods and ssrviosa, leaving $60 billion or so of surplus to be invested. Total reserves of the oil-producing nations are likely to exoeed $70 billion by the end of 1974. $140 billion by OTS. and $200 billion by the end of 1976. These huge surpluses must of necessity be offset by corresponding deficits on the part of oil conThls suggests a structural disequilibrium of major proportions in the balance of payments of countries around the world—ons that could have serious implications for the pluses of the oil producers must be recycled bade to the deficit on consumers. I f recycling does not occur, the oil consumers will bo forced eventually to deflate their economies, with severe worldwide consequences. I n considering this recycling problem I t is helpful to distinguish between the short run—say the next year to 18 months and the longer period. We already have soma experience of recycling In the short run. The first steaMe payments were made by the oil companies to the producer nations I n March. April, and May. and thus far they have been recycled successfully—principally through the International banking system. The oilproducing nations have been placing their money mainly in the Eurodollar market or In sterling. The banks have been the major recycling vehicles, taking this, money on doposit. usually at call or on very J — ' turtty, and mending It to oilnations for periods at five to This far this year. $13 billion or committed to industrial nations to help cover their 1974 balance-of-payments deficits. While this process oan be suoessTul for a limited period oC time, them a n at least four vary serious shortcomings to It, especially In view at the First, the banks cannot continue Indefinitely to tain very short-term money and lend it out for long periods. Second, and even more serious, 1* the likelihood that banks eventually will reach the limits of prudent credit exposure, especially with regard to countries where tt Is not clear how balanceof-payments problems can be solved. Third, the oil-producing countries cannot ba expected to build up their bank deposits Indefinitely. They, too, will soon reach prudent limits for individual banks or even for Individual nations. My own view is that the process of recycling through the banking system may already ba Close to the and tor some countries, and in general It Is doubtful, that this technique can bridge the gap for aaore than a year, or at most 18.months. Finally, this form of recycling is not even a temporary solution, for lesser-developed countries in a weak financial position—countries like India, Bangladesh, and Sri Lanka which are not I n a position to borroy at all Justments, of course, will gradually get trader way between the economies of the ofl producers and the consuming nations. Prloes may decline somewhat, and the oil producers win step up their Imports and Increase the speed at their own Internal development. But in the Interim, they win be large accumulators of reserves. Moreover, countries such as Saudi Arabia, Kuwait, and the united Arab Emirates clearly lack Internal absorptive capacities commensurate with the Incomes they will receive. On the contrary, one of their major alms is to accumulate a body of invested wealth outside their countries which will yield an Inoomo great enough to replace their oil revenue as I t runs out. Naturally they are concerned about such matters as world inflation, exchange risks, and the possibility of expropriation of their assets. Though not yet large, long-term Investments by Middle Eastern countries In the Industrial nations are beginning to build up In real estate, selected securities, and some direct investments In industry. Yet th« sums requiring investment are so enormous, and the Institutional facilities necessary to cany this out so limited, that I question whether such Investments will have much Impact on the gap for some time to oome. All at this clearly suggests that both the World Bank and the I M F win increasingly bo called upon to play key redes In the recycling process. Iran, for instance, has already offered to lend funds to the World Bank and IMF, and . t i n to ^ ' ^ t direct loans to ^ f f ^ others at oonoessionary rates to finance oil Imports. Similarly, the raoently announced willingness of the oil producers to establish a $2.75 billion "oil facility" to help countries with balance-of-payments problems Is a positive move, at least In the shorter term. I tear, however, that this oan only be seen as a modest first step when one the magnitude of the fnnds that must be redistributed. If we arrive at constructive longrange solutions, i r techniques, si a haw to ba 4 have to ba plaoed on International cooperation. which would represent a basks* of oles and hence neutralise the exchange risk between major currencies. Perhaps this assat oottld play a cola In future invnslinut plans at the ofl-producing nations, and. Indeed, it is assumed that It win ba part of the now IMF "ott faculty." I t may also ba possible to work out International guarantee Investments abroad—they could leave the oft in the ground. I t Is highly desirable that ways be found to channel surplus ofl revenues Into projects designed to create alternative souroea of energy. This would not only help the wortjl at large, but would also provide a source of continuing revenues for the on-producing nations- after their oil reserves are exhausted. Finally, tt Is Imperative that the developed countries Join with the ofl producers to assist the less-developed countries. Unless there Is a far more concerted effort In this direction. I fear that the result can only ba economic and political chaos. Underlying aU of these requirements Is the fact that we must come up with a means at recycling funds on a far mom massive scale than now possible. Soma argua that we should simply wait foe the fames at supply and demand to bring prioss down and thereby create a new structural equilibrium. lam. While there is some validity to both 1974 of these positions, I believe we must also be aware of their limitations. First of all, inflation has little hope of answering the problem since the purchases of even the largest oil producers are so relatively smalL Second, X fear that relying solely on supply and demand can have disastrous results for many nations—leading to disruptive unemployment and depression. Creating a mechanism to handle recycling of this scale and to determine acceptable concessions and rides is exceedingly difficult. Perhaps the mission of the I M F could be expanded In this direction, or perhaps it would be beet to create a separate vehicle so as to avoid burdening the IMF with the dual responsibility of policing monetary affairs and curbing unemployment. Whatever the means, I believe it Is imperative that we develop — a new way at looking at world flnah- appears that production is i somewhat ahead at oonsun^ti on prices could very well , be large enough to solve the recycling problem. Indeed. I would guess that we would need a price reduction of some 40% or 80% to produce anything close to * new structural equilibrium. Thus we have no choice but to free the recycling challenge and, tn cooperation with the oil produoers, to dsvtsa the Institutional arrangements necessary to cope with It. The suuuussful creatkm of such mechanisms wfll ba highly dependent on the political climate. The Mlddft East countries, by reason of a shift of wealth and resources, are entering a new period I n which their - -"teal lnflu ~ - " • -.tit, wffl I At the same time, the new wealth of the is likely to strengthen the hands of moderate t orient them i XT sustained, this trend toward moderation may well ba a highly desirable and significant political dividend. I t will also be essential In assuring the stability that must underlie an orderly approach to the redistribution of . International capital. Qiven a dear realisation of the Interdeof an the nations Involved. I bean find ways to transform the problem of surplus capital tn the hands of some nations Into many positive opportunities for grass and development worldwide. But i wtn not happen by itself. I t wffl demand the invotvment and dedication of both the public and private sectors on a scale tar exceeding that which exists now. Above aU. It must Involve a degree of global teamwork which we have not seen up to this point. I f the nations of the world approach the.energy to hope that It oan ba use catalyst and a rallying point for" a i 139 FROM THE NEW YORK TIMES, JUNE 10, 1974 Oil Fueled U.S.-Arab Tie But Milestone Pact Has Given Little Glue to Future ior Prices or Output By LEONARD SIElC bo^ $tabl$ ,e£opomic t h S t S S V n r nfifitali growth and to WQrld moneagreements reached this past' tary order. weekend between the United Yet there was no evidence States and the Saudi Arabian that anything tangible has Governments was oil. But oil yet been agreed to by the Saudis regarding the future was the catalyst that precipiprice or volume of oil productated this new "special rela- tion. In an interview, Prince tionship" between the Saudis Fahd Ibn Abdel Aziz, Second and the Americans. •Deputy Premier and halfFrom the Aral*! stand- brother of the king; said, "we point, ,the most faf-feaching wish the price of oil to go result of the October war was down." But neither the -the discovery of oU as a po- prince, who was the chief litical weapon. Despite the negotiator here, nor any of shock of the economies ofHhe his ministers present would United States, Western Eu- indicate just how lower oil rope and Japan, the oil weap- prices might come about. Hisham Nazer, the Minister on is leading to decisive changes in the bilateral rela- of State for Planning, inditions between the rich indus- cated that the Saudis-intrial countries of the West tended only t^ fty to persuade and the Middle Eastern oil other member governments producers. The United States of the Organization of Peagreement with $a*idi Arabia troleum Exporting Countries, may be the lcey to a series who wiH meet in Quito, Ecuador this %eek, to lower of similar pacts. From the Americans' stand- oil prices. But Saudi Arabia, added, would not act point, access to oil in ade- he unilaterally to reduce its. own quate volume and at lower price. prices is regarded -as crucial Asked why Saudi Arabia did not increase its oil productiqp as a me4ns of putting greater pressure on world oil prices, Mr. Nazcr said his country was already producing more than it should, given long-hm needs to conserve oil resources. He said that if Saudi Arabia were prepared to break with its partners—which it is not— if would simply reduce its to Saudi Arabia, James Akins, who was at a party ^t the Saudi Embassy in Washington last Friday nigiht, said Saudi Arabia is already producing nine million barrels of oil a day and that its fullcapacity production was only 9.2 million. The. American hope in the negotiations was 140 NEW YORK TIMES MONDAY, JUNE 10, 1974 Oil Pact Gives Little Clue to the Future for Prices to induce the Saudis to increase their capacity and daily output over the longer run, Mr. Akins indicated. The atmosphere among the Arabs at the Saudi Embassy was* close to euphoria last weekend. Prince Fahd, who is considered the most likely successor to the Saudi throne, said he was delighted with his trip to the United States and thought it had been "ve'ry successful." He said he found Mr. Kissinger*"brilliant" and, referring t orecent changes in American policy toward the Middle East, the prince added, "Mr. Kissinger should have done it sooner." There was a great throng of top American Government officials—virtually the whole inet—-present at the Saudi top layer of the Nixon CabArfbian Embassy, together with many private American bankers and industrialists. Said one American banker: "Fantastic — imagine it, the great of the world coming to kowtow to the Arabs." A Second Weapon There was little reference to what the Arabs wjll do with, the billions of dollars they are receiving for their oil. However, there is general recognition that the oil weapon has given birth to a second bargaining weapon that may inspire as great repect as oil among the Western officials and financiers. Salah al-Din al-Bitar, a former Syrian Prime Minister, has suggested that the Arbs now Have a second weapon, the'money weapon. If billions of dollars of Arab money were to be withdrawn from European banks, he has said, this "would' give rise tion, manpower and educato an unprecedented financial tion, technology, research and crisis in most Western development, and agriculture. countries." The Saudi-American agreeHowever, the Saudis them- ment seems more cautious in selves appear adverse to suggesting that the joint risking any such world mone- commission will seek ways to tary crisis. That is.why they encourage cooperation in fiare virtually alone among nance—4he area of-greatest the oil-producing countries in interest to the private investfavoring lower oil prices, ment community in this However, Western finan- country. ciers and businessmen do However, Prince Fahd, like not let them forget the his half-brother the king, power and 'attractiveness of seems far more concerned their vast and rapidly-grow- about political stability in the ing supply of oil dollars. Middle East, the "rights" of The Arabs are receiving the Palestinian Arabs, anjl more proposals for what access to the Arabs' holy they should do with their shrines in Jerusalem. money than they can Basic U.S. Policy quickly evaluate and process/ They appear to be in no Yet the Saudis appear to huiry to do so. They insist be moving, without being their priorities are, first, to willing to say so explicitly, assure the security of their toward some sort of accomcountry; second, to promote modation with Israel. its economic and social deIn praising Mr. Kissinger's velopment and, third—appar- diplomacy, and celebrating ently a poor third—-to expand their own success in achievtheir long - range foreign ing^ new relationship with investments. 2 Joint Commissions The pacts they have negotiated With the Americans reflect these .priorities. They have set up two joint commissions on security and economies. The security commission will be headed by Robert F. Ellsworth, who left ' his post as President Nixon's , Ambassador to NATO to join 1 Lazard Freres, the invest- ' ment banking concren, and has now rejoined the Administration as Director of International Security Affairs at the Pentagon. , The joint economic com- 1 mission, which will be headed by Secret ary of the Treasury i William E. Simon, will work on programs of industrializa- ; the United States, the Saudis appear to accept the basic United States policy line;; enunciated last November by Mr. Kissinger "We have a special relationship with Israel an4, we are committed tx> protect her security, and we believe that Israel's security can. only be protected by respect for your sovereignty. If we have a special relationship' with Israel,, we do not regard it as incompatible with the friendship we want to promote and consolidate with you . . . what we want is that the peoples of this area should build their own system of life and security in conformity with what they see fit and in harmony with world facts." The new Saudi-American agreement of this past weekend appears to represent real motion in that direction. 141 N o t e : T h i s i s f r o m " I n t e r n a t i o n a l F i n a n c e " a b i - w e e k l y p u b l i c a t i o n o f Chase M a n h a t t a n B a n k , June 3 , 197^* W o r l d Payments Problems i n 1974 and 1975 Higher oil prices have thrown a financial monkey wrench into the world economy, with an unprecedented impact on the current account of the balances of payments of both the oil-producing and the oilconsuming countries. The current account includes the basic non-capital items in a nation's balance of payments—the import and export of goods, and receipts and payments for services such as tourism, shipping, and insurance. I t is generally a good indicator of the state of a nation's external financial health. Forecasts of current account deficits also give a rough idea of external borrowing requirements, since the size of any country's deficit can only be as large as the total that can be financed by capital inflows—including borrowing abroad—and the drawing down of foreign reserves. The problem of massive oil-related current account imbalances w i l l not last forever. As higher prices induce greater conservation in energy use and the development of alternative energy sources, oil imports w i l l eventually put less of a strain on nations' payments accounts. But in the meanwhile, the importing countries' deficits w i l l pose a major problem of world financial adjustment. Clearly, this year and next are critical. According to latest estimates, the oil producers will achieve an aggregate current account surplus of roughly $60 billion in 1974 and again in 1975. This compares with a combined surplus of $4.6 billion in 1973 and only $1.6 billion in 1972. Saudi Arabia is setting the pace for the major oil producers, with its current account surplus projected to soar from $2 billion last year to $17 billion in 1974. I n second place, Iran's surplus is expected to grow from $200 million last year to $11.5 billion this year. Other producers w i l l show smaller —but still very substantial—gains in 1974. Future surpluses w i l l enable the oil-producing countries to increase their financial assets—their claims on foreign resources. Over time, these countries w i l l utilize their financial assets to purchase more goods and services from the oil-consuming countries. But during the next two years, none of the oil producers can effectively absorb the huge increase in imports that would be required to balance their current accounts. Even in those countries that have the potential, the Texperience, and the institutional framework for undertaking import-using development projectssuch as Iran and Venezuela—it w i l l be at least two years before a substantial volume of funds can be spent effectively. I t takes time to undertake feasibility studies, to select projects, to develop engineering plans, and to order and receive equipment from abroad. Therefore, in 1974 and 1975, the main problems posed by the recent oil developments for the producing nations will be financial—in which countries or markets to place their rapidly accumulating funds, which intermediaries to use, which financial instruments to select, etc. Later, there will be the economic problem of transferring real resources from the oil-consuming to the oil-producing countries. Of course, oil-producing nations can record current account surpluses only if the oil-consuming countries run an aggregate deficit of equal magnitude. Close to $40 billion of this deficit, or two thirds, w i l l be borne by the developed countries, and the remaining $20 billion or so by the less developed and socialist countries. Britain w i l l face the largest current account deficit—about $9 billion—this year, followed by $6 billion for Italy, $4 billion for France, $3.5 billion for Japan and $3 billion for the United States^ Germany should post a current account surplus of some $3 billion this year, due to continuing strong foreign trade and a relatively moderate rate of inflation. The current account deficits expected this year and next could be met, to some extent, by the drawing down of reserves. However, most countries have moderate or minimal reserve holdings. Thus, in 1974 and 1975, the main problem facing most oil-consuming countries w i l l also be financial—how to finance their very large current account deficits. A number of these countries have already succeeded in obtaining financing from foreign private banks—the so-called balanceof-payments loans. But the more that any one country borrows, the more difficult it becomes for that country to obtain additional financing. Also, there is an overall limit to the volume of funds that private financial institutions will want to recycle—especially if the process involves converting short-term borrowings into longer-term loans. Large current account deficits are expected to persist through 1975 and probably throughout most of this decade. This makes the world financial system highly vulnerable to disturbances. If any important financial institution becomes over-extended, or if one country is unable to repay its financial obligations, or if one key country seeks to improve its current account position at the expense of others—through trade controls or deliberately depressing the external value of its currency—then all countries and their financial institutions may be in difficulty. Richard H. Kaufman 142 Saudis Agree to Buy Large U.S. Special Securities Issues By JOHN 6ERRITY THE MONfY MANA6EH JUNE 17. WW WASHINGTON—Much more is riding on the success or failure of President Nixon's unprecented visit to four Arab states than the mere erasure of tarnish from M r . Nixon's political image at home, as many of his critics have hinted or openly charged. Perhaps the most delicate diplomatic accomplishment hanging in the balance, that will be determined in the final assessment of the President's dual journeys to the Middle East and Soviet Russia, is the new "special relationship" accord reached between the United States and Saudi Arabia, the world's largest exporter of oil. A key feature of this aecord, the "Money Manager" learned last week, is a proviso whereby the United States will play a very dominant role in the so-called "recycling" of vast amounts of new oil revenues by absorbing perhaps as much as $10 billion of the Saudis' heavy cash accumulations annually through the sale of new, possibly gold backed, "special issues" of U.S. Government securities to Saudi Arabia. The accord, with its special proviso for a U.S. Government securities swap for excess oil revenues was reached on Saturday morning, June % at a formal signing ceremony at the State Department. The principal' figures in the ceremony were Secretary of Sttite Henry Kissinger and Prince Fahd Ibn Abdul Aziz A1 Saud, regarded by Middle East experts to be the second most important map in Saudi Arabia. State Department and Treasury officials refused to discuss specific details of the securities-for-oil swap deal, such as whether the Government's "special issues" may or may not be gold-backed, rates of interest to be paid, maturities, and so forth. Neither is there any confirmation of an absolute "fix" or "ceiling" on the total amount the United States may issue in special Government securities, to help drain off currency accumulations Saudi Arabia would acquire as a result of the 400% increase in crude petroleum prices at the peak of the fuel crisis earlier in the year. Of the total increment in oil revenues to Middle East countries, estimated generally to be about $50 to $60 billion, approximately one half, or $25 to $30 billion, would accrue to Saudi Arabia as the largest exporter of oil in the world. I n light of other international monetary Continued ARAFRBMF developments last week, most notably new gold arrangement contrived %y the Group of Ten Industrialized "Countries to help bail Italy out of iter economic troubles, the possible future use of gold-backed special U.S. Government Security issues to help <soak up an over-abundance of cash Concentrated in a single country, is a development that's bound to generate Imaginative reactions and conjurings. Just prior to the formal accordSigning ceremony, P r i n c e F a h d stressed to both President Nixon andlo, Secretary Kissinger that longrange development of good U.S. relations with Arab world would be "contingent" upon further Israeli Withdrawals from Arab-claimed lands. " Additionally, the U.S.-Saudi Arabian agreement provides for the U.S. recognition of Palestinian "national rights".—a neat diplomatic phrase, which means simply the ultimate establishment of a Palestinian state op the lands now occupied by Israel's forces in the west bank of the Jordan River. The President's visit to the Middle East counties, in effect, certifies his personal involvement in the general Agreement aimed at strengthening. economic ties between the U.S. and the Arab world. Too much stress has very probably been placed on the assumption tihat the U.S. might beeome "militarily involved" in the Middle East, according ip'one State Department official. ; "This is especially so," he said, "in view ofthe erroneous interpretation that some attached to a $100 million *ftpecial requirements fund' provision in the Pfesident's $6.19 billion fiscal 1975 fowigs aid pregxsm." Secretary Kissinger explained to both House and Senate Foreign Affaire Committees that, while some of this $100 million "special requirements fund" might be given to Syria to help rebuild war-damaged areas, particularly the provincial capital of Quneitra, no "hard commitment" for such aid was made as part of the peace pact ending, the seven-year war between Israel and Hie Arab republics. Obviously Egypt, Syria and Jordan, as well as Israel, which will share in the (proposed $907.5 million aid program for the area* "welcome the new: compact will prove to be somewhat overblown. But there can be no masking the fact defense pacts are not sufficient at this juncture of history. Of far greater importance 'is the economic assistance that can be made available, pins, Of course, the extent to which the United States is able to fill the void left by the withdrawal of Soviet Russia support for Arab states. In all of this delicate maneuvering, the President's role and presence is important, and significant—and is not, as some have asserted, an exercise in "political barnstorming," calculated to offset political damage caused by the Watergate affair. The Uftiterf State* Certainly, the President will draw political refurbishing from hia Middle Sagdi Affrftw t j r p t i f Bf East visit and: his summit meeting in Soviet Russia, that begins on June 27. proTUesftrfoeHS. But whatever personal gains lb* recognitor $f Mestiatat Nixon makes on the home front, they are regarded as "ancillary" to the "Batfowl rights." larger achievement of new and vigorous links between the United States prospects of U.S. aid flowing in," the and the Arab world. State Department official said. Moreover, Mr. INixon's direct parOil-rich Saudi Arabia, which has ticipation in this new and highly senlong nurtured strong pro-U.S. sym- sitive venture into geopolitics is conpathies, is, in a very distinct sense, sidered a very important element in "special case to be regarded in a winning the necessary Congressional special manner." support for his world-embracing dipThis separate-but-contingent rela- lomatic endeavors. tionship, is rooted in the simple fact But the excitement provoked by any that Saudi Aaabia wants U.S. tech- securitiea-for-oil agreement is subject nology and commitments for .markets to some serious caveats. to help industrialize that desert kingThe U.S.-SaUdi Arabia accord, no dom. more and no less than any other Indeed, according to the State De- agreement the United States might partment, increased American eco- reach with a foreign country is, in. nomic involvement in the MiddleEast the final analysis, a treaty, subject was always considered to be a key to ratification by the Senate. component in whatever new diplomatic There's no gainsaying the fact that relations might evolve between the the President's massive foreign aud U.S. and the Arab states. program—to say nothing about such It may be that expectations of far-rmdmc "apodal arrangements" benefitsflowing-to both sides in the as that with 8aadi Ar»6i*-**m ran into some tough questioning and opposition in Congress. "I'd like to know how far thest commitments go," said Cong. H. R. Gross, R-Iowa, with respect to the overall, agreements' resulting from. Mr. Kissinger's Cairo-to-Damascus diplomatic junketing. "I am waiting to see' all of the commitments that fiaye been made in the'Middle East. Echoing a similar belief that the President and Mr. Kissinger face a tough selling job with Congress "under the best circumstances," Peter Frelinghuysen, R-NJ., said "if .experience is any guide, some severe slashing will be made" in the total dollar request. Senator Barry Goldwater, R-Ariz., one of Mr. Nixon's most stalwart backers throughout the entire Water* gate matter, waa even more outspoken on his personal hostility to any aid that might be given to Syria. Senator Goldwater sharply criticized t h e "Special Requirements Fund" as an aid program "inappropriate to a country we have never attacked, never been particularly friendly to, Mid whose aid we have never particularly sought." The Arizona -law-maker added that, in his judgement, "it was time for a long, thoughtful discussion" of U.S. foreign aid programs, which he suspects have "been largely failures from their beginning." Besides these sorts of obstacles, there's an. undefined mass of opinion, especially in the House of Representatives, that balks at the notion of the U.S. rendering economic assistance to the Arab fttates, which together with Venezuela, were largely responsible for the fuel crisis and inflated oil and gas prices. - "It jnst doesnt mike sense to me to have the United States subsidizing C i i i h m — Mat page 144 Arab Peal rO>fctfnu«d from preeediag page its <yonomie enemies," one member of the House Foreign Affairs Committee said. Committee Chairman Thomas R. Morgan, D-Pa.. a long-time hacker of foreign aid programs through Republican and Democratic administrations alike, voiced s«m« similar concerns. After a Jong, ol<wed-door session with Secretary Kissinger, chairman Morgan emerged, shaking MB head thoughtfully, to aay to reporters that he had some "serious reservations" about the entire aid program for the Middle E*»t. It was just because of *ueh comments and fears as Mr. Morgan expressed that Secertary Kissinger went to some pains to repeat on several occasions that he would "consult closely" with Congrasa on all specifics such as the Saudi Arabian accrd, the proposed 1350 million military aid scheduled for Israel, the $207.f. million military and «-conumic aid for Jordan and the $25<> milHon economic aid program for Egypt. Consequently, it can be taken for granted that, si nee the a>.vord involves the issuance of new instruments of Federal Government dvbt, the Senate Finance Committee, as well as the Senate Foreign Relations Commit t.-v, will sihare in the pre-ratiflcation process. In that sort of environment, close questioning an-l fairly intense surveillance can be regarded as matters of fact, which won't be dealt with casually. • 145 THE WASHINGTON POST rrUv.Mv3.mi Saudi Arabia Could Buy Into Oil Companies Reutar, . ' • "" NEW YORK, May 2—Any <»n buy oiir stock, IncludiHg Saudi Arabian interest Jn Skudi Arabia." buying into four; giant Amer- . One administration offiican oil companies faces lit- cial saidthat the governtle opposition, according to ment cofctd oppose the purchases on grounds of nagovernment and industry tional security, but even sources. that seems unlikely at the U.S. laws, designed to pre- moment. •* vent companies from lessen"Since those companiefing competition, "never envisioned direct government sell fuel to the Defense D&* purchases," a top Justice partment and have other Department official said to- government contracts, thecf' J retically, a foreign governday. ment in control would cei*' Deputy assistant attorney tainly not be in, our best tis-'j general Keith Clearwaters terests," the official said." pointed out teat present an- "Out since this is aU so hisT titrust laws apply only to pothetical cant see usatdoing rate, % any anything: corporations, pot to- coUn- abput it yet". ' tries, which, In theory at If the Saudis actually go" least, would give the Saudi ahead with the stock buyirifc" government a free hand. plan the cost would be enor* * Two newspapers in Ku- njous, even for a country wait reported yseterday that that could earn $20,000 milthe Saudis are interested in lion this year from selling, buying large stock intei*sts oil. * in the four Ajnerican partExxon alone has close tp ners of the Arabian Amerl- 250 million shares issuM can Oil, '' Company selling for about $80 each. (ARAMCO)—Epxon CorpoJust to bpy a 5 per cefit, ration, Texaco, Mobil Oil interest in Exxon—2' per and Standard Oil of Califor- cent more than the amourit nia. held by. Chase Manhattan • Spokesmen /or the four Bank, the biggest owner <afc»« companies declined to offer preseni>T-the -Arabs would,; any confirmation of the re- have to pay in the rfeighba^V ports, but an Exxon official; hood of $1 billion,stoeTmat, ' •lid "Anyone who wants ket encysts estimate. 146 CHAIRMAN OF T H E BOARD O F GOVERNORS FEDERAL RESERVE SYSTEM WASHINGTON, D. C. 20551 June 1 9 , 1974 The H o n o r a b l e Henry B . G o n z a l e z , Chairman Subcommittee on I n t e r n a t i o n a l F i n a n c e Committee on B a n k i n g and Currency House o f R e p r e s e n t a t i v e s W a s h i n g t o n , D . C. 20515 Dear M r . Chairman: Thank you f o r your l e t t e r o f May 2 9 , r e q u e s t i n g my comments on r e c e n t developments i n t h e p e t r o l e u m m a r k e t . I s h a r e your v i e w t h a t t h e r e c e n t a c t i o n s o f OPEC c o u n t r i e s i n m a n i p u l a t i n g p e t r o l e u m shipments and p r i c e s a r e h a r m f u l t o t h e i n t e r e s t s of the United S t a t e s . I n d e e d , by weakening t h e i n t e r n a t i o n a l monetary system, OPEC c o u n t r i e s a r e a c t i n g a g a i n s t t h e i r own b e s t i n t e r e s t s as w e l l . For t h e l o n g e r - r u n , I see no v i a b l e a l t e r n a t i v e t o a r e d u c t i o n i n the p r i c e of petroleum. The l o n g e r t h e p r e s e n t p r i c e i s m a i n t a i n e d , t h e more i n t e n s e w i l l become t h e economic f o r c e s operating to modify i t . Most c e r t a i n l y , a l t e r n a t i v e sources o f energy w i l l be d e v e l o p e d and c o n s e r v a t i o n i n energy use increasingly practiced. An i m p o r t quota scheme, such as t h e one P r o f e s s o r Adelman has s u g g e s t e d , has s e r i o u s l i m i t a t i o n s . A quota i n i t s e l f w o u l d , i f s e t a t a low enough l e v e l , r e d u c e our energy i m p o r t s . Howe v e r , u n l e s s energy c o n s e r v a t i o n t e c h n i q u e s and expanded d o m e s t i c energy p r o d u c t i o n were a l r e a d y i n p l a c e , cutbacks i n our energy i m p o r t s c o u l d s u b j e c t our economy t o s e r i o u s s t r a i n s . Furthermore, s i n c e such a quota system c o u l d be i n t e r p r e t e d by t h e OPEC n a t i o n s as an a g g r e s s i v e a c t on our p a r t , i t m i g h t s e r v e as a r a l l y i n g point for t h e i r c a r t e l . Sincerely yours Arthur F. Burns 147 "3***.% £ Hfli Burden of Oil Money Worries Bankers By EDWIN L. DALE Jr. SpcaUl to The New Yoffc Timet WILLIAMSBURG. June Two leading Bankers expressed deep reservations today over how long the international banking network could carry the burden of recycling the vast flows of money resulting from the huge jump in prices. remarks were summarized later. The one Arab speaker at the conference, Edward C. Awad, technical manager of Petromin, the Saudi Arabian oil agency,! told reporters that he generally agreed with the diagnosis of the bankers—that short-term recycling would only create a "false financial atmosphere" and was not a long-term soli)-; tion. At issue was the channeling But he had nothing to proback to oil-consuming coun pose on a longer-term investtries of the tens of billions of ment strategy for oil-exporting dollars that have begun to flow countries, saying only that "it to a small group of oil-producis a question of education" and ing countries, particularly Arab that general policy had not yet nations with small populations. been established. The forum was a session toAccording to the summary of day of the International Monethe meeting, none of the extary Conference here, which perts expressed the hope that a brings together bankers and drop in the price of oil—even government officials from the though some decline was possiUnited States, Europe and Jable—would be sufficient to pan. solve the financial problem of The doubts about the ability the vast flows of funds to oilof the international banking producers. system, including the Eurocur- director of the Deutsche Bank Giving new estimates, Mr. rency markets, to handle the of West Germany. Rockefeller said total monetary problem for more than about Mr. Rockefeller made public "reserves of the oil-producing another year were expressed his address, although the ses- nations are likely to exceed by David Rockefeller, chairman sions of the conference are $70-billion by the end of 1974, of the Chase Manhattan Bank, closed to the press. Mr. Guth's $14Q-billion by end-1975 and and Wilfred Guth, managing $200-billion by the end of 1976." He added that "these are staggering amounts" and said they "could have serious impli-j cations for the world economy1 and international financial mechanisms." The payments to the oil countries have only just begun, Mr. Rockefeller said, and "thus far they have been recycled back successfully—principally through the international banking system." But he cited four reasons for his doubt that this could continue beyond "the next year to eighteen months' f"The banks cannot continue indefinitely to take very short-term money and lend it out for long periods of time." This concern was also expressed at a session of the conference here yesterday. f'Banks eventually will reach the limits of prudent credit exposure, especially with regard to countries where it is not clear how present balwc^f-payments problems can 3 "The oil-producing countries cannot be expected to build up their bank deposits indefinitely. They, too, will soon reach prudent limits for individual banks or even for individual nations." q'This form of recycling is pot even a temporary solution for lesser developed countries in a weak financial position." He mentioned such nations as India and Bangladesh "which are not in a position to borrow i t all in commercial markets." Mr. Rockefeller, injured in a fall in Taiwan last month, moved about with aluminum crutches, but otherwise seemed in good condition. Emphasis on Credit Mr. Guth also emphasized the problem of creditworthiness —that private banks could not go on making loans to governments where thfc prospect of repayment was dim because of a continuing deficit in national balance of payments. Payment deficits reduce monetary reserves and thus the means Of repayment At an earlier session today on the general problem of world inflation Herbert Stein, chairman of President Nixon's Council of Economic Advisers, argued that the "fundamental" or "traditional" means for curbing inflation—control of government spending and deficits, and restraint on the growth of money and credit—had not failed in recent years but rather had not been sufficiently used. "Our own history of accelerating inflation in the past decade," he said, "certainly is not the history of a vigorous end unsuccessful adherence to the old-time religion." Mr. Stein cited figures on large budget deficits and large increases in various definitions of the nation's money supply ovnr most of the period since 1965 to back up his point 148 THE HEW YORK TIMES June 3, 1974 Oil and the Cash Flow By C. Fred Bergsten Second, the prophets of doom conWASHINGTON—Arab oil earnings will rise by $65 billion this year, the fuse the balance of trade and the amounts will get even bigger in fol- balance of payments. They ignore the lowing years, the balance-of-payments simple but central fact that the oil positions of the consuming countries exporters must invest in the industrial will plunge into the abyss, the inter- world any of their increased earnings national monetary system will col- that they do not spend. The Arabs lapse, the Arabs will buy up all our will not bury the money in the ground. companies—so goes the refrain heard Thus, there can be no deficit in the frequently since the dramatic increase balance of payments of the industrial world as a whole. in oil prices in December. There are indeed extremely serious * To be sure, the flow of money from the Arabs will not necessarily go to consequences of the oil crisis: individual industrial countries in Inflation has spiraled upward; re- amounts that precisely match the decessions are possible if governments cline in the trade balance of each. mistakenly cut back aggregate de- Some industrial countries may wind mand to cope with shortages of up with a sizable surplus; others may supply; countries producing other raw have deficits. materials have been encouraged to But this problem is solvable solely emulate oil exporters; a few of the through action by the industrial counpoorest countries will suffer serious tries themselves to recycle the money deprivations, and political tensions de- to where it is needed. Much financial riving from the energy problems recycling will take place through norcould intensify among countries. mal market forces. Some can be But the international monetary situ- handled by government borrowing in ation adds relatively little to the prob- the private capital markets. The Eurocurrency markets — those lem. No industrial country will go that lend a variety of currencies from bankrupt. The monetary system will European centers—have grown as rapnot collapse. The prophets of financial idly in several past years as they will doom simplistically compare the increase in each country's oil bill with have to grow now, and the United States capital market is now fully its existing monetary reserves. They available with the abolition of connote that United States imports will rise by $15 billion and that its reserves trols. Together, they can handle the vast bulk of the money on their own, are $12 billion, and conclude that the and are in fact doing so even as the full United States cannot pay—even for amount of the higher oil earnings is one year. now being invested. Such observations are absurd. First, they ignore that a sizable share of The rest of the money can move the increased earnings of the oil-exporting countries will be spent on im- , through such existing intergovernmenports from the industrial world. Some tal institutions as the swap network among central banks and the Interoil countries will spend virtually all of national Monetary Fund. Indeed, such their increased earnings themselves; backstopping will be needed for any all are rapidly revising their developindividual borrowers whose creditment strategies and military plans to worthiness comes under doubt in the do so. Some will lend their monev to private market. But Italy is the only others who will quickly spend it. such case to date. So even the trade balances of the industrial world will not decline by In any event, no special cooperation more than, say, half of the increase with the oil exporters is needed in in its oil bill this year. Those trade this area. It helps for the International balances will be even better in subseMonetary Fund to borrow from them quent years, as any further increases to help finance members' deficits, but in oil countries' earnings are more there is no reason to give the oil exthan offset by their increased imports. porters better terms than other lenders. Indeed, the United States appears to Doubts are sometimes raised about have already reached its new plateau the plausibility of such smooth hanof oil imports in April at an annual rate dling of the oil money. First, it is feared of $27 billion), but there was a surplus that the money, like th6 oil itself, wm in over-all trade as exports reached an be "politicized." But it is highly doubtannual rate of almost $100 billion. ful that .the Arabs will try to promote monetary instability by shifting their funds from place to place. Once invested, the very size of the funds will make it increasingly difficult for the Arabs to liquidate quickly without incurring substantial losses. If they were to make such shifts, the money could readily be recycled through the swap network. Second, it is argued that some industrial countries may be unwilling to accept the needed shift in the structure of their balance-of-payments positions. It is certainly true that all of their trade balances will deteriorate and be offset by increases in capital inflows. But such a situation might well be sustainable indefinitely since the capital inflow will by definition continue as long as the trade imbalances do. And it is certainly sustainable for the interim period until enorgy conservation and the development of new sources of oil and alternative forms of energy are brought into play to change the energy situation to its roots. Third, some industrial countries fear that many of their companies will be taken over by the oil producers. They need not. Most of the oil countries will soon find, ways to spend most of their income on goods and services. And since they have decided to nationalize most of the foreign business concerns within their boundaries, they are quite unlikely to seek majority control of firms within the boundaries—and legal jurisdiction—of others. Even if they wanted to, they do not have the manpower to exert much effect on the operations of very many firms anyway. So the present pattern of diffused and highly liquid portfolio investment in a wide range of financial assets is likely to persist. Finally, the proposed solution to the monetary problem requires the industrial countries to agree on at least a broad pattern of exchangerate relationships among them, around which the financial flows can be recycled. It will be tricky to reach such agreements, which amount to taking oil out of each country's balance of payments for the purpose of determining exchange rates. However, there was already evidence of progress toward such agreements before oil prices soared. They atfe a necessary component of any stable monetary system for the future, and were thus already at the top of the agenda for monetary jeform. And history clearly shows thamhe alternative of competitive exch|nge-rate depreciations will not work. v It seems clear from the series of official pronouncements on the subject that all countries have recognized these facts and that this latest crisis —like most/past crises—will speed rather than derail needed monetary reform. There is good reason for confidence that the mistakes of the nineteen-thirties and the nineteen-sixties can be avoided in resolving the latest international monetary crisis. C. Fred Bergsten is a senior fellow at the Brookings Institution. 149 FEDERAL ENERGY OFFICE W A S H I N G T O N , D.C. 2 0 4 6 1 JUN 2 0 1974 THE ADMINISTRATOR Honorable Henry B. Gonzalez House of Representatives Washington, D.C. 20510 Dear Mr. Gonzalez: Thank you f o r your l e t t e r of May 28, 1974, i n which you discuss Professor Morris Adelman's proposal f o r an o i l import quota system to c u r t a i l the c a r t e l power of the Organization of Petroleum Exporting Countries, and h i s ideas on the r o l e of o i l companies. Professor Adelman's suggestion that the US Government should r e - e s t a b l i s h o i l import quotas, with quota r i g h t s to be auctioned o f f by d i r e c t , sealed competitive bids to o i l producing nations eager to gain access to the US market, raises a number of questions. Professor Adelman's theory that producing countries eager to get access to the US market w i l l submit lower bids, produce more crude, and thereby force down o i l prices, neglects several points. F i r s t , i n a s e l l e r ' s market f o r o i l , the OPEC countries are free to s e l l t h e i r o i l to more than one prospective buyer. I f the US i s unwilling to purchase t h e i r o i l , other countries may buy i t a t r e l a t i v e l y high prices. Most, i f not a l l , members of OPEC would probably not favor a program that would increase t h e i r own r i v a l r i e s . Because of the small number of members (11) of the o i l producers' c a r t e l , i t would be d i f f i c u l t to protect the secrecy of the bids submitted by the producer countries. Indeed, the national o i l companies of the producer countries would f i n d i t i n t h e i r i n t e r e s t s , to exercise collusion i n bidding on the quota r i g h t s . Thtis, the fundamental problem i s to avoid collusion between producer countries and somehow n e u t r a l i z e the effectiveness of the OPEC c a r t e l . CONSERVE VAMERICA'S 1 ENERGY Save Energy and You Serve America! 150 2 As you i n d i c a t e , Professor Adelman's ideas on the future r o l e of o i l companies are i n t e r e s t i n g . However, he f a i l s to give the companies s u f f i c i e n t c r e d i t for the important l o g i s t i c a l and technological contributions that they have made. At the same time, I share your concern over the p o s s i b i l i t y of p r o f i t e e r i n g by some o i l companies i n t h e i r foreign operations. The Federal Energy O f f i c e recently i n i t i a t e d several studies on the i n t e r n a t i o n a l o i l companies. One of the studies involves a comprehensive survey of o i l company cash flows and p r o f i t s from domestic and i n t e r n a t i o n a l operations. Another study was r e f e r r e d to i n my recent testimony before the Church Subcommittee on M u l t i n a t i o n a l Corporations on June 5, 1974. I indicated that an i n depth study was to be undertaken on o i l company government relationships around the world. I t s purpose i s to help policy-makers by providing the a l t e r n a t i v e s open to the US Government to have an e f f e c t i v e voice on the terms under which o i l i s imported. Unfortunately, both inquiries are presently a t an early stage and, therefore, I am unable to respond f u l l y at t h i s time to your request for information on the r o l e of the o i l companies. The f i r s t study i s t e n t a t i v e l y scheduled to be completed i n e a r l y July while the study on the relationship between o i l companies and governments w i l l be finished by next spring. When the p r o f i t s study i s completed, a copy w i l l be sent to you. 151 HENfcY B. GONZALEZ, TEX.. CHAIRMAN HENRY 8. REUSS. WIS. WILUAM S. MOORHEAD, PA. THOMAS M. REES, CALIF. RICHARD T. HANNA, CALIF. WALTER E. FAUNTROY, D.C. ANDREW YOUNG, OA. FORTNEY H. (PETE) STARK. JR.. CAUF. ROBERT G. STEPHENS. JR.. OA. U.S. HOUSE OF REPRESENTATIVES ALBERT W. JOHNSON, PA. J. WILUAM STANTON, OHIO PHIUP M. CRANE, ILL. BILL FRENZEL. MINN. JOHN B. CONLAN. ARIZ. CLAIR W. BURGENER, CAUF. SUBCOMMITTEE ON INTERNATIONAL FINANCE OF THE COMMITTEE ON BANKING AND CURRENCY NINETY-THIRD CONGRESS W A S H I N G T O N , D.C. 20515 May 28, 1974 B4a The Honorable John Sawhlll Administrator Federal Energy Office Room 3^00 - Post Office Building 12th & Pennsylvania Avenue, N.W. Washington, D. C. 20044 Dear Mr. Sawhlll: As Chairman of the Subcommittee on I n t e r n a t i o n a l Finance, I am becoming Increasingly concerned about the lack of action by the United States and other o i l consuming nations against the price increases imposed by the Organization of Petroleum Exporting Countries. My Subcommittee has l e g i s l a t i v e r e s p o n s i b i l i t y i n two areas seriously affected by the o i l price increases: the i n t e r n a t i o n a l monetary system and the m u l t i l a t e r a l development lending i n s t i t u t i o n s . I am not sure how w e l l the world monetary system w i l l hold up under the strains of the approaching petrodollar glut and how i t can accommodate the d i s t i n c t p r o b a b i l i t y of the Arab o i l producers owning 70# of t o t a l world monetary reserves by 1980. While there i s a number of schemes f o r recycling the petrodollars i n the works, I question t h e i r v i a b i l i t y . I am sure that you are f a m i l i a r with what the o i l price increases w i l l do t o the economies of the less developed countries. They now face a sad f a t e , a f t e r so many years of economic growth aided by the United States through b i l a t e r a l a i d , m u l t i l a t e r a l aid and private foreign investment. Yet we seem powerless t o do anything about i t except beg the o i l producers t o give some a i d t o those countries which the OPEC group i s i n the process of bankrupting. But the aid funds being set up by the o i l producers w i l l be only a minor help to the developing countries. 152 The Honorable John Sawhlll Page - 2 - May 28, 1974 I t seems t h a t the Administration I s reconciled to the o i l c a r t e l and the prices I t has set and that I t f e e l s that somehow through cooperation the disastrous e f f e c t s of OPEC price Increases can be minimized. I am not sure t h a t the evidence supports t h i s p o s i t i o n . I t would appear t h a t we are being f a r too weak I n the face of a price gouging, i n t e r n a t i o n a l monopoly which is c l e a r l y harmful t o American i n t e r e s t s . I am impressed with the proposal by MIT Professor M. A. Adelman t h a t the U.S. auction Import t i c k e t s f o r o i l as a means of undermining the c a r t e l , or at least protecting ourselves p a r t l y against I t . He f e e l s t h a t the U.S. should Impose o i l Import quotas to be sold by sealed competitive bid to anybody who I s w i l l i n g to pay cash f o r a s e l l i n g l i c e n s e . Professor Adelman also feels that high o i l prices are e a s i l y maintained under the present system wherein the o i l companies i n e f f e c t act as agents f o r the o i l producing nations. He f e e l s t h a t i f i t can be done i n unison with i o t h e r countries, the U.S. should get I t s o i l companies out of the crude o i l marketing business and leave t h i s function t o the OPEC countries. I would l i k e t o know your opinion of Professor Adelman^ proposal f o r an Import t i c k e t system and his Ideas on the r o l e of o i l companies. Your ideas would be very much appreciated as w e l l as most h e l p f u l . With best regards, I am Sincerely yours, Henry B. Gonzalez Member of Congress Chairman Enclosure 153 F r o m FORBES m a g a z i n e , June 1, 1974 Enlightened Self-Interest What can the oil-rich countries do to help the poor countries? In his deal with India, the Shah of Iran is showing what can be done. W H I L E the Arab oil-billionaires preach Islamic solidarity and the brotherhood of the T h i r d W o r l d , Muslims are starving to death i n Central Africa. Perhaps out of t i m i d i t y , perhaps out of greed, the Arab oil magnates have done little b u t talk about sharing their wealth—or even lending it out—in any b u t the most conventional ways. Iran, however, is a different matter. I n a shrewd mixture of self-interest and benevolence, the Shah's government last m o n t h committed over $1 billion to help I n d i a t h r o u g h the crisis created b y swollen oil prices. I n the long run, the deal w i l l mean more to India than the atomic bomb it recently detonated. India desperately needs the help. Its runaway inflation and food shortages are especially hard on the already suffering poorest classes. Thus India's social stability may be seriously threatened for the first time since Prime Minister Gandhi of India deal, too. I t locks I n d i a i n as a customer against the day when oil may be in surplus and hard to sell. I t also strengthens I n d i a at a time w h e n the Arabs, the Shah's enemies, are strengthening Pakistan, India's enemy, Beyond politics and price, however, the deal also gives Iran access to India's potentially rich b u t undeveloped raw materials. Iran, on a crash course to industrialization, w i l l need all kinds of basic products. The deal between the Shah and Mrs. I n d i ra Gandhi provides for Iran to l e n d over $1 billion over 20 years to expand India's basic industries: cement, sugar, steel products, paper and newsFORBES, JUNE 1, 1974 the turbulent years when it achieved independence f r o m Britain. I n 1972 I n d i a ' s ' o i l b i l l was $250 million, already a heavy burden for a country that has chronic troubles making ends meet. But last year it soared to $625 million, and this year it could go as high as $1.5 billion. T o p u t it in perspective, it is as though the U.S. spent $35 billion to import oil. A n d India wastes little oil: O n l y a t i n y share goes for private motoring. The bulk is needed for India's industries and public transportation. But where can India find the extra $1 billion-plus? India simply does not have this k i n d of money. A n d w h o is there to lend it? Enter Iran. India's needs are not huge: less than 500,000 barrels a day, about what the U.S. uses every 40 minutes. India produces about a t h i r d of those needs indigenously; it imports 70% of the rest from Iran print. India w i l l repay the loans in the products of the expanded industries. Again, the interest rate w i l l be a nominal 2.5% w i t h 20 years to repay. The products that India w i l l supply to Iran are i n short supply throughout the w o r l d and desperately short i n India. "These things are needed at home also," concedes C. Subramanian, India's Minister for Industrial Development, " b u t we must strike a balance on how far we should starve the home market to get the fuel we need to keep our industries going." The first t w o projects involve iron ore and bauxite. I r a n w i l l p u t u p nearly $140 million for a plant to extract alumina f r o m bauxite; I r a n w i l l get two-thirds of the expected 330,000ton annual output. I r a n has also pledged around $500 million to develop a low-grade iron ore deposit i n Kudremukh, i n the south I n d i a n state of Karnataka. W h e n the project is i n f u l l operation it w i l l produce 8 million-plus tons of i r o n pellets yearly, all of it for export to Iran. I n making these deals, I n d i a has quietly abandoned the r i g i d socialist planning that has characterized her economic policy ever since independence. The softening of India's stand is undoubtedly made easier b y the and the balance from Saudi Arabia and Iraq. Under the terms of the fiveyear agreement, Iran w i l l supply all the needs of India's Madras refinery, w h i c h ran 2 1 million barrels last year b u t w i l l be expanded, perhaps eventually to 4 1 million barrels. The National Iranian O i l Co. is a partner in the refinery. Iran w i l l also provide at least 7.4 m i l l i o n barrels a year over the refinery's needs. For India, the best part of the agreement involves price. Officially, India w i l l be paying the m a r k e t price. Unofficially, she w i l l be getting a huge discount. T h e deal works like this: India pays $3.50 a barrel—in cash. But the balance, $6.50 or so a barrel, is deferred, w i t h no payments for five years and w i t h a nominal interest rate, 2.5%. T h e principal is payable over five years—after the fiveyear grace period. Looked at as a hard business deal, the discounted present value of India's deferred payments cannot be more than 60 cents on the dollar. Thus, in effect, India is gett i n g the Iranian oil at $7.50 or so a barrel, 25% below the going market price. This is a way to cut prices w i t h o u t openly cutting them. A n d it buys India time to adjust. Iran stands to benefit from the fact that Iran is not one of the traditional imperialist powers or one of the principal Cold W a r antagonists. The main motivation, however, is that I r a n is an oil-exporting nation. " W e are doing this iron-ore deal because it is I r a n that wants i t , " says a h i g h I n d i a n government official. " W e wouldn't do it for anyone else." There are other signs of a loosening u p i n India's old policy of economic isolation. After years of waffling on whether Western o i l companies w o u l d be allowed to d r i l l offshore, the Indian government has given the Natomas Co. d r i l l i n g rights on 7 million acres i n the Bay of Bengal. T h e government is also t r y i n g to streamline the almost unbelievably bureaucratic procedures that are required of anyone wishing to invest i n India. I n the past a "yes" or "no" could take as long as six years; now they sometimes come i n as little as 90 days. T h e Iranian deal, the d r i l l i n g contract and the liberalized license rules suggest the Indians are finally facing reality: T h e Iranians offered to help India, b u t asked that India, i n turn, bend some of its socialist dogma. India accepted. For India, the situation remains desperate, b u t perhaps it is not too late. • 154 AMERICAN PETROLEUM 1801 K STREET, NORTHWEST INSTITUTE WASHINGTON, D.C. 20006 (202) 833-5580 Frank N. Ikard June 1 4 , 1974 PRESIDENT The H o n o r a b l e H e n r y B . G o n z a l e z U . S . House o f R e p r e s e n t a t i v e s 2446 R a y b u r n House O f f i c e B u i l d i n g W a s h i n g t o n , D . C . 20515 Dear Congressman Gonzalez: I a p p r e c i a t e d r e c e i v i n g y o u r l e t t e r o f May 2 8 r e l a t i n g t o y o u r concerns a b o u t t h e i m p a c t o f o i l p r i c e i n c r e a s e s upon the i n t e r n a t i o n a l monetary system and t h e m u l t i l a t e r a l development l e n d i n g i n s t i t u t i o n s . I f u l l y share i n your a p p r a i s a l o f t h e possible impact o f these abnormal p r i c e s . Up u n t i l r e c e n t l y , many k n o w l e d g e a b l e people urged us t o use "cheap and abundant" f o r e i g n o i l and f o r g e t domestic development. I r e p e a t e d l y warned o f heavy r e l i a n c e upon f o r e i g n o i l , n o t i n g t h a t once t h e U . S . became e x c e s s i v e l y dependent t h i s o i l would p r o b a b l y be n e i t h e r cheap n o r abundant. As y o u n o t e , t h i s impact i s f a r g r e a t e r upon n a t i o n s a l m o s t w h o l l y d e p e n d e n t u p o n OPEC o i l t h a n u p o n t h e U . S . , a n d h i t s h a r d e s t a t weak d e v e l o p i n g c o u n t r i e s . The A P I h a s n o t f o r m u l a t e d a n y p o s i t i o n w i t h r e g a r d t o t h e p r o p o s a l s o f P r o f e s s o r Adelman. Consequently, a l l I can do i s give you a few personal thoughts f o r whatever they are worth. I t i s d i f f i c u l t f o r me t o s e e how r e i n s t a t i n g a n o i l import quota program could b e h e l p f u l a t t h i s t i m e . Uncertainty a b o u t s u p p l y , stemming f r o m t h e o l d i m p o r t q u o t a p r o g r a m , was a f a c t o r w h i c h a c t e d t o d i s c o u r a g e new r e f i n e r y c o n s t r u c t i o n a n d c o n t r i b u t e d t o our energy problems. Moreover, i t c o u l d have some u n f o r e s e e n a n d s e r i o u s i m p a c t s u p o n c r u d e o i l s u p p l i e s . T h i s p r o p o s a l w o u l d need l o n g and s e r i o u s s t u d y b e f o r e a d o p t i o n . I know P r o f e s s o r Adelman and have h i g h r e s p e c t f o r h i m a s a n economist. O n t h e q u e s t i o n o f OPEC, h o w e v e r , h i s p r e d i c t i o n s a b o u t t h e f a t e o f such a c a r t e l have n o t , u p t o now, m a t e r i a l i z e d . H i s p r o p o s a l f o r b r e a k i n g i t u p seems a l i t t l e t o o s i m p l i s t i c . 155 Hon. H e n r y B . Page - 2 - Gonzalez June 14, 1974 W i t h r e g a r d t o the r o l e o f o i l companies, i t i s e v i d e n t t h a t a m a j o r and permanent s h i f t i s t a k i n g p l a c e i n t h e w o r l d marketing of o i l . However, I would q u e s t i o n a b l a n k e t r u l e r e q u i r i n g U.S. f i r m s t o get out o f crude o i l marketing i n foreign nations. Such a r u l e m i g h t m e r e l y r e s u l t i n a s u b s t i t u t i o n o f o t h e r f o r e i g n o i l companies f o r U.S. f i r m s . I quest i o n whether a simultaneous withdrawal of i n t e r n a t i o n a l o i l companies c o u l d be a c h i e v e d . I t w o u l d seem t o me i n t h e i n t e r e s t s o f our n a t i o n t o t a k e advantage o f the access t o o i l s u p p l i e s w h i c h U . S . o i l companies a r e a b l e t o m a i n t a i n . I c o n t i n u e t o b e l i e v e t h a t t h e U . S . o i l i n d u s t r y has t h e t e c h n i c a l , f i n a n c i a l , a n d human r e s o u r c e s w h i c h c a n p e r m i t i t t o c o n t i n u e t o p l a y a n i m p o r t a n t and u s e f u l r o l e i n t h e d e v e l o p m e n t o f n a t i o n a l e c o n o m i e s , and w o n d e r i f i t i s n e c e s s a r i l y d e s i r a b l e t o r e s t r i c t t h e a c t i v i t i e s o f o i l c o m p a n i e s a n y more t h a n t h e y w i l l be r e s t r i c t e d by h o s t g o v e r n m e n t s . I recognize the importance o f the issues r a i s e d i n your l e t t e r . A l l o f us a r e g r a p p l i n g w i t h t h e s e d i f f i c u l t and c o m p l e x p r o b l e m s w h i c h a f f e c t n o t o n l y o u r i n d u s t r y and t h e n a t i o n , b u t c o u l d l e a d t o w o r l d m o n e t a r y i n s t a b i l i t y and serious hardships f o r developing nations. 156 THE WHITE HOUSE WA S H I N G TO N Dear Mr. Chairman: The P r e s i d e n t has asked me t o r e p l y t o your l e t t e r o f A p r i l 3 0 , 1974, concerning t h e impact o f o i l p r i c e i n c r e a s e s and t h e problem t h i s has c r e a t e d f o r t h e s t a b i l i t y o f t h e i n t e r n a t i o n a l monetary system and, more p a r t i c u l a r l y , f o r o i l - i m p o r t i n g l e s s developed c o u n t r i e s . I n response t o your q u e s t i o n as t o what t h e U n i t e d S t a t e s i s doing about the o i l p r i c e i n c r e a s e s , t h e most d e s i r a b l e s o l u t i o n t o t h e whole problem would b e , o f course, a s u b s t a n t i a l s o f t e n i n g or r o l l back i n petroleum p r i c e s ; and I can assure you t h a t t h e U n i t e d S t a t e s Short o f adequate movement i s endeavoring t o promote t h i s s o l u t i o n . i n t h i s d i r e c t i o n , however, t h e most i m p o r t a n t t h i n g t h e U . S . can do i s t o develop our own n a t i o n a l energy r e s o u r c e s i n o r d e r t o m i n i m i z e U.S. v u l n e r a b i l i t y , i n c r e a s e t o t a l w o r l d energy s u p p l i e s , and reduce t h e impact o f U . S . demand on the energy m a r k e t . The Congress c l e a r l y has a c r u c i a l r o l e and an immense r e s p o n s i b i l i t y i n advancing t h i s " P r o j e c t Independence." I n r e s p e c t t o t h e i n c r e a s e d pressures on t h e i n t e r n a t i o n a l monetary system as a r e s u l t o f t h e quantum jump i n o i l producers* income, I b e l i e v e t h a t t h i s i s a manageable problem; a l t h o u g h i t i s one t h a t must be r e s o l v e d on t h e b a s i s o f i n t e r n a t i o n a l c o o p e r a t i o n . The U n i t e d S t a t e s i s working c l o s e l y w i t h o t h e r developed n a t i o n s , as w e l l as w i t h t h e o i l p r o d u c e r s , t o develop and s t r e n g t h e n t h e f i n a n c i a l mechanisms and i n s t i t u t i o n a l arrangements needed t o p e r m i t t h e r e c h a n n e l i n g o f t h e o i l funds t o p r o d u c t i v e uses w i t h o u t d i s r u p t i n g t h e i n t e r n a t i o n a l monetary system. We have a l s o i n i t i a t e d a c o o p e r a t i v e e f f o r t among consuming n a t i o n s t o a v o i d d i s r u p t i v e c o m p e t i t i o n i n t r a d e and monetary p o l i c i e s designed t o manage i n d i v i d u a l balance of payments problems; and we have proposed a program t o e x p l o r e means f o r a c c e l e r a t i n g development o f a l t e r n a t i v e energy resources and expanding t h e p o s s i b i l i t i e s f o r energy conservation. I n a d d i t i o n t o these e f f o r t s w i t h t h e major consuming n a t i o n s , we a r e a l s o i n i t i a t i n g c o n s u l t a t i o n s w i t h t h e Government o f Saudi A r a b i a c o v e r i n g a range o f s u b j e c t s o f mutual i n t e r e s t , i n c l u d i n g o i l p r i c e s and p r o d u c t i o n . 157 Page 2 W i t h regard t o t h e l e s s developed c o u n t r i e s , t h e higher cost of i m p o r t e d f u e l and p e t r o l e u m based p r o d u c t s has c r e a t e d n o t o n l y a d j u s t m e n t d i f f i c u l t i e s , b u t a l s o , as y o u r l e t t e r p o i n t s o u t , s e r i o u s b a l a n c e o f payments problems f o r t h o s e LDCs w h i c h have n e i t h e r a r e s e r v e c u s h i o n nor s t r o n g e x p o r t e a r n i n g s from O t h e r products. T h e r e i s , as you know, a l r e a d y a number o f i n t e r n a t i o n a l schemes and p r o p o s a l s t h a t have been p u t f o r w a r d t o meet t h e a d d i t i o n a l LDC f i n a n c i n g r e q u i r e m e n t s . The U . S . p o s i t i o n i s t h a t the primary r e s p o n s i b i l i t y f o r r e s o l v i n g t h e o i l r e l a t e d problem l i e s w i t h t h e o i l e x p o r t e r s , and t h a t t h e y have an o b l i g a t i o n t o ease t h e burden by l o w e r i n g o i l p r i c e s and by p r o v i d i n g f i n a n c i a l assistance. W i t h i n t h i s framework, t h e U n i t e d S t a t e s i s working a c t i v e l y t h r o u g h m u l t i l a t e r a l as w e l l as b i l a t e r a l channels t o d e f i n e t h e magnitude and t i m i n g o f t h e problem f o r each o f t h e h a r d e s t h i t LDCs. However, t h e m a j o r c o n t r i b u t i o n of t h e U . S . must be t o c o n t i n u e t h e a s s i s t a n c e l e v e l s we c o n t e m p l a t e d b e f o r e the events of l a s t F a l l . The i n c r e a s e i n o i l p r i c e s makes our development a s s i s t a n c e more — n o t l e s s — e s s e n t i a l . Our a b i l i t y t o c o n t i n u e development a s s i s t a n c e a t p r e v i o u s l e v e l s i s , however, handicapped by t h e Congress* r e l u c t a n c e t o meet c u r r e n t f o r e i g n aid funding requests, including t h a t for the I n t e r n a t i o n a l Development A s s o c i a t i o n . P e t e r M. F l a n i g a n Assistant to the President f o r I n t e r n a t i o n a l Economic The H o n o r a b l e Henry B. Gonzalez Chairman Subcommittee on I n t e r n a t i o n a l F i n a n c e House o f R e p r e s e n t a t i v e s Washington, D . C . 20515 Affairs 158 HENRY B. GONZALEZ GAIL J. BEAGLE 20TH DISTRICT, TEXAS *ITXAR COUNTY KELSAY R. MEEK MRS. BONNIE CALDWELL RAYMOND I. CANTU ELLA M. WONG IRMA DE LEON LUCIA GONZALES MRS. CHRISTINA MOONEY MRS. LORRAINE G. INMAN C o n g r e s s o f tfie ® m t e b & t a t e * $ou*e ot Dtepreaentattoetf Wasfofogton, 3B.C. 20515 SAN ANTONIO. TEXAS 78205 5 1 2 - 2 2 9 - 5 5 1 1 , EXT. 4 3 8 9 OR 5 1 2 - 2 2 3 - 8 8 5 1 A p r i l 30, 1974 B4a MRS. LUZ G. TAMEZ MRS. CORA FAYE CLAYTON MARY JESSIE GONZALEZ The Honorable Richard M. Nixon President of the United States The White House Washington, D. C. 20500 Dear Mr. President: As Chairman of the Subcommittee on I n t e r n a t i o n a l Finance, I am becoming increasingly concerned about: ( 1 ) the disastrous e f f e c t s of the OPEC o i l price i n creases, and ( 2 ) the p o t e n t i a l damege t o the i n t e r n a t i o n a l monetary system and the woxld economy as a r e s u l t of the petrodollar glut. I am sure t h a t you are f a m i l i a r w i t h what the o i l price Increases w i l l do to the economies of the less developed countries. They now face a sad f a t e , a f t e r so many years of economic growth aided by the United States through b i l a t e r a l a i d , m u l t i l a t e r a l a i d and p r i v a t e foreign investment. Yet we seem powerless t o do anything about i t except beg the o i l producers to give sjme aid t o those countries which the OPEC group i s i n the process of bankrupting. And I seriously question the v i a b i l i t y of the a i d funds being set up by the o i l producing countries. Secondly, I am not sure how w e l l the world monetary system w i l l hold up under the strains of the approaching p e t r o d o l l a r glut and how i t can accommodate the Arab o i l producers 1 owning 60$ of t o t a l world monetary reserves by 1980. While there have been some suggestions f o r recycling the p e t r o d o l l a r s , I also question t h e i r v i a b i l i t y . 159 The P r e s i d e n t Page - 2 - April 30, 197^ I n t h e U . S . , we h a v e w o r r i e s a b o u t g a s o l i n e p r i c e s and l o n g - t e r m programs f o r development o f o u r abundant energy resources. W h i l e s o l v i n g t h e s e p r o b l e m s we c a n n o t l e t t h e r e s t o f the w o r l d s i n k around us. Based on t h e t h o r o u g h i n f o r m a t i o n c o l l e c t e d b y my S t a f f , I c a n see f e w reasons f o r o p t i m i s m . S o m e t h i n g m u s t be done a b o u t t h e c a r t e l a c t i v i t y o f OPEC a n d t h e r e s u l t a n t o i l p r i c e s . I w o u l d a p p r e c i a t e y o u r a d v i s i n g us w h a t t h e U n i t e d S t a t e s i s d o i n g o r i s g o i n g t o do a b o u t t h e o u t r a g e o u s p r i c e i n c r e a s e s b y OPEC a n d t h e a p p r o a c h i n g p e t r o d o l l a r glut. With best wishes, I am Respectfully yours, Henry B. Gonzalez Member o f C o n g r e s s Chairman 160 THE NEW YORK TIMES. MONDAY, MAY 13, 1)74 Recycling Petrodollars The enormous increase In oil prices and resulting transfer of purchasing power to the oil-exporting nations has confronted the world with "an over-all disequilibrium in trade accounts of unprecedented magnitude." Behind that temperate estimate by H. Johannes Witteveen, managing director of the International Monetary Fund, lies the staggering reality that the balance-ofpayments deficits of oil-importing countries this year alone may amount to $65 billion. The sum is so large that it threatens the world economy with simultaneously contractionary and inflationary forces. For the moment, the forces of Inflation are most evident. But if the drain continues; many oil-importing countries will suffer a devastating blow-to their real incomes and living standards. The danger affects such developed countries as IfcdywulBritain but is greatest for the developing nations of South; Asia arid Central Africa where massive starvation and death could result This world payments problem will not automatically be corrected by ail increase in imports by the oilexporters or by their investment of funds in the deficit countries. The situation is analogous to the critical period after World War II, when a devastated world economy was dependent for its reconstruction on a recycling of funds by the United States—which this country carried out through the Marshall Plan and other aid and loan programs. Will the oil-producing states, which created the present payments disequilibrium, now participate in a genuine effort to resolve it? On the face of it, the answer would appear to be no. Obviously, the simplest method of. solving the problem would be a major cut in oil prices. Yet the nature of the cartel andttie^pofitfcs' of"manyof its members makes a large enough price rollback unlikely unless there develops a breakdown in the world economy—and an attendant shattering of the oil cartel. The International Monetary Fund has taken the initiative of persuading the oil-exporting countries to recycle part of their oil money back to the importers via a new "oil facility." According to Dr. Witteveen, Arab and other oil exporters have just "indicated their willingness" to the I.M.F. to lend that facility about $2.75 billioh. But even excluding the developed nations, the developing countries face extra oil deficits of at least $20 billion in 1974 alone—seven times as much as the oil producers are offering to lend. I t is far'from sure, that even this modest amount will be forthcoming. The.Saudi Arabian oil minister, Sheik Zaki al-Yamani, has expressed coolness toward the I.M.F. plan. Since his country had initially offered Dr. Witteveen more than $1 billion, a Saudi Arabian decision to withdraw could undermine the proposal. Actually, however, the oil-exporting countries have strong reasons of their own to lend, under appropriate terms that would give them security and a reasonable rate of return. That is precisely what the I.M.F. hopes to provide. Given the difficulties and risks of placing their enormous gains in secure foreign loans and investments —and their common,stake in the viability of the world monetary system-*—the oil. exporters have a powerful incentive to help make the i.M.F.'s "oil facility" succeed. It could help tide over for: the next year or so the poorest of the developing nations. In the long run, however, lending back hundreds of billions of dollars to the deficit countries seems out of the question. The disequilibrium is too great.. 161 T H E WASHINGTON POST A p r i l 13, 1974 By Brace Handler ers, further diversity their SpecialtoThe Washington Post economies and coordinate inGUATEMALA CITY—The dustrial development world oil crisis is threatening Despite some rocky spotsthe economies of the Central El Salvador and Honduras American countries, wiping {ought a mini-war in 1969 and out 13 years of economic prog- stopped trading with each ress they had made by joining other—the Central- American Common Market has survived. in a common market. Central America, including A new social class of busiGuatemala, El Salvador, Hon- nessmen, independent farmers duras, Nicaragua and: Costa and ranchers, and white-collar Rica, produces no oil. workers has started to emerge If crude oil prices remain at and industrial production tricurrent levels or go up, ex- pled between 1960 and 1972.. perts say all five of these The value of textile output small republics could be dowrr rose from $25 million to $116 to their last centavo in re- million. Production of shoes serves by 1975. and clothing rose from $49 A U.S. economist here put it million to $111 million. Light this way: "If the international machinery and home appli-i oil picture continues _ ance maufacturing output inchanged, it's all over for Cen- creased from $1.4 million to tral America." $26 pillion. ( "The oil crisis is a serious Central America's total for-j problem in places like the eign trade rose from $1.2 bil-j I United States and Europe, of lion in 1963 to $2.7 billion in course," an American busi- 1972. Trade within Central nessman in Guatemala City America skyrocketed from $16 said, "But in underdeveloped million in 1950 to $64 million countries, its effects are far, in 1960 to $611 million in 1972. far worse. RoadS and communications "Central America's economy improved-greatly, and directis baaed on agriculture," he distance-dial telephone link explained. "Governments in Tegucigalpa, Honduras, and this region have been trying Guatemala City—an impossito modernize farming methods ble dream only a few years aid increase production, and ago. they've made progress. But to do this, you need tractors and Despite some rocky spotsfertilizer.' Well. ^ half the El Salvador and Honduras world's fertilizers are made fought a mini-war in 1969 and from petrochemicals, and trac- stopped trading with teach othgr—the Central American tors don't run on bananas." Ustil the lMQs, Central Common Market has survived. America — slightly larger A new social class of bwithan California and with 16 nessmen, independent farmmillion people—was a remote, ers and ranchers, and whitfbackward and economically collar workers has started to emerge and industrial ptfcstagnant region. Its economy depended on duction tripled between 1960 coffee and bananas. Power lay and 1972. with a few local millionaire The value of textile output landowners and large foreign rose from $25 million to $116 fruit exporters, Most others million. Production of shoes were illiterate, underfed peas- and clothing- rdse from $49 million to $111 million. Light ! ants. j During World War n, the machinery and home appliI United States financed the ance manufacturing o u t p u t increased from $1.4 million to | building of a highway through ! Central America, to gate a stra- $26 million. Central America's total fortegic overland route to the Panama Canal. Panama itself elgn trade rose from $1.2 bilis not considered part of Cen- lion in 1963 to $2.7 billion in 1972. Trade within Central tral America. This road made .trade among America skyrocketed from $16 the Central American repub- million in 1960 to $64 million lics possible for the first time. in 1960 to $611 million in 1972. It also- allowed medium-size Roads and communications agricultural entrepreneurs to improved greatly, and directopen the rich Pacific coastal distance-dial telephones link -plain to cattle ranching and Tegucigalpa, Honduras and growing of cotton, sugar and Guatemala City—an impc ble dream only a few years vegetable oil seeds. In 1960, the five countries *go. formed a Central American The Common Market, alio Common Market. The purpose made this region less depend•frarto eliminate trade barri- ent on the United States. In 1963, the United States bought, of this decade-long struggle and sold 43 per cent of the to- in less than two years. tal imports and exports. By Guatemala, the most popu1972, this figure had fallen to lous country, had $213 million 33 per cent. in its treasury at the end of Gold, and hard currency re- 1973. But it spent $30 million serves climbed slowly from on oil products last year$130 million in 1961 to $416 compared to $15 million in million in 1972, but the oil 1971—and its estimated Oil bill crisis could erase the results for 1974 is $105 million: T H E WASHINGTON POST TkmnJky.MviS.im HobartRowen The Oil Cartel and Development Aid Despite the noble efforts of IMF Managing Director H. Johannes Witteveen, the oil cartel countries have bpeii willing to cough up only small amounts of money to help the oil-importing countries meet the outrigeous prices that the cartel itself has set The defense offered by the Organisation of Petroleum Exporting Countries (OPEC) is a mixture of clever, chetoric and sheer , arrogance. In essence, they argue tHat the cartel countries have not become truly rich, like the industrialized West, but merely <nore "liquid"; that oil prices are still below the level that should be achieved to balance off inflation in other commodities; and that the West -r-notably the United States and Canada—are soaking the poor countries by extortionate prices for food. Dr. Abderrahman Khene, the SecretaryOeneral of OPEC, made the rounds here recently, delivering this pitch. He argues that the industrial nations have been raising the prices of their manufactured goods and food, and that the problem of the poor countries thus didnt start with OPEC. ; Agriculture policy in this country, of course, has stupidly contributed to inflation. But as Dr. Khene knows, the price of wheat bears a close relationship to weather and crop yields—a matter quite different from a halfdozen oil sheikhs sitting down in Teheran, arbitrarily deciding on a price for oil that costs 10 to 30 cents a barrel to produce—a cost that hasn't Varied. If tbe United States decided to price wheat the way OPEC prices oil, it has "The lack of generosity of other countries does not excuse the OPEC for the burden they placed on the rest of the world*9 enough leverage on the market to get |20 a bushel. But there is little doubt that the major countries of the world, especially the United States, must be faulted for lack of generosity in development aid. Far from meeting the recommended goal of 1 per cent of total Gross National Product, UJ3. development aid is about one-fourth of that figure, ranking 19th in a list of 16 wealthy countries. That does not excuse the OPEC countries for the special and sudden burden they have placed on the rest of the world, notably on the poor countries, by a fourfold increase in the price of oil within a year's time. When Dr. Khene talks of OPECs "moderation" and "wisdom" in "limiting" the price of oil to provide a government-take of $7 a barrel, he is talking economic nonsense. The abrupt shift of $50 to $60 billion of resources from the oil-consuming countries to OPEC (even if some of the burden is postponed byfinancingschemes) is beginning to raise havoc in industrial as well as less developed nations. "In thinking about the effects of the sharply higher oil price," Federal Re- serftf adviser Robert Solomon said lit a thoughtful speech the other day, 1 haw. found it useful to view It as a sales tax on consumption. Hie imposition of this tax* has raised the price of petroleum products." Solomon, vice chairman of the Committee of Twenty Deputies, points out that the OPEC countries "must lend their enlarged revenues" back to those who are paying through the nose for their oil. But not much it coming hack. Against the $58 billion increase in OPEC surpluses this year alone projected by Witteveen (to a total of $65 billion), the total amount pledged for a special IMF 'facility" is some $2.8.bfllion. of the hardeethit countries is so 4ea* perate that the World Bank is scraping together about $160 million tar diverting some of the International Development Agency (IDA) funds—pitifully small to . begin wtthHto the poorest countries on the list. International agencies calculate that higher oiVfOed, fertilizer, and capital goods casta to the poor nations this year will rim about 90 button mora than what the? will recover in higher export price* Assistance by theIMF-and other interaationar agencies, plus a reduction of reserves will cover f t bllBon, Wav ing a minimum of $2 billion in new assistance needed by the poor countries. Projections are that this "gap" will increase to f * J WIHon In 1975, and run to $4 or $5 billion a year from 1976 to 198&. In the immediate and desperate period ahead, the United Nations is trying to get contributions—in any form — that would work out to roughly a 60> 50 share between the industrUized world and OPEC. But the industrialized world, even if Much has been made of some sales . of oil at concessional terms to India.* it comes through with contributions BUt the concessions dontseem overly this year equal to OPEO's, is likely to generous—and in total, are a drop In resist carrying an equal share into the the bucket. For example, India will get future. about $100 million worth of oil from The strong view of the United Iraq and a similar amount from Iran States, as it sees new OPECs over the in special deals. Against that, India's horizon for bauxite and other commodextra cost for oil this year is move ities, is that the btgge^ p * v m m than $1 billion. burden outfit to Jail en thee* w e r e The need to get cash into the hands ate the problem. h' O to 163 T H E W A L L S T R E E T JOURNAL Editorial May 6, 1973 Attracting Petrodollars With one easy stroke, the United states can go a long way toward improving its eminence as an internatianal capital market, with financial benefits that would exceed the $200 'million the Treasury would lose i n tax revenues. The necessary step is the elimination of withholding taxes on. interest and dividends that flow out ,<Df the U.S. to foreigners holding U«S. securities. The prograun ambunts to a tariff on foreign cafciThese taxes have been on the books a long time, but until t h e « r rival of petrodollars have been of relatively little significance. The l e rate 6i 30% applies to all residents (other than Americans) of Countries that don't ^have tax treaties with the United States. Most of our m a j o r trading partners do have treaties with us which lessen the sheiks cqugh up 30% of their intome from investments here when they can keepi it all when their investments are cycled through Londoi*? We are not prepare^ to atgu* that this simple tax change will mean an extra $4 billion to $6 billion a y e a r of investment in the United States, as some proponents of the change a r e ' forecasting. A1EW& all, whichever market is recycling the oil money will put" it here, directly or indirectly, when that market finds superior opportunities here. The withholding tfexes simply insure that Landon^nd Geneva will do the picking and choosing, not New York. I f the zxiost promising investment for a Kuwait dollar is in Niger or Bolivia, it won't be banked through New York consideration. Thia no ^vial S^Tdln . S tors and on capital flows Butthe wlrproducmg nations of the MidcUe reserves merket. through v the . , .Eurodollar . What this means is that as a matter of natidhal.policy, the United States is protecting the Eurodollar and Eurobond market to the detrfment of its domestic capital market. The $200 million t r e a s u r y would forego by eliminating these taxes is admittedly a lot of money, but it is . m a l l potatoes compared to the tens of billions in petrodollar business that the U.S. is throwing away to foreign capital markets. Why should 6Very % to ^ ^ diation. ^ or two of banking profits recycled petrodollar adds ^ ^ ^ the gross ^ financial interme- v.,,. P ™ * * ® of rebuilding i h e U.S. capital market began earher ^ i s year when Treasury elumnated m t e ™ equalizafaon tax and. A ^ ^ q ^ i S ^ ? ment ' P«>gram* that E w ^0^1.mar!cft\ Tag B 7 j will be further aided if U.S. tax laws . invite, rather than discourage, all that oil money. 164 FROM THE WALL STREET JOURNAL, JUNE 19, 1974 REVIEW &> OUTLOOK Squeezing the Goose i n Quito Having acquired the golden agree to cut back production, and as ffoose, the Organization of Petro- fast as they cut production, and the leum Exporting Countries is discov- world economy continues to soften, ering that the* bird has . to< be they'll have to cut again. With the squeezed harder and harder to pro- Saudis refusing to go along, even duce the same size eggs. Global in- toying with increased production, flation coupled with decreased de- there's not much chance the other mand for crude keeps nibbling away producers would commit thexnat the real incomes they'd projected selves to that kind of play. And if for themselves. they don't, the marketplace itself force So the cartel met in Quito, Eeua- ^ Production cutbacks. Connor these past few days to plan its ® u m e r s « W * y won't buy all the oil squeeze for the next three months. * * * Producers want to sell at the on While it couldn't resist h ^ g the P n c e s charging, royalty rate on crude by 23 cfents a The strains in the cartel result barrel, it wisely decided against the because each of the OPEC nations inclination of 11 of its 12 members to has its own optimum timetable for cut into the goose. All but Saudi Ara- selling its oil. Those who want revebla favored another sizeable in- nues now, fast, for internal developcrease of the tax on the crude ment are the most stubborn about > shipped by foreign companies. sticking to the high cartel prices. I t occurs to Saudi's Sheik Ya- B u t to d o *°> tkey have to bet I a ainst n e w mani, who went to school at Har- ^ supplies and oil substi-1 yard, that OPEC's 300% price in- t u t e s coming along before they no 00 1 crease over the last nine months may J ®® " need expanding oil revenues have had something to do with both to finance development. A global reglobal inflation and faltering de* cession throws all their schedules mand for crude7~ Although be o£f » Pitting them closer by that time couldn't manage to impart this wis- m u c ? competition from dom to his fellows, he did get them and North Sea oil, as well as now to hold off merely by refusMg to go unknown > technological breakalong with them on the tax increase. tkroughs <» ^ demand side. A reHe won't apply the royalty increase cession of serious proportions or dubl w aither, and because Saudi Arabia r a t £ n ^ P ?PEC "Pa*\. can by itself control the world price, „ Mr. Yamam understands all this, this split in OPEC is bound to widen B u t ™ colleagues insist on learning Mr. Yamani was turned down way Eventoally they will when he recommended a Cut, rather ^ v e to learn that while a successful than an increase in price postings, cartel has its obvious advantages, it But give him time. The sharp drop ? a n t ^ ^ u l a t o d from fiie probmte from projected demand for crude* in l e m ® ®f *?rld ^co^omy " response to its higher price is now g r a t e d ° s np ^ 8 accelerating in reaction to a soften- S T ? ™ ' ^ J f ^ be prepared to see ing Wo»ld economy. Treasury Secref a c i a l assete it accumulates tary Simon says second quarter real ^ ^ ^ T ' ' <*»; GNP growth in the United States ? r a l h a ? k a c a n n o t Po^cally resist will be close to zero. If it remains money growth to pay the flat the rest of the year, simple P 1 *™! 18 - And if the cartel insists on arithmetic suggests there ^ i l l soon ^ ^ protection, tying its oil be more oil around than anyone F " c e ? to 8 1 1 m . d e x o f l t s choosing, , there 8 no can wants to buy. escape driving | . oc/ ± orrf t f f ? « m a .yCar " " son. Increased price postings now a have had a chilling effect on I n order to maintain the current even clearer picture of how destrucVosimgs, obviously some tive and self-defeating that would I countries would have to be. OPEC 165 BUSN I ESS WEEK May 11, 1974 Commentary by John Pearson The crisis of paying for the oil When the gasoline queues disappeared from the filling stations a few weeks ago, it may have appeared to many consumers that the worst of the energy crisis was over. Italy's abrupt restrictions on imports, aimed at stemming a sharp deterioration in its balance of payments, are a reminder that the crisis is only beginning. The problem now is not the availability of oil, but how to pay for it. A t least half of I t a l y ' s average monthly trade deficit of $l-billion in the first four months this year stemmed from the steep rise in the cost of oil imports. But the Italian trade curbs will not slow the inflow of vital oil. Instead, the measures will cut back imports of other products, from meat to automobiles, and thus shift the trade deficit to Italy's traditional trading partners. The result could be increasi n g pressure on countries such as France to take similar steps to shore up their balance of payments. Thus Italy's unilateral action could set a precedent for beggar-thy-neighbor protectionism without doing anyt h i n g to solve the oil crisis. The oil consuming countries, taken together, will run a deficit of $40-billion or so in trade w i t h the oil exporters in the year ahead, and they cannot diminish it by buying less from each other or selling each other more. Such protectionism poses a real threat of a trade war. Heavy borrowing. Even i f such a conflict is averted, European bankers such as Dr. Andries Batenburg, president of the Dutch Bankers Assn., are warning that the energy crisis may reappear in the shape of an international financial crisis. That is because most oil consuming countries can finance the increased cost of energy imports only by borrowing heavily. The Italians, British, and French have already done so by tapping international financial markets for billions of dollars in loans. Ultimately, a big part of the funds for such loans will have to come from the oil exporting countries themselves. Managing Director Johannes Witteveen of the International Monetary Fund announced this week that he has persuaded Saudi Arabia, Iran, and other nations to contribute $2.8-billion to a special fund that will make medium-term loans to member nations to help pay their oil bills., But much more will be needed, and private capital markets are the only other mechanism available for "recycling" large amounts of the oil producers' surplus money. So far, the oil-rich states have shown a marked preference for putting their money into short-term "Eurocurrency" deposits that bankers in London and other financial centers then lend out to oil users. The trouble with this system is that the borrowers, even i f they are financially respectable European governments, will eventually exhaust their credit. No banker in his right mind will keep supplying money to a client who uses i t to meet current expenses, unless the borrower has a credible plan for getting his income and expenditures back into balance and paying off the loans. The oil consuming nations, unfortunately, have no such plan. Instead, they are looking desperately for financial gimmicks, including the revaluation of official gold reserves in order to create new money that could be used to pay for oil. But more than monetary wizardry is needed to deal w i t h the energy crisis that underlies the financial threat. Wishful thinking. Of course, the oil shortage "scare" and the rising cost of fuel have slowed the dizzy growth of energy consumption in industrial countries from 5% annually in recent years to an estimated 2% to 3% this year. But unless economic growth comes to a complete standstill, oil imports are bound to keep rising until alternate sources of energy are developed. Faced with this bleak prospect, Administration officials are taking the official line that oil prices will have to come down. More and more, this sounds like wishful thinking. There is, in fact, no cheap and easy solution. I f a new crisis is to be avoided, it wifl require a combination of energy programs and financial measures, including heavy investments to develop new sources of e n e r g y ; stepped-up recycling of "petrodollars" through intermediaries such as the IMF that can make loans w i t h longer maturities than private banks; and encouragement of long-term investments by the oil producers in the U. S. and other consuming countries. Even so, tougher energy conservation measures may be unavoidable. The Italian government is talking about reviving restrictions on automobile use and cutting back on home heating next fall. While curbs on energy use are politically unpopular, the alternative may be financial and economic turmoil that would lower oil consumption by plunging the world into a recession. 166 BUSINESSWEEK A p r i l 6, 1974 Oil: How the poor nations hope to pay their Mils The world's poor nations are scrambling frantically to find ways to pay their sharply higher oil bills. And while the outlook is grim, some of these efforts promise to show results. This week, Hassan Shash, Egypt's ambassador to Ghana, announced in Accra that the Arab oil states have set aside more than $800-million to help African economies. Last week, Libya's fiery leader, Mu'ammer al Qadafi, announced a three-tier price system for Libyan oil that would favor less-developed and Muslim nations. Meanwhile, a committee of the Organization of Petroleum Exporting Countries (OPEC) are discussing ways to recycle Arab oil money to the developing nations in the form of cheap loans. Individual governments also are active. Prime Minister Zulfikar Ali Bhutto of Pakistan, whose country will benefit from Libyan price adjustments two ways-as a less developed country (LDC) and as a Muslim state-made plans to visit Iran this week for talks with the Shah. Export earnings. Certainly the LDCs need all the help they can get. The Londonbased Overseas Development Institute estimates that their 1974 oil bill will soar to $12.2-biUion from last year's $2.2-billion. Singapore will be nicked for an extra $517-million, while Kenya, Tanzania, and Uganda as a group must fork over $178-million more. Tiny Jamaica will have to ante up an additional $123-million, roughly half the island's export earnings. The bite explains Prime Minister Michael Manley's widely publicized efforts to obtain higher prices for his country's bauxite exports. Manley would like to join that select group of lucky LDCs that either have their own existing or developing oil reserves-chiefly Indonesia, Nigeria, and Malaysia-or that have other valuable resource exports whose prices are strong enough to pay for expensive oil. Thus, the Philippines had no trouble raising a $500-million loan from a group of U. S. banks led by New York's Manufacturers Hanover Trust Co. Roughly $150-million of the money will help Manila pay its oil bill. "Even though the Philippines now pays three times the price for its oil," says Tristan E. Beplat, senior vice-president of Manufacturers Hanover, "it is selling copper at $1.50 a lb. instead of 40* or 50*. I t will sell sugar at high prices, too. And the same goes for lumber, copra, and nickel." Nations without resource exports essential to industrial countries are in more serious trouble. Says William J. McDonough, senior vicepresident of First National Bank of Chicago: "Some of the Latin American nations have pretty strong little economies. But all they produce are agricultural products. What do you do if you can't get a higher price for bananas?" Easy term*. No country, of course, faces so gloomy an outlook as India. The oilpoor nation has a large industrial base that needs energy, and it may have to spend as much as 60% of this year's anticipated export earnings of $1.4-billion to buy oil. So New Delhi is hustling to stave off disaster. One deal calls for the purchase of Iranian oil for $3.50 per bbl. in cash and the balance in deferred payments of 2.5% interest or in barter arrangements. Last week, India arranged a similar deal with I r a q - a $10million loan to purchase 2.S-million tons of Iraqi crude this year. The Indian government also is hoping to roll over some of its international debt at a meeting with creditor nations this month. Yet it still may have to draw on its nearly $l-billion in reserves. Tapping reserves is a delicate matter for an LDC. Commenting on what may be the Catch-22 of international banking, M a n u f a c t u r e r s Hanover's' Beplat notes that "if these countries pay cash and get their reserves down, then everybody will be so damned scared it will become hard for them to borrow money." • T H E W A S H I N G T O N POST Sunday, May 19, 1974 Inadequate Plans in Payments Crisis By C. Gordon Teiher Financial Tim«a For all the efforts of Managing Directors. J. Witteveen to put a brave face on ^t, the drive the International Monetary Fund has emfoarked lipon to enftet tbe cooperation of the oil-producing countries in resolving the mammoth international payments crisis their price increases have sparked does not eetfea to be getting us very far. And aa the fund itself can only perform a-;, bridging, operation and - the Euro-oufency market is ill-suited to do morel than fill the breach temporarily, the further outlook remains grim— unless t&at is, Wo can quickly think up some entirely newrecyclingideas. According to ^itteveen's latest appraisal, the oil producers are going to shcrW an overall surplus in the region of # » billion in 1074 or about $58 billion more than they did last year. The corresponding deficit elsewhere will be distributed in a ratio of about two to one between the advanced countries and the less-developed world. The f i l producers' are thus best plaeedto help sort out this monument a l new payments mess. Yet the visits the fund's top brass have made to these countries to interest them in providing financial backing for its proposed special oil loans to oil-importing countries seem to have produced plenty of expressions of good intentions but remarkably little money. I n fact, the total promised for 1974 so far amounts to a bare $3 billion. The IMF has, of course, some money of itis own it can throw into the battle. But the fact is that its total funds amount—even valuing its gold stock at the current free market price—to ma- lt • News Analysis terially less than the oil-importing countries' 1974 deficit alone. So Witteveen is doing no more than stating the obvious when he says that his projected oil facility can only be "a bridging operation while longer-term solutions are worked out." The Euro-market might appear to be a better bet, being seemingly able to generate money like water to meet each and every need, provided there is a willingness to pay the interest rates demanded. But, as Witteveen himself and other experts have been pointing out, it is an unsuitable vehicle for massive medium-term and long-term operations. j The fund's chief was certainly not exaggerating, therefore, when hp concluded a recent progress report on the attempt to resolve the recycling problem with the assertion that "we cannot see with any clarity what arrangements will eventually be made to provide for an orderly investment of oij revenues in the medium term." The fund is affecting to believe that the best hope lies in getting the oil-importing countries to open their markets to long-term foreign investment. And to this end, it is proposing to make a member's access 'to the proposed oil facility conditional upon it "taking measures to encourage capital inflows in the required amounts." But these things are far easier said than done. What we really have to aim to do in the Interim is to provide the surplus countries with a way of investing their money that meets their present preference for keeping it in relatively liquid form yet is not so exposed to rapid purchasing power erosion as the paper currencies they are accumulating now. And in this connection, it is as well to recognize that the new-look Special Drawing Bight, "denominated in a basket of currencies," which the fund plans to offer them in exchange for donations to its "oil facility" futnd in a few months time, can have no more appeal than a typical currency. For it,. too, will be losing value at the average inflation rate. This points to a way in which the speedy remonetization of gold could do great service for the frorld in a double • sense: For it seem^more than likely that the oil-producing countries would be prepared to think in terms of accepting gold in settlement of a sizeable part of their vast surpluses for a while —always provided this was part of an international monetary stabilization program which guaranteed that the purchasing power of the metal they absorbed would itself be maintained. Since such a plan could pave the way for all-out attack on the global inflation menace now threatening our entire planet, it would be serving the interests of the peoples of the oil-importing countries hb less than those of the exporters. O* 168 FROM THE WASHINGTON POST, MAY 2 5 , Arab Money Seen Moving Into U.S. Real Properties Oil rich Arab nations may soon become stiff competitors with Japanese investors in the acquisition of real estate investment properties in the United States, according to a leading real estate research firm. , SfidcQe East oil nations this year alone will accumulate $80 billion in investment capital, a study by New Orleans-based Robert L. Siegel firm reveals. "At least $2 billion will flow into the United States, most of it for real estate," said SiegeL The firm's study found that Arab investors are seeking the same types of Javestments that have attracted Japanese funds for more than two years: income producing residential housing and retail facilities, resort proiperties, hotels and other transient facilities and land developments. So far, the bulk of Arab investments have been concentrated mainly in the East, Midwest and South, while most Japanese funds have been invested in Hawaii, California and other parts of the West. u One factor — the fear of nationalization — has made the Arab investor more cautious than his Japanese counterpart in placing his fundaJaMthe United States, the sinfey reported. "Some Arab nations have nationalized their oil industries so they tend to be mewhate fearful that the me tactic could be used against them when they invest funds in another nation," Siegel said. Some examples of Middle East real estate investments in the United States, the survey reveals, include: • Financing of a major office building on New York's Fifth Avenue by the Iranian government. S • Providing $200 million .n capital for the development of a mammoth apart-; ment project in St. Louis. • Providing $50 million in investment capital by Kuwait dnd Lebanese sources to a Louisville investment company for the purchase of U. S. real estate. • Financing oflhe development of an islahd xeaoEt off the coast of South Carolina by Kuwait money. • Purchase of raw land in California by Saudi Arabian investors for future development < Siegel also 'reported that Middle East oil money has flowed into Atlanta for the financing of new retail and hotel facilities in the downtown area. "The American motorist was the first to feel the pinch when the Arab nations raised the prices of crude oil. Now, the funds are coming back into the United States and the real estate industry is the first to feel the effect," he said. While Siegel sees an Increasing flow of Arab investment funds into the United States, he 'believes that few, if any, of these p r o j e c t s actually will be developed or managed by the Middle East nations. "These off-shore investors need the expertise of the American developer, who can put the entire package together for toe group providing the money," hejsaid. 1974 169 T H E WASHINGTON POST May 14, 1974 Impact of Massive Oil Price Seen Hitting Gradually Jg** By Hobart Rowen tiuWuhlnctoB Fort Staff Writer M h e real burden on the ^JNSonsuming world caused fer^massive boosts in oil S e e s will be gradual rather A immediate because of k inability of the oil-exg countries to quickly e their imports, i, according to Robert lemon, deputy chairman ~ IMF's Committee of y Deputies and senior r to the Federal Bei Board* "the real imgsct on the standard of liv Ipg of the rest of the world gill be mitigated." He. made these observations in a speech prepared delivery to a conference New York yesterday. A dbpy of the text was made available here. Solomon, who will leave the C-20 to resume full-time duties at the Fed after midyear, was actually in Paris for the deputies' meeting prior to the full committee session here June 1243. His speech was read for him by Edwin M. Trtiman of the Fed. Solomon said that the oilexporting countries, even those with more diversified economies, will develop large surpluses because it will take time to "increase their imports in line with their increased export earnings." Thus, the consuming nations for the time being will be paying for their higherpriced oil with debt, rather than transferring goods and services. But the rfeal effect can not r be delayediorever, Solomon Solomon declared, "as indistressed, and the deficits vidual ell-importing coun, must befinancedpreferably tries' go into debt to finance by co-ordinated moves in which countries try to di- their unavoidable trade defivide <tp the debt burden cits." He pointed out that the equitably, and not try to consuming cquntries as a shift it to each other. group will be able to repay In finding ways of financing the debt—which could be their debts only when the exporters are in a posin the neighborhood of biljieo—S&ldmon said "it may tiOft to buy mop goods from become necessary to alter a world markets. "Thus, we come back to number of conventional the question of the real burways of thinking." For example, he said it den of the oil price inmay be necessary to set crease," Solomon said. "Just aside usual fears about fi- as; the real burden is denancial institutions that bor- lved by the inability of row "short" and lend in the many oil exporters to accelerate their imports, their long term. ability to collect their debts - He pointed out that funds —to accept repayment—-will placed by the oil exporters , be delayed until they are in what are. usually termed able to generate an excess short-term assets (as in of imports over exports." * Euro-currency) are likely to be held for a long time, while the exporting nations develop the capacity to absorb large imports. At the same time, whatever form the borrowing by oil consumers takes, "tile fact is that they are likely to be debtors for a long time... v "All this means that conventional fears about financial Institutions borrowing short and lending long ought to be looked at ana tempered in the light of the likely patterns over time of the balance of 'payments positions of oil consumers and oil exporters," Solomon said. Conventional attitudes toward creditworthiness may have to be revised, as well, 170 T H E W A L L S T R E E T JOURNAL January 2 2 , 1974 REVIEW and OUTLOOK The Robin Hoods of OPEC Fundamental to the oil problem is to subscribe to romantic notions about who will lose and who will gain from where the OPEC winnings will be reinthe seemingly imminent sudden trans- vested. I t is likely that most of them fer of an added $50 billion a year from will be reinvested right back in the inoil consumers to oil producers. I t can dustrial world, where there are estabbe said with some assurance that if the lished capital markets, experienced OPEC price boosts stick, few people in bankers, political stability and any the world will not feel aome effect. number of viable projects. For examThere can be less assurance in trying ple, a Kuwaiti investment company has bought a 20% interest in an Atlanta to assess specific effects. But economics being what they are, firm that plans' to finance a resort in history shows that the poor are usually South Carolina. the first affected by adversity. I t is a None of this is to say that the indusreasonable bet that it will be already trial world won't suffer as well from underprivileged places like Recife, the big oil payoff. Economist Walter Bombay and Mombasa, rather than . J. Levy, one of the soundest oil experts Paris or Atlanta, that will feel the around, fears that the sudden moveworst effects of the OPEC price grab. ment of that much money out of the For that reason, the leaders of nations foreign exchange coffers of the induslike Brazil, India and Kenya might do trial nations could precipitate a worldwell to re-examine the notion that wide recession. His view may be there is any real community of interest overly pessimistic; if money managers among the so-called "Third World" na- in the industrial lands don't become tions, of which both they and the OPEC too panicky and over-inflate their curcountries are a part. Their best inter- rencies to compensate for the loss, ests may well lie in joining with the in- there might even be some beneficial dustrial nations to persuade oil nations effects from damping down industrial of the unwisdom of their cartel-type en- world consumption and applying some deavor. of the OPEC bank deposits to capital The OPEC nations, have, of course, projects. But the large foreign exnot been unmindful of the opinion of change dislocation could indeed be disthe other Third World nations. At a ruptive to industrial economies. meeting of the so-called "Committee of Conversely, there could be some 24" Third World nations, held in Rome benefits to the non-oil producing Third last week concurrently with a meeting World. Some of oil capital may well of the International Monetary Fund go to Niger or Zaire in search of new "Committee of 20" industrial coun-, oil or other mineral resources. The retries, a delegate from India voiced his sources they already have may prove fears. But an oil nation representative more valuable than money in the bank on the Committee of 24 is said to have in an inflationary world. offered assurances that oil nations But by and large, the effects on would divide their new riches with Zaire, Niger and similar places are other Third World countries through likely to be bad. With foreign exchange special aid and lending programs. The reserves crimped, there will be less Committee of 20, in the rather vaguely money for foreign aid and developworded communique issued after its ment in the Third World. The U.S., meeting, also recognized the special having been burned by the Third World problems of the oil-poor of the Third oil producers, has become more inWorld and proposed that developed na- clined to develop its domestic retions, the World Bank and the I M F all sources rather than seek projects seek ways to help out. abroad. Outside help for nation buildAs to the Committee of 24 promises, ing might become hard to find. indeed it is a noble thought that the We suspect that a good many Third OPEC nations will play Robin Hood. World countries are having difficulty But historians have ungenerously sug- deciding whose side they shoufd be on. gested that for even the real Robin We can offer a suggestion: Cartels are Hood, helping the poor was rather sec- seldom good for anyone, even the naondary to the main object, which was tions who build them, in the long run. robbing the rich. Taking a stand for law and order is I n other words, we would suggest much more realistic than' expecting a that the Third World not be too quick handout from Robin Hood. 171 MASSACHUSETTS INSTITUTE OF TECHNOLOGY DEPARTMENT OF ECONOMICS CAMBRIDGE, MASSACHUSETTS 02139 * E52-350 May 14, 1974 Honorable Henry P. Gonzalez Subcommittee on I n t e r n a t i o n a l Finance Committee on Banking and Currency Washington, D. C. 20515 Dear R e p r e s e n t a t i v e Gonzalez: Thank you f o r y o u r l e t t e r o f May 9 . Enclosed are (1) a l e t t e r t o Honorable Henry S. Reuss, and (2) a t a l k g i v e n i n Washington l a s t week, (3) an a r t i c l e from F o r e i g n P o l i c y , and (4) a f o r t h c o m i n g paper from the American Economic Review. These summarize my suggestions about how t o b e g i n undermining or a t l e a s t s t o p p i n g the i n t e r n a t i o n a l o i l monopoly. I do n o t see any o t h e r method by which we can s t a r t t o b r i n g a l i t t l e c o m p e t i t i o n i n t o :the w o r l d o i l m a r k e t . But I t h i n k t h e more I m p o r t a n t t a s k i s t o convince more people of your o p i n i o n , which I s h a r e , t h a t w h a t ' s bad f o r the c a r t e l i s good f o r the U.S.A. I t seems q u i t e c l e a r t o me t h a t the a d m i n i s t r a t i o n i s n o t o n l y r e c o n c i l e d t o t h e c a r t e l and the intended h i g h p r i c e s b u t has a c t u a l l y helped them from the s t a r t and i s a r g u i n g i n f a v o r o f g i v i n g them what they w a n t , so long as they " r e c y c l e " enough d o l l a r s back t o t h e U n i t e d S t a t e s , and p e r m i t us t o pay f o r o i l by handing over our c a p i t a l e q u i p ment. I have even seen ( i n t o d a y ' s New York Times (May 13)) a h i g h a d m i n i s t r a t i o n o f f i c i a l quoted as b e l i e v i n g t h a t s e c u r i t y o f o i l supply i s b e s t achieved by b e i n g dependent on Saudi A r a b i a , and s h i p p i n g them arms and o t h e r goods. I t h i n k t h e panic about shortages w i l l g r a d u a l l y s u b s i d e , and more of your colleagues w i l l share your o p i n i o n t h a t t h e problem i s one o f a w o r l d monopoly which can be thwarted and broken up i n t i m e . The o n l y i r r e p a r a b l e damage would be done by t h e k i n d of a long term commodity agreement a t which Mr. K i s s i n g e r seems vaguely t o h i n t , a t a " j u s t p r i c e " . I f e a r the loss of d i s c r e t i o n on t h i s c o u n t r y ' s p a r t . So long as we remain uncommitted I t h i n k common sense w i l l p r e v a i l b e f o r e t o o much time has passed. Yours s i n c e r e l y M. A . Adelman Professor 172 The Petrocurrency Peril The oil-supply emergency ended this spring with the lifting of the Arab petroleum embargo, but a different kind of world oil crisis is approaching with onrushing speed. It is a potential money crisis caused by the quadrupling of oil prices orchestrated last fall and winter by the Organization of Petroleum Exporting Countries. The threat that these increases pose to world financial mechanisms absorbed much of the attention of bankers and government officials from the U.S., Europe and Japan who gathered in Williamsburg, Va., last week, but their deliberations produced no clear solution. The dimensions of the threat are simply stated. This year the twelve OPEC countries stand to run up a trade surplus of $65 billion, v. a mere $7 billion last year, and the money will come out of the financial hide of the rest of the world. Underdeveloped countries that do not happen to be oil producers, such as India, Kenya and Bangladesh, could run up a combined trade deficit of $20 billion or more—if they can beg or borrow the money to pay for oil. The industrialized nations of the non-Communist world, which enjoyed a combined trade surplus of $12 billion last year, likely will swing this year to a deficit of around $40 billion. Costly Debts. Financing such enormous deficits puts a heavy strain on the Western banking system. Already, many European nations are having to borrow at interest rates of 10% or so to pay for their oil. Though most have good credit, Italy recently had trouble raising $1.2 billion; it wound up borrowing from no fewer than 110 banks. Franz Aschinger, economic adviser of the Swiss Bank Corp., warns that over the next eight years "the accumulated debt [of the industrialized oil-burning nations] would be $400 billion with annual interest payments of $30 billion." European bankers worry that some day one government, most likely Italy's, will default on paying interest oh its loans, putting several banks under and setting off a Continent-wide banking panic. Even if that is avoided, the most strapped nations will be sorely tempted to cut their imports of non-petroleum goods so that they can save cash to pay for the oil, a strategy that could cripple world trade. Italy in April did in fact clamp restrictions on many non-oil imports, to the anger of its eight partners in the European Common Market, who fortunately did not follow suit. The solution is to somehow "recycle" the oil money—or, more bluntly, get it back from the oil producers in the TIME, JUNE 17,1974 form of purchases, loans and investments. It is fairly easy in the case of four oil producers, Algeria, Indonesia, Iran and Venezuela, which have large populations and ambitious industrialization plans. They can be counted on to spend much of their wealth buying goods and services from the U.S., Europe and Japan. But the richest oil producers, Saudi Arabia, Kuwait, the United Arab Emirates and Libya, have small popu- derstandably reluctant to make longterm loans out of money that may be swiftly snatched away. Indeed, the Arab strategy carries its own danger: that billions in Arab cash switching suddenly out of one currency into another could set off an international monetary crisis. Several ways out of the bind are under consideration. H. Johannes Witteveen, managing director of the International Monetary Fund, is setting up an "oil facility" that would accept deposits from oil producers and lend the money at bargain rates of about 7% interest to nations that have trouble paying for petroleum. Unfortunately, he has collected pledges for only $3 billion in deposits, an amount far too small to be of much help. Some European countries want to quadruple the $42.22-an-ounce "official" price of the gold stored in their central banks, putting it about in line with the free-market price of gold. That would in effect give Italy more than $10 billion, and France almost $ 13 billion, of new reserves to cover oil deficits. The U S. opposes the idea, fearing that it might help restore gold to an unwarranted special position in world monetary affairs. Some highly technical compromises have been suggested that would hold the official price in theory while allowing countries in effect to pay for oil with revalued gold—a sensible idea. The best solution of all might be for the Arabs to launch a massive program of loans and aid to poor countries that have no oil. The poor countries could, lations and preindustrial economies; they can spend on imports only a minor part of the $100 billion oil revenues that they will collect this year. So for, the Arabs have been reluctant to put their excess cash into longterm investments, where it would help stabilize world finance. Western stocks and bonds, they believe, do not pay enough to be a good hedge against skyrocketing inflation, and real estate holdings could be seized by Western governments. Instead, the Arabs have been putting most of their money into the shortest-term investments possible: U.S. Treasury bills, New York and London bank certificates of deposit, and Eurodollar bank accounts—many of them "call" accounts from which the money may be withdrawn instantly without advance notice. That is a form of recycling that does little good; banks are un- (hen build up their economies with frany purchases of industrial goods and msrh'mery from the U.S., Europe and Japan. But the Arabs so far have shown iir-ue interest in helping the Third World. Perhaps that attitude will change, and the reluctance to make long-term investments in the industrialized world will diminish as the Arabs become more sophisticated in handling immense wealth. The question is whether a change in attitudes will come quickly enough to avoid bankruptcy for some of the Arabs" best customers. 173 WASHINGTON STAR-NEWS Washington, D. C., Sunday, March 10,1974 Super-Rich Arab Oil Sheiks Begin Bringing $$$ Back By John Hotasha Star-News Stall Writer American businessmen keep having this bad dream. I t involves a dark-eyed man who steps unannounced one night from an airplane at New York's Kennedy Airport. He carried a briefcase bulging with checks bearing the imprints of companies like Exxon and Texaco. Quietly he sets off on a-series of clandestine meetings with managers of major pension and mutual funds. A few days and a few billion dollars later, the United States learns that the ruler of an obscure Arab principality has taken over General Motors. Or U.S. Steel. Or DuPont. Or all three. Although it is the feeling of most Arab watchers that the newly super-rich sheiks don't presently plan to seize control of important U.S. ' companies, it is clear they will have the financial capacity. Right now, the Arab oil producers are estimated to have $50 billion in liquid capital. All the outstanding common shares of G M could be purchased for about $15 billion at current prices. And their wealth continues to mount. The oil producers will take in an estimated $40 billion to $60 billion this year alone. By 1980, some experts project they will have taken > in as much as $750 billion. T H E Q U E S T I O N is, what a r e they going to do with that ocean of money? A vast amount, of corirse, will be spent to develop industries in the producing countries and to improve the quality of life of Arabs in general. But some of the biggest producing states are sparsely populated. Saudi Arabia Was able to absorb 3 7 - 2 1 1 O - 7 4 - 12 only half its 1972 income of $3 billion, even with welfare state programs such as interest-free home loans. This year it may have as much as $10 billion in surplus forThe situation is even more acute in Kuwait which has one-fifth as big a population as Saudi Arabia (less than 1 million) and an estimated income of $9 billion to $10 billion. The Arab leaders' problem is how to preserve that wealth against the day the oil runs out—not an easy task in an uncertain world. H i e lesson of Spain, which squandered its New World gold in a few genera- . tions pf opulence and then sunk back into poverty, is not overlooked. See ARABS, A-12 174 u.2>. tanks mm tear retaliation against their overseas FINANCIAL sophistic* 1 . tion varies greatly from country to country, al- , though all have progressed I beyond the thinking of Abu Dhabi's, Sheik Shakbut who was overthrown in 1966 for keeping the national treasury in cash under htebed. Nevertheless, according to. the British magazine Economist: "The typical Arab investment strategy is j still to put funds OQ bank ' deposit while waiting for the ^brainwave to come/' One brainwave that has struck some Arabs is U.S. real estate. The experienced and fabulously wealthy KuwaitjThaifls turned up in -•several p r o j e c f r r ^ - * ^ ^ The goverument-pnrate-Kuwait Investment Qo> recently paid $J7.3 million for Kiawah I s l & d off Charleston,. S.C. It plans to spend , $100 million over the next decade developing it as a resort. The same company put up $10 million for a half interest in the new Atlanta Hilton. A peal estate company in Louisville, Ky., says it is dickering through intermediaries for SSO mfllioh in Kuwaiti .money to be invested in properties such as of-; fice buildings, shopping centers, and apartments. B. M. HOLLINGSWORTH, of Enck, Hollingsworth & Reveau said there were indications the deal' might eventually swell to $500 million. He said the investors don't care about income now. They want "secure positions; they aren't Richard WlllUtrason, represents the Kuwait Lbvestment Go. in tiie United States describes its investment program as "extremely broad." He adds: "They're not especially concerned aoout casn now now; they're looking for a solid investment with upside potential" Nor are their appetites confined to real estate. "There's very little we're not interested in as long as it is attractive and the people involved are ethical." Money, he makes it plain, is not a problem. He doesn't have a budget. "We receive the money as it is required. If we find a good investment, the money is there." WILLIAMSON estimated that the Kuwaitis, using both public and private funds, have already invested about $SOO million directly in. the UnfcedStates. Another $3.5 billion 1*8 gone into portfolio investments — stocks, bonds, Treasury securities, etc. — he estimates. He said the Kuwaitis aren't interested in takeovers. "We're looking for passive investments that will just leave us in a position to participate in t£e discussions if something oes sour. We're not the apanese," Williamson said. Massive Japanese purchases of propety and resorts in Hawaii and West Coast states in the last few years have prompted calls for laws restricting foreign investment in the United States. Ironically, the massive oil bills due the Arabs has taken the steam out of the Japanese buying binge. Other reported Arab real estate investments include an office building on Fifth Avenue inf New York purchased by the Shah of Iran and $1 million in California land bought by Adnan Khashoggi, a flamboyant Saudi J Arabian thought to be close to the ruling family. Last year Khashoggi bought Security National Bank of Walnut Creek, Calif, from Democratic Rep. Fortney H. Stark. At that time, Stark expressed surprise that Khashoggi was willing to pay $29 a share for the bank's stock when die open market price was in the $10-$12 range.. T H E R E HAVE been , some reports that Arab interests favor buying into American banks or organizing their own to help control their investments here. Foreign-owned banks with head offices overseas have an advantage over domestic banks since they can branch nationwide. U.S. banks are not allowed to branch across state lines,. Rep. Wright Patman, DTexas, the chairman of the House Banking Committee, has introduced a bill to regulate and restrict foreign branch banking in this country—a move which has sent tremors through major The overseas brandies of U.S. banks, particularly in London and Beirut, profitably handle largfe amounts of Arab deposits. Ova-half the 70 banks operating in Beirut are reported to be partiallyforeign owned. A Commerce Department official, recently returned from a Mideast investment conference, said the Arab participants scoffed at the idea of massive takeovers of U.S. companies. "Why *b09l**Make oveMSM," he quoted one as -saying, "What would we oo with it?" He slid the Arabs were aware they lack the managerial talent to run sucha massive enterprise. In Saudi Arabia, for example, there are less than 5,000 college graduates.. ONE EXCEPTION to the no-takeover policy thatrwas discussed; the official said, was "downstream petrochemical operations." This includes everything from oil refineries to neighborhood gas stations and plants using oil/based fee-stocks. . An indication of what the future might hold is a deal made last year by Ashland Oil, Inc. In return fora half interest in a Buffalo, N.Y. refinery and a chain of service stations, the Shah of Iran agreed to supply 60,000 barrels of oil a day to the refinery. . As their experience with refining and marketing increases, it is not unreasona. ble to expect that the oil producers will seek to control and profit from their product from the well to the gas pump. It appears likely that Arab purchases of real property in the United States is likely to continue. For one thing, the dollars we pay for oil have got to come home eventually. And. buying something substantial is a good way to preserve the wealth represented by those dollars. Currencies are fragile. Inflation erodes their value. If the United States has 10 percent inflation this year, an investor in a 9 percentbond actually loses 1 percent. DEVALUATION is a constant threat. Some cynics have suggested that we pay the Arabs anything they ask for oil and than just devalue the dollar drastically. It is improbable the U.S 175 government would ever adopt such a plan. Nevertheless. Saudi Arabia, Lybia and Kuwait were reported hurt badly try the two recent 10 percent dollar devaluations. " K u w a i t . . . lost a half a billion dollars'as a consequence of its extraordinary conservatism" in sticking, with dollar securities' through the devaluations, Harvard Prof. Howard Stauffer told a congressional panel last November. Nationalization of property is always a risk, too, but the oil producers are counting on their control of crude production to prevent any retaliation for the seizure of western-owned facilities in their countries. Moreover, it is their practice to maintain a low profile. Investments in stocks , and bonds, Wall Streetecs : say, are made via the untra-secret Swiss through select New York banks. PARTICIPANTS in the few real estate deals which have' surfaced indicate there may be many better camouflaged investments underway. "If anyone else is talking with the Arabs, they're doing it in secret," real estate operative Hollingsworth said. " I t makes sense. Publicity about Arab money brings everybody Initial investment counts else into your area. Its' as an inflow, but as profits happened here already." Investment in the United are taken back by the invesStates isn't confined to the tor, it results in a cadi outArabs or Japanese. In these flow from the United States. "Over the long term, forunsettled economic times, the U.S has become a havea eign direct investment will for nervous money. Just have a negative effect on last Week, a New York the balance of payments banker reported that a West and result in a dollar outGerman group was pre- flow," a staff report for the pared to pour up to $100 mil- House banking subcommitlion into U.S. real estate. tee on international finance They are particularly inter- concluded last year. A NUMBER of bills have ested' in shopping centers, he said . v been introduced to control Direct foreign investment foreign investment in the in the United States—a United States including one category which does not in- by Rep. John H. Dent, Dclude stocks and bonds- Pa., which would bar nonhas soared from less than citizens from buying more $500 million in 1971 to an than 5 percent of the voting estimated $2 ft billion last stock of any publicly-traded s corporation. year. A series ot Key Hearings The influx, which is expected to accelerate, has wi the entire issue of forprompted a growing debate eign investment in the on its effect on the U.S. United States are planned for April and May by subeconomy. committees headed by ON ONE SIDE are U.S. Reps. Henry Reuss, Dbusiness interests which Wisc., Henry B. Gonzales, are fearful about the mud) D-Texas and Rep. John E. larger U.S. investment Moss, D-Calif., > himself overseas ($94 billion com- sponsor erf proposed restricpared to about $16.5 billion tive legislation. owned by foreigners here.) On the other is the concern of some elected officials that foreign interests could take over key sectors of the economy and that ultimately their investments could worsen the balance of payments. 176 THE. N&W V®^ AID TO POOR LANDS URGED BYEXPERTS $3-Biltior> From Industrial and Oil Nations Asked By EDWIN L. DALE Jr. SpccUl to The New York TlmM WASHINGTON, June 9 — A Report prepared by three economic experts proposes that the industrial nations of Europe, North America and Japan join the oil-producing nations in contributing $3-billion to aid kome 30 poor countries that have been hard hit by higher oil and food prices. • Under the proposal, the emergency relief would be provided in 1974 and 1975, with the oil-producing nations giv)ng half the aid and the industrial nations the other half. The kid could be in money or food or, from the oil countries, in the form<of easy credit terms tor oil sales. J The proposal is the highlight of a 23-page report prepared for the Trilateral Commission, I n organization established last 5ear of leading citizens and Some government officeholders from Europe, North America fmd Japan. The report, which Vas made available to /pie W York Times, was wntten &y Richard N. Gardner of the United States, Saburo Olota of Japan and B. J. Udink of the Netherlands. All have held government positions and have otherwise been involved m international economic affairs. 'Fourth World' The report says: "The plight of the 'fourth world' countries cannot wait for a general restructuring of the international economic order—a task that may take years. Without emergency measures in the next few months, the shortage of food, energy and other essential supplies will bring mass starvation, unemployment and increased hardship for millions already at the economic margin." I The report refers to the inbOStrial countries of Europe, North America and Japan as the "trilateral world" and says: "W« must not allow the plight of the non-oil-producing developing countries to worsen while the trilateral world and the [oil-producing] countries argue about who is to blame for the present crisis, nor will anything be gained by controversies about what is a 'fair* price for oil." Urging an "extraordinary act of cooperation" that would not strain the finances of either the trilateral world or the oil countries, the report says'. "Time is now of the essence. The full impact of the plight of the developing countries has not registered so far because financial settlements for oil are made quarterly and bills for oil shipped at the new high prices are only just coming due. . 'Crunch' This Summer i - "The 'crunch' will come this summer when accounts for the second quarter of the year have tp be settled," the report says. • The report suggests that the industrial countries divide their $1.5-billion contribution according to the formula of their Shares in the World Bank's International Development Association. This would mean onefftird for the United States, or i500-million. No specific suggestion was made as to how the oil-producing countries Should share their $1.5-billion «ontribution. ; The 50-50 sharing of responsibility "should be accepted as fin ad hoc measure appropriate only to the present emergency and without prejudice to burclen-sharing arrangements for {he longer term, the report-says. T»wtes 177 lUashinaton StarHems SATURDAY, MAY 11,1974 Plan for Petroleum A sense of utmost urgency is reflected in a new British proposal for getting some kind of control over oil pHces and putting some order into the anarchic conditions that prevail today in the world oil and money markets. The problem, as the British government sees it, must be dealt with immediately if the world is to avoid a possible collapse of the West's financial system before the end of the year on the same proportions as that which followed the stock market crash in 1928. Especially among the developing poorer countries such as India, it is believed that bankruptcy is a real possibility in a matter of weeks. And the industrialized nations would feel the crunch soon thereafter The British plan — still not formally approved by the Wilson government — is being outlined to administration officials here by Harold Lever, a minister without portfolio and financial adviser in fhe Labor cabinet. It is being billed as the first European response to Secretary of State Henry Kissinger's plea for cooperation between oil producers and consumers in meeting the crisis precipitated by the skyrocketing price of crude. It proposes a collective effort by the major oil consuming states in dealing with the producers. The six major consumers (the United States, Britain, France, West Germany, Italy and Japan) would bargain collectively with the major producers for most of the world's oil production. They would then resell the oil to consuming countries at cost, plus a small surcharge. The main idea is not to force down the price of crude by hard collective bargaining, but rather to put an end to unrestrained competition among consumers for oil and credits that promises to force prices even higher. The surcharge on the huge cash turnover would be used to offset the price increases by loans or outright gifts to the poorer countries. The producers, furthermore, would be encouraged to take in cash only what they can usefully use to buy commodities and increase their reserves — perhaps about $15 billion. The balance — about $50 ' billion — would be deposited with the six-nation agency to be loaned out as needed to cover deficits among consuming nations, rich and poor. All payments and deposits would be tied to the export commodities index, insuring against devaluation through inflation. It is a bold and imaginative scheme and it just might work. The objections, of course, are largely political,— the suspicion of the producers that the West is ganging up on them in forming a consumers' cartel — the tendency of some countries, notably France, to go it alone in such matters — the fact that the scheme is certain to require an enormous amount of American dollars, a preferred currency. Still, if .the situation is anything like as critical as it appears to be, with all that is implied in terms of economic and social dislocation among the oil consuming nations, there is no time to be lost. Certainly the British proposal deserves the most prompt, careful and sympathetic consideration by administration experts. 178 T H E WASHINGTON POST A p r i l 8, 1974 Expert Urges ILS. to Adopt New Oil Import Quota Setup By Daniel Q. Haney Ausclated Pr«M CAMBRIDGE, Mass., April 7—The United States should start a new oil import quota system to. make it easy for members of the international Oil monopoly to cheat on ea<^h other, says a world oil expert. Such a policy could lead to the downfall of the Organization of Petroleum Exporting Countries, the cartel that has quadrupled the price of foreign oil in the past year, says Maurice A. Adelman, an economist at Massachusetts Institute of Technology. But before this can happen, American foreign policy makers must acknowledge tjiat the oil cartel isr bad for American interests, says Adelman, whose views on OPEC often run opposite to fellow oil economists and N i x o n administration policy. OPEC is made up of 11 of the 12 biggest oil exporting countries in the world and controls m o r e t h a n twothirds of the world's known oil'reserves. The most important members a r e t h e Persian Gulf countries which inblude Saudi Arabia, the world's largest producer of oil after the United Statfes. Also included In the membership are all the major Arab oil-producing s t a t e s which only recently lifted an embargo on oil shipments to the United States. Canada is not a member of OPEC. * M. A. ADELMAN. , < . * way to cheat a controversial, but #}dely respected authority on the international oil market. M My suggestion is that we put this limit in the form of a quota and that we put parts of the quota up for sale by direct, sealed competitive bids," he says. "The higher the price, the more profitable it is to export oil into the United States. "Anyone w i t h potential oil knows lie can find a home for it in the U.S.A. All you require of a bidder is that he plunk down some good, hard cash" for oil-selling licenses: This system would magnify the tensions that already exist Among OPEC countries( he says. Some of them want to sell as much oil as possible now so that they can invest the profits, while The OPEC countries deothers want to hang onto cide among themselves how their oil to keep prices up. much oil they will sell and how much they will charge This way, any government for it. Their goal is to sell as that wants to do some chiselmuch oil as possible without ing has a perfect vehicle for creating a s u rp 1 u s that it," Adelman says. No counwould drive down prices, try would know how much Adelman says. its colleagues were selling to the Americans, he says. "There is no question that "This mould shake the caroil imports into the United States are going to be limit- tel," he says. "It means you ed" as the nation moves to- cannot make any kind of ward its goal of energy inagreement to keep the price dependence, says Adelman, at a certain level, because you can't control the people It vastly enriches the Arab who are going to cheat, , nations and makes it easier, ' "If it works well ip the for them to impose future Unitecl States, other counembargoes, he says. It alio tries wiU try it, and that will makes a scramble for j&l be the end of the cartel. This would bring oil prices that creates hard feelings baek down. How far, I dont - between the United States and its allies in Europe and know, but there's lots of Asia. ( room to go down." The price of oil produced Adelman maintains thatby the Cartel now . hovers U.S. foreign policy os pararound $8 a barrel, and tially to blame for the curOPEC says this price will be rent Strength of OPEC. He maintained until June when says that because of fears in it will meet again to con-' thcf 1850s that the Soviet Unsider adjustments. . ion would gain too much inThere is no wbrldwide oil fluence with Arab oil-producshortage, pqly a market artiing states, the United States ficially controlled by the embarked on a policy of cartel, Adeftnan says. Arab appeasement. One of Iran, Iraq, Saudi Arabia, the results of this policy was Kuwait and Abu Dhabi the development of a system "have a huge excess of po- whereby American oil comtential production capacity panies can deduct , from which can be made into ac- their U.S. incom® tax royaltual capacity in a relatively ties paid on oil from OPEC short time. c o u n t r i e s . OPEC w a s "Always the problem has founded in 19(J0 with the enbeen how do you keep up couragement of the U.S. the price by containing this government, Adelman says. potential and not letting it Adelman's view that become actual?" . OPEC should be actively opAnd herein lie the seeds posed by the United States of disagreement that could a n d o t h e r oil-consuming lead to the cartel's downfall, countries has been heavily Adelman says. criticized by some of his fel"There are some countries low economists. The Nixon —Iran is the most important administration itself seems —with fairly sizable populadisinclined to take an advertions, Water and natural resary posture agrtist OPEC. sources who can put -tb very The U.S. oU import quota „ profitable use all of the rev- law, in effect since the Eisenues they can get, building enhower administration, was the infrastructure of a civilifted last year Ijy the Presilized society," he says. "Foi dent as oil shortages began every dollar they .invest, to appear. There have been they can probably get a reno indications that the quoturn of 20 per cent a year if tas will be reinstated in the it's done sensibly. near future. "Other countries, such as The Nixon administration Abu Dhabi, have to invest in has called for consumingthe international financial country unity in the face of market. They cannot hope OPEC price increases, but to get any such high rate of with little success. The return. Between those counAmerican government £as tries who want to make repeatedly warned its Euromoney as fast as possible pean allies not to make and those who don't, there country-to-country deals for is a big difference of opinoil. But several European ion." countries are in the midst of The cartel is bad for negotiating separate deals American interests, because for oil with OPEC countries. 179 THE WALL STREET JOURNAL, W«dne»dmy, M»y 8, 1974 Britain Leaning to Oil Purchases, Sales By IMF to Attack World Monetary Woes B y RICHARD F . JANSSEN Staff Reporter of THE WALL STREET JOURNAL Fear that the world's banking system will break down by year-end is impelling British government officials to broach a drastic new approach to the oil money prob7 lem. The idea surfacing in the Labor Party government's highest circles is that the International Monetary Fund should swiftly be empowered to buy oil from producer "nations and resell it to consumer countries to assure that both oil prices and currency flows are kept under orderly multilateral control. Top U.S. officials are sure to be sounded out on the British thinking this week,when Harold Lever, special economic and financial adviser to Prime Minister Harold Wilson, is on a mission to Washington. In London, it is hoped he may find some supporters in incoming Treasury Secretary William Simon and in Chairman Arthur Burns of the Federal Reserve Board. Earlier this week, the IMF's managing director, Johannes Witteveen, described a plan for his agency to borrow funds to relend to oil-consuming countries. The British idea, being described as a brainchild of Mr. Lever rather than official government policy, goes further by suggesting that the IMF purchase the oil outright. The two ideas, In the British view, aren't incompatible. British officials privy to the plan concede it sounds incredibly ambitious, but some of them, at least, contend that continuation of current uncertainties about currency movements and values poses the gravest risk to the Western world's financial stability since World War n , and with economic consequences that could be comparable to the depression that followed the 1929 financial crash. Basically, the worriers reason that nearly all the extra $50 billion that oil-producing nations are apt to receive this year due to higher prices will be placed in the commercial banks of the U.S., Britain and other industrial countries. The deposits, and the need to find lending opportunities for them quickly, will Increase far faster than the underlying capital of the banks, they figure. This is a concern that some other sources separately attribute to the Fed, as well. The banking system's soundness could succumb more swiftly, the reasoning goes, if some of the non-oil poor countries and some of the hardest-hit industrial countries, such as Italy, launch dollar borrowings outside the U.S.'that flop. Attempts by major banks to call existing debts of such countries for immediate repayment would fail, too, it's figured, possibly triggering a panicky chain reaction of financial collapses of governments and banks alike. Cooperation by the U.S. would be crucial to preventing or arresting such a process, British strategists say, if the idea spreads that dollars aren't safe to hold outside the U.S. Theyvcould imagine a drain from the London-centered market in Eurodollars (dollars on deposit in banks anywhere outside the U.S.) and back to New York. That would mean that the countries hi direct needf of Eurodollar credits to offset their enlarged oil bills wouldn't b* getting them. The consequences, sources who couldn't: be quoted directly say, would be akin to those afflicting the secondary or fringe banks in Britain, which have suffered runs by major creditors. The rescue operations that central banks and governments would have to mount on a global scale would be so va?t and so sensitive, they warn, that mishandling could easily cause results ranging from a major mishap to catastrophic economic slumps in major nations. Whether the IMF's Committee of 20 deputies will discuss the British ideas during their meeting this week in Paris remains to | be seen. The deputies already are, b « g diverted from their once-ambitious long-range planning for a new monetary system to doing some Interim patching up and to preparing standby plans that may need a shelf life of some years before conditions become calm enough to try putting stabler exchange rates into being. It is conceivable, though, some Paris participants say, that the desire of Common Market finance ministers to make use of gold reserves at something closer to the market price, currently $163 an ounce, than to the nominal official price of $42.22 an ounce, could lead to a breakthrough on the long-standing demand of the poorer countries for an extra share of the IMF's "paper gold," or Special Drawing Rights. Should it appear that the richer ones are about to hand themselves a windfall by roughly quadrupling the worth of their gold reserves to market levels,, planners worry, the poorer or developing nations may block agreement on anything else unless they get their long-sought "link" between SDRs and foreign aid. The U.S. and West Germany in particular are against using SDRs as aid, preferring to limit them to a reserve asset function. The rich countries will be watching the poor ones for clues during the deputy-level sessions, so they'll have an idea whether a ministerial meeting June 12-13 in Washington may get bogged down an the link issue. If the Europeans feel strongly enough on making use c^ their gold, though, some Insiders figure it Is possible that a grand-slain compromise could be worked out, givinff the rich what amounts to a richer Msard of gold and giving the poor an extra ration of SDRs. 180 MARCH 21, 1974 Ibe toasijington fwt AN INDEPENDENT NEWSPAPER Pavlovian Politics and Arab Oil P RESIDENT NIXON was evidently caught between two opposite impulses at his Houston press conference when he talked about the end of the Arab oil embargo. There was the strong temptation to play up the good news and tell the country that Its oil troubles are over.. But Mr. Nixon knew, of course* that our oil troubles are anything but over; the Arabs mean to keep the shipments lower than this country had expected. As it turned out, Mr. Nixon chose his words skillfully and managed to harvest several rounds of applause from Bis audience without giving away any substantial part of his position. He announced, for example, that he was rescinding his "order" to close gas stations on Sundays. But the order was never anything more than a request for voluntary compliance, and it was being increasingly Ignored. The important parts of the oil conservation program all stay in place—the allocations, the low speed limits, the mandatory savings in industry. Prices will Continue to rise, the strongest force of all for conservaIt is unpleasant but absolutely necessary to hold oil consumption. In view of the Arabs' public statements, this country has no reason whatever to rely on the continuity of their future oil shipments to us. The Arab oil producers now say that they are going to end their embargo against the United States temporarily, depending upon our good behavior. Dr. PaVlov rings the bell, and the dog salivates. In order to keep the dog salivating on signal, it is necessary to give him a morsel from time to time. In the same orderly and scientific spirit, the Arabs evidently intend to train us to identify our interests with their purposes. When we are obedient, the oil will flow. When we are refractory, the oil will stop.' But if the oil is stopped too long, there is a danger—from the Arabs' point of view—that Americans will learn to live without the embargoed oil. It follows that the canny Arabs do not intend to leave the oil turned off Indefinitely, even though progress toward a firm peace in the Mideast continues to 'be very slow. But to underline their intention, the ministers mean to meet again on June 1, less than three months from now, to "review" the decision on the embargo. - The Pavlovian politics of oil requires not only continuous uncertainty regarding the embargo but, much more important, a lower flow of oil than the world was expecting. Saudi Arabia has said that It will ship 1 million barrels a day to the United States, an amount not quite sufficient to bring our oil imports back up to the level of last fall. Until last fall, American oil policy assumed relatively low prices and a massive increase in oil consumption. Most of that increase was to come from abroad and, specifically, from' Saudi Arabia. The Arab exporters are now offering us the opportunity to end our present discomfort by re-establishing our dependence on them. Everything comes down to Saudi Arabia and its position. The Saudis command vastly the largest and most accessible oil reserves in the world. It is not really a matter of a cartel, because very little depends on what the other Arab producers choose to do. Saudi Arabia is by itself a large enough element in world oil trade that when it holds, down production there is a worldwide shortage, and if it pumps to capacity there will be a worldwide glut. A lot of oil exporting countries are going to be pressing the Saudis to restrict shipments in order to keep up the prices for everybody else. More dangerous, every setback in the Arabs' negotiations with Israel will immediately bring an outcry from other Arab governments and political movements to invoke the oil weapon again. With every rise in their level of frustration, and with every rebuff to the Palestinian cause, the more militant and radical Arabs will begin to lean on the Saudis to turn off the oil; Saudi Arabia, a small country in terms of population and military strength, is in no position to stand up to unlimited pressure from its neighbors. That truth needs to be kept very much in mind by Americans as they consider the stability of our future oil supplies. Now that the Saudis are going to ship to us again, for the time being, what ought we do? First of all, we need to keep the present conservation rules in force. If we drop these precautions, after having been plainly warned that the Arab oil ministers are taking up the embargo question again in June, we are foolish to the point of negligence. Next, we ought to store at least some proportion of the new imports. Building oil storage capacity is expensive, but it is not as expensive as the anxieties and uncertainties of recent months. The oil weapon has been a great success in terms of raising prices, dismaying consumers and disrupting economies in the industrial countries. But it has had no visible effect on .the pace or direction of the peace negotiations between Israel and its Arab neighbors. The United States is trying earnestly to assist the negotiations and speed both sides toward a stable peace agreement. But it has been slow work, and it will continue to be slow work. The oil weapon has been effective for everything except the one purpose fpr which it was evoked. The United States can readily agree to continue to deal with both sides in good faith, but it cannot promise rapid or dramatic results. We must assume that the oil embargo may flicker on and off over the months to come. If it catches us unprepared a second time, we shall have no one to blame but ourselves. 181 Address Co N a t i o n a l Press Club, Washington, D. C . , Thursday Hay 9 t h , 1 P.M. COPING WITH THE OIL CARTEL M. A . Adelman M.I.T. I am honored t o address the N a t i o n a l Press Club, a l s o g r a t e f u l . The press has created the p u b l i c record o f the w o r l d 611 market, d i r e c t l y and i n d i r e c t l y , o f t e n i n t e r a c t i n g w i t h Congress. I f i t were not f o r you, academic i n d u s t r y study would be i m p o s s i b l e , which some people t h i n k would not be a bad i d e a . 1974 may be the year o f r e t u r n i n g s a n i t y . There seems a t l e a s t the beginning of understanding t h a t surging demand pushing us a g a i n s t l i m i t e d resources i s a f a n t a s y . World o i l remains i n huge p o t e n t i a l s u r p l u s , as i t has been f o r a t l e a s t 50 y e a r s . how t o c o n t a i n t h a t s u r p l u s . The problem f o r the i n d u s t r y has always been Before the g r e a t turbulence began i n 1970-71, the Persian Gulf p r i c e was about $1.20 per b a r r e l . There was a chronic s u r p l u s , w i t h more o i l a v a i l a b l e than demanded, because a t t h a t p r i c e i t was enormously p r o f i t a b l e t o expand p r o d u c t i o n by d r i l l i n g new w e l l s . Now t h a t the p r i c e has been m u l t i p l i e d by a f a c t o r of 7 or 8 , t h e r e i s a f a r bigger p o t e n t i a l s u r p l u s , but a l s o a much stronger b a r r i e r t o h o l d i t back, namely, the c a r t e l of the producing n a t i o n s , the members o f OPEC. A good p i c t u r e of the market f i v e years ago i s the memorandum released by Senator Church's subcommittee, w r i t t e n i n December 1968 f o r the top management o f the Standard O i l Company of C a l i f o r n i a , which f o r some obscure reason t r y i n g t o b e l i t t l e i t and shove i t under the r u g . is I t confirms o t h e r evidence, o f people doing t h e i r best t o c o n t a i n the surplus b u t unable t o p r a c t i c e c o l l u s i o n w i t h the other companies. From 1947 t o 1969 the Persian G u l f p r i c e came down, i n r e a l terms, by about 65 p e r c e n t . The o i l companies were beating a 8low but long r e t r e a t . The c u r r e n t f u r o r against the o i l i n d u s t r y d i s t r a c t s our a t t e n t i o n w h i l e the c a r t e l nations l i f t $100 b i l l i o n every y e a r . 182 - 2 - The b i g change since 1969 I s t h a t a group o f governments have taken over from the companies the j o b o f c o n t a i n i n g the s u r p l u s . r e a l l y new. This i s something A p r i v a t e monopoly can r e s t r i c t output and r a i s e p r i c e s , but o n l y w i t h i n l i m i t s p e r m i t t e d by the coercive power of government. may l o s e t h e i r monopoly, o r go t o j a i l . do as they please. Monopolists But a group of sovereign s t a t e s can There i s nobody t o stop them from charging what the t r a f f i c w i l l b e a r , which i s the cost o f the cheapest a l t e r n a t i v e . When somebody says i n defense, i n a c c u s a t i o n , o r as a simple f a c t - t h a t oil producers set a p r i c e equal t o the " r e a l v a l u e " o f t h e i r p r o d u c t , as s e t by competing products, he i s saying t h a t they are monopolists. I f the farmers could m a i n t a i n a monopoly, they would charge us whatever we were w i l l i n g t o pay f o r the p r i v i l e g e o f e a t i n g . The p r i n c i p l e i s : w h a t ' s i t worth t o you? The man who p o i n t s a gun i n d says "Your money or your l i f e " i s a l s o g i v i n g us a lesson i n monopoly p r i c i n g . Right now the governments a t the Persian Gulf are t a k i n g between $7 t o $11, and p r i c e s range from $8 to $12. I w i l l not waste your time I n t r y i n g t o d i s t i n g u i s h between taxes and r o y a l t i e s and buybacks and d i r e c t s a l e s , nor about ownership and p a r t i c i p a t i o n 4nd j u s t compensation. The governments are completely I n charge, but they have not y e t s e t t l e d the p r i c e a t which they convey the o i l t o the companies who do the a c t u a l work o f f i n d i n g , developing, and producing. tQj&7 than $11, The average w i l l probably s e t t l e out c l o s e r 183 -3- Today producing capacity a t the Persian Gulf i s already 20 percent above p r o d u c t i o n . As f o r the years t o 1980, a number o f people are now doing a few sums. They use v a r i o u s methods, and come out w i t h v a r i o u s answers. But estimates o f consumption and p r o d u c t i o n i n consuming c o u n t r i e s suggest t h a t the demand f o r o i l from the OPEC c o u n t r i e s w i l l not be much l a r g e r i n 1980 than i t was l a s t y e a r . Among the OPEC n a t i o n s some are d r i v i n g as hard as they can f o r g r e a t e r o u t p u t . In*prudence, count o n l y the announced p r o d u c t i o n p l a n s , n e a r l y a l l f o r 1976, which have not been c r i t i c i z e d as i m p r a c t i c a l . This assumes no Increase a t a l l f o r A l g e r i a ; and i t assumes t h a t I r a n , Indonesia, and N i g e r i a , w i l l take seven years to expand as much as they have i n the past t h r e e . and Abu Dhabi are assumed unchanged. Venezuela, L i b y a , Kuwait, What's l e f t f o r Saudi Arabia i s l e s s than what they a c t u a l l y produced l a s t year* There I s even a good chance t h a t i f a l l the OPEC nations but Saudi Arabia produced a t r a t e s which they can e a s i l y reach before 1980, t h a t country could shut down completely, and y e t the amount supplied would equal the amount demanded a t c u r r e n t o r l e s s than c u r r e n t p r i c e s . Of course, Saudi Arabia i s not going t o shut down. Nor w i l l they be content w i t h 5 m i l l i o n b a r r e l s d a l l y when t h e i r capacity i s already twice t h a t and growing. Of course, we have heard from Americans and Saudis t h a t Saudi Arabia i s producing f a r more than I s i n t h e i r economic I n t e r e s t - t h a t they are s a c r i f i c i n g , producing f o r sweet c h a r i t y . anything. Some people w i l l b e l i e v e The p o i n t i s , Saudi Arabia cannot by i t s e l f c o n t a i n the surplus by r e l a t i v e l y s m a l l and manageable cutbacks. must share the burden o f r e s t r a i n t . their differences. Therefore other OPEC nations The nations must n e g o t i a t e , and compose The only argument any w i l l heed i s the t h r e a t o f damage. The best way t o make t h r e a t s c r e d i b l e i s t o b u i l d excess c a p a c i t y i n case o f a fight. 184 -4- I w i l l not guess how much excess capacity w i l l a c t u a l l y accumulate by 1976 o r 1980. But assume the Investment needed f o r one b a r r e l per day added c a p a c i t y stays around 1972 l e v e l s . For a Persian Gulf country which enjoys average costs - n o t the lowest l e v e l - one d a l l y b a r r e l o f o i l s o l d a t $8 a b a r r e l pays back the Investment I n 16 days. per year p r o f i t on Investment.) 32 days (only 14,000 p e r c e n t . ) (This i s 23,000 percent I f the p r i c e has dropped t o $5, i t takes I f there i s any chance o f ever f i n d i n g a market, the excess capacity I s w e l l w o r t h b u i l d i n g and s i t t i n g on. The c a r t e l w i l l t h e r e f o r e b u i l d a l o t o f a c t u a l excess c a p a c i t y . The sooner the governments r e a a l y n a t i o n a l i z e and take over the investment d e c i s i o n s , the f a s t e r the b u i l d u p o f excess c a p a c i t y . probably not c o l l a p s e by i t s e l f . easily. But the c a r t e l w i l l The gains are too enormous t o g i v e up One must i n common prudence assume the OPEC nations w i l l h o l d t o g e t h e r ; i f they q u a r r e l they can r e c o n s t i t u t e the scheme. What the surplus does promise i s a great t.emptatlon on each o f them t o c h i s e l and cheat, t o make Incremental sales a t lower p r i c e s t o get additional p r o f i t . This i s the t r a d i t i o n a l nemesis o f c a r t e l s . When producing nations b u i l d r e f i n e r i e s and buy t a n k e r s , there w i l l be many more o p p o r t u n i t i e s to shade p r i c e s . And the Impulse i s i r r e s i s t i b l e when f e a r r e i n f o r c e s hope - the f e a r t h a t others are p r o f i t i n g by your s c r u p l e s . D i s t r u s t melts the glue t h a t holds the monopolists t o g e t h e r ; each can reflect: When you have a f r i e n d t r i e d and t r u e , do him q u i c k before he does you. The temptation to c h i s e l and cheat i s a l l the s t r o n g e r when t h e r e e x i s t s a very l a r g e market which any producing n a t i o n can hope t o p e n e t r a t e , t o get l a r g e blocks of a d d i t i o n a l business by rebates which do not a f f e c t p r i c e s elsewhere. This i s the t r a d i t i o n a l r o l e of the l a r g e b u y e r , which the U n i t e d States can play i f I t so d e s i r e s . 185 -5- Zero Imports f o r the United States are a mirage. There w i l l be Imports, and those Imports must be l i m i t e d f o r the sake o f n a t i o n a l s e c u r i t y . A tariff w i l l not do because one cannot p r e d i c t I n advance how much I t w i l l reduce Imports. Domestic producers w i l l have no f i r m ideai of how much they can s e l l . Hence there must be an absolute Import l i m i t . The t o t a l o f p e r m i t t e d Imports must be d i v i d e d up and a l l o c a t e d somehow. Consider a t i c k e t which permits the holder t o import a given amount o f oil. The value o f the t i c k e t i s the d i f f e r e n c e between the United States p r i c e of o i l , on the one hand, and the cost o f o b t a i n i n g and t r a n s p o r t i n g o i l on the other. Producing governments can b i d several d o l l a r s per b a r r e l , i n f a c t t h e i r l i m i t i s t h e i r take. Import quota t i c k e t s are e x a c t l y l i k e other valuable r i g h t s , l i k e leases to produce. They should be awarded i n e x a c t l y the same way? for flexibility they should be s o l d i n assortments:, from 3 months t o perhaps three y e a r s . Anybody a t a l l ought t o be permitted to b i d , the only requirement being a c a s h i e r ' s check f o r the amount b i d . up the money. Nobody need know who was p u t t i n g Resale o f quota t i c k e t s should be p e r m i t t e d . : v I n t h i s way, any government which wanted sales i n the United States could have them, by r e b a t i n g p a r t o f i t s gains t o the United States Treasury. They would have t o f u r n i s h t i c k e t s to the producing companies who otherwise could not import here. We could o f f e r a home f o r o i l a l l over the w o r l d , and an i n c e n t i v e t o expand output. Since our imports would be a minor f r a c t i o n of world p r o d u c t i o n , it would take only a small m i n o r i t y , under cover o f anonymity, t o b i d f o r a l l the tickets offered. get the business. Those who put p r o f i t s higher than l o y a l t y t o the c a r t e l would 186 - 6 - Thia scheme would n o t a f f e c t t h e domestic p r i c e of o i l , which w i l l for t h e foreseeable f u t u r e be f a r above p r o d u c t i o n costs a l l over the w o r l d , and much higher than a t any time since World War. I I . The sooner we face t h i s , the b e t t e r ; b u t i t i s an issue separate from our a p p r o p r i a t i n g a s l i c e o f the monopoly g a i n s . The consumer i s n e i t h e r helped nor h u r t - as a consumer - because t h i s scheme has no e f f e c t on the domestic p r i c e . The consumer b e n e f i t s as a taxpayer. The immediate reward t o t h i s country o f a quota t i c k e t system would be a l a r g e r e d u c t i o n i n the economic burden of o i l i m p o r t s . A l s o , we would s t a r t the war o f a l l against a l l and put the c a r t e l on the s l i p p e r y s l o p e . Once i t b e g i n s , the s l i d e can a c c e l e r a t e . Those OPEC nations which c u r t a i l p r o d u c t i o n can only a f f o r d t o do so because o f the h i g h p r i c e s they r e c e i v e . Hence a r e d u c t i o n i n p r i c e s i s t w i c e blessed f o r us and o t h e r consuming c o u n t r i e s . I t reduces the burden and i t a l s o makes the producers w i l l i n g o r anxious t o expand o u t p u t . This idea i s p r a c t i c a l but t h a t does not n e c e s s a r i l y make i t good. we want the c a r t e l to f l o u r i s h or fade? My own o p i n i o n i s t h a t w h a t ' s bad f o r the c a r t e l i s good f o r the United S t a t e s . The burden o f paying f o r imports has been much exaggerated b u t i s s t i l l very g r e a t . underdeveloped c o u n t r i e s , i t i s r u i n o u s . we w i l l need t o b a i l them o u t . Do oil For most o f the There i s no way they can pay, and We are embroiled w i t h our f r i e n d s and t r a d i n g p a r t n e r s i n attempts to shove the burden o f higher p r i c e on each o t h e r . Our government denounces the b i l a t e r a l deals o f armaments o r other goods f o r oil, tfille we ourselves n e g o t i a t e the b i g g e s t b i l a t e r a l deal o f all. 187 -7- The c a r t e l I s a l s o making the w o r l d a much more dangerous p l a c e . arms b u i l d u p i s j u s t beginning a t the Persian G u l f . A vast Every l i t t l e patch o f barren ground i s worth f i g h t i n g over because of i t s p o t e n t i a l w e a l t h . The Arabs w i l l be out o f the c o n t r o l of e i t h e r the Soviet Union or the United States because they can buy arms from a l l the w o r l d . When Saudi Arabian revenues were o n l y $4.5 b i l l i o n per y e a r , i n 1973, we got one shooting war and one economic war. Imagine what we w i l l get when t h e i r revenues are m u l t i p l i e d . U n l i m i t e d arms, plus the " o i l weapon" which made the consuming c o u n t r i e s shake liKje j e l l y , do not add up t o peace. O i l supply i s very Insecure because the producing nations are saving so much money t h a t they can a f f o r d t o c u t back p r o d u c t i o n and pass up the revenues f o r a t i m e , i n order to i n f l i c t damage on consuming n a t i o n s . A l l of these dangers and burdens are simply unneccessary. do not r e s u l t from s c a r c i t y , imposed by n a t u r e . High p r i c e s o f Men have made them and other men can un-make them. I t w i l l not be easy or quick work to remove t h i s t h r e a t . I t w i l l be years before the c a r t e l can be pronounced w e l l and t r u l y dead, because the OPEC nations have learned the enormous rewards of a successful monopoly. They w i l l not soon g i v e up, and they are encouraged today as they have been f o r years by consuming country governments' t a l k o f "cooperation". The producing c o u n t r i e s are amused not Impressed by American warnings t h a t they may go too f a r . n h e i r experience has been t h a t they can go as f a r as they please and they w i l l get nothing but meek deference from the United States whose p o l i c y I s t o see, hear and speak no e v i l o f them. Any move t o i n j e c t competition i n t o the w o r l d market w i l l of course s t i r b i t t e r complaints: himself! What a v i c i o u s animal! When a t t a c k e d , he defends oil 188 - 8 - Our government seems t o have I n mind some vague grand design f o r a w o r l d commodity agreement t o f i x what Mr. K i s s i n g e r c a l l s "a j u s t p r i c e , " whatever t h a t means. street. Such an agreement would be a f l o o r b u t not a c e i l i n g , a one way The Persian Gulf n a t i o n s have a clean r e c o r d ; they have never y e t f a i l e d t o v i o l a t e an agreement on o i l . I f they can r i g the p r i c e h i g h e r , up i t w i l l go; the agreement w i l l merely keep us from t a k i n g defensive a c t i o n . I n 1971, the State Department r i g h t l y claimed c r e d i t f o r the T r i p o l i and Tehran s o - c a l l e d "agreements", which they t o l d us would b r i n g " s t a b i l i t y " and "durability". Those wonderful people who brought you the f i r s t Tehran are now preparing a super-Tehran which w i l l freeze a dismal present i n t o the indefinite future. I t h i n k we can do much b e t t e r ; i t ' s hard t o see how we can do any worse. Thank you. 189 The Washington Post May 3, Indeed, after New York it becomes a real question whether there is much advantage for the poor in coming together in a big political forum such asthe United Natidns and trying to get , the rich to agree to come across on dovelopment financing, trade, food, energy, emergency aid, and > so on.'Nothing useful can happen in a political forurri on such issues unless there is a consensus, and there is no consensus. 1974 — ; ;i Stephen S. Rosenfeld j Aiding Algeria's President Boumediene, opening the session, cited the postwar Marshall Plan for Europe as a hopeful model. But, as Secretary of State, Kissinger replied, "then tfce driving force was a shared' sense of' purpose, of values and of destination. As yet, we lack a comparable sense of purpose with respect to development." Developing Nations He could have added that the stirrings of detente have rendered anticommunism inoperative as a source of The special session of the United Nations General Assembly on the world economy has dealt a heavy blow to the enlightened "liberal" notion of economic interdependence—the notion that we're all in the same basket and that we therefore must Cooperate for our common good. "Partisans of interdependence warn that the alternative is confrontation. For what the session seems to have demonstrated is that some nations, es- peciallj poor ones, are more in that basket than other nations; that what economic interdependence there is is not matched by a corresponding recognition of political interdependence; and that the organized international community is not likely to act significantly to ease the critical condition brought to some 40 of the poorest countries by, principally, the massive price increases laid down last winter by the oil cartel. The warning is fair*' such a sense of purpose. Oil inflation, turning publics and governments inward, has nipped even more cruelly that common sense. So has the Western public's keen awareness that the .Mideast oil states have billions of dollars rattling around in their bank accounts that they have no conceivable way to put to rational use now at home. These are the political realities which crush worthy appeals to interdependence. A member of that cartel, Algeria, . took the lead in calling the special session, apparently for the purpose of diverting oppobrium and responsibility for the new misery from the oil cartel to/the good old "imperialists." Partisans of interdependence warn that the alternative is confrontation. The warning is fair. No one can say just who will be the target but it seems to me inconceivable that countries like India, Pakistan or Bangladesh, to cite three of those worst hit, will sink meekly into deep public catastrophe without blaming someone and perhaps wildly casting about. I t is not yet clear who will be blamed for the limp and inadequate steps actually taken at the special session but it is clear that very little benefit has been gained by what the United Nations calls the "MSA" countries, those "most seriously affected" by the higher energy costs. Something like a billion people live in those countries. To some goodwilled observers, the result—indeed, the general reluctance of old rich and new rich alike to do much more than make speeches for the poor—reflects a shortfall not only of moral values but of an understanding of the close link between the economic and political fortunes of rich and poor. This is the interdependence argument: the rich, needing the resources, markets and investment opportunities of the poor, should help them. Thus is self-interest hitched to internationalism and human dignity. 3 7 - 2 1 1 O - 74 - 13 A second alternative to recognition of interdependence will surely be mass suffering on a scale heretofore unimagined. I t becomes even more tGfficult to see how millions of people are going to avoid dying by starvation and associated causes, soon. , j The best available answer is simple. The newly rich oil states should take their excess billions and apply' them immediately to the relief of the. world's poor. Then and only then will it be possible for all nations to apply the mbral and political dictates for interdependence and to fnove forward on real development. | 1 j j i i 190 BUSINESSWEEK: May 11. W * cope w i t h the huge funds we w i l l have." UBAF is expected to attract a substantial share of the $50-billion in annual Arab oil earnings that will result from oil price hikes last October and December. A cool billion. The UBAF group, established in 1970, is 40% owned by the French banks Credit Lyonnais and Banque Francaise du Commerce Exterieur. The rest is held by 25 Arab banks and governments, of which the Abushadi: The New York market 'can cope with the huge funds we will have' An Arab bank shops , for a New York off ice - 1 One of the Arab world's newest and most aggressive banking groups, the Union des Banques Arabes et Francaises (UBAF), is wrapping up negotiations this month to open its first New York operation-a joint venture w i t h at least two U. S. banks. Significantly, the Paris-based bank is 60% owned by Arab governments and banks, many of which are scrambling to find places to invest the fiow of new oil money into their coffers. The new office would give them a window into the U. S. capital and money markets. "There's a great deal of enthusiasm on the Arab side, and the Americans seem quite receptive, too," says Mohamed Abushadi, the Egyptian chairman of UBAF. "We expect to file for a New York license in June." Six months later the bank could be in business. E x p l a i n i n g the New York penetration, Abushadi says: "There has recently been great improvement in relations between Arab countries and the United States. So the flow of trade justifies i t . " Abushadi says the New York financial market is best suited to the Arabs' needs " i n the sense that it can main shareholders are the Arab Bank (Jordan), the Banque E x t e r i e u r d'Algerie, the Commercial Bank of Syria, the Libyan Arab Foreign Bank, the Rafidain Bank (Iraq), the Central Bank of Egypt, and the Arab African Bank (mainly Kuwaiti and Egyptian interests). Total deposits, mostly in short and medium-term funds, are about $l-billion. Abushadi, former chairman of the National Bank of Egypt, says he has already launched a search for New York office space on F i f t h Avenue and in the Wall Street area. He is also looking into salary levels and personnel availability. And while he declines to name the U. S. banks he is negotiating with, banking sources in Paris say Bankers Trust, Irving Trust, and First National Bank of Chicago are among them. "We need qualified Arabs to share in the management of our operations," he says. "They are very hard to get. And we don't want to operate under a false Arab image, with Arabs playing no effective role in management." Fast expansion. Abushadi plans UBAF affiliates in India, Latin America, Greece, and Spain. "We will go wherever there is a great need for credit and project financing," he says, UBAF has a joint venture in Germany with Commerzbank and Bayerische Vereinsbank, in Britain with Midland Bank, Ltd., and in Rome with Banco di Roma and Banca Nazionale del Lavoro. Total deposited funds of all three ventures come to about $730-million. Some recent UBAF major deals range from co-management of a $1.5-billion Eurodollar loan to the Italian government, to a $200-million loan to Algeria's national shipping company for building liquefied natural gas tankers. The UBAF-American venture also will keep its activities diversified. Besides recycling Arab dollars back to the Middle East and Europe, i t will probably invest in U. S. securities and real estate. " I t ' s in both our interests to go ahead w i t h our New York operation," says Abushadi. " I t is essential to attract Arab funds to the U. S." • 191 OIL MONEY AND THE POOR HON. HENRYITGONZALEZ OP TEXAS I N T H E HOUSE OP REPRESENTATIVES Wednesday, May 8, 1974 M r . G O N Z A L E Z . M r . Speaker, everyone I n this c o u n t r y realizes t h e awesome i m p a c t of oil price increases imposed by t h e O r g a n i z a t i o n of P e t r o l e u m E x p o r t i n g C o u n t r i e s o n o u r o w n e c o n o m y . Less w e l l r e c o g n i z e d is h o w m u c h t h e poor c o u n tries h a v e been a n d will be affected by t h e oil price hikes. W e h e a r m u c h about w h a t t h e exporting countries m i g h t do I n b e h a l f of t h e poor, b u t one l i t m u s test o f t h e i r r e a l i n t e n t i o n s is w h a t t h e A r a b n a t i o n s a r e doing for their t r u l y desperate Moslem brothers in the subS a h a r a regions of A f r i c a w h e r e mass s t a r v a t i o n is n o t m e r e l y a t h r e a t b u t a d a i l y f a c t . H e r e is a r e g i o n w h e r e t h e wealthy M o s l e m countries m i g h t well show t h e i r c o n c e r n f o r t h e f a t e of t h e poor a n d helpless. B u t as a r e c e n t a r t i c l e i n t h e N e w Y o r k T i m e s points out, little or n o t h i n g h a s been f o r t h c o m i n g f r o m the oil w e a l t h y 6tates to relieve the e x t r a o r d i n a r y a n d t e r r i f y i n g disaster t h a t has o v e r t a k e n t h e S a h e l a r e a of Africa. I f t h e A r a b n a t i o n s h a v e d o n e so l i t t l e f o r t h e i r M o s l e m brothers, I can only wonder how sincere t h e y are i n their proclamations of willingness to help other poor countries meet the extraordinary demands placed on t h e m by t h e O P E C increases to p e t r o l e u m p r i c e s . T h e article follows: [ F r o m t h e N e w Y o r k T i m e s , A p r . 3, 1974] On, BILLIONS FOR THE FEW—SAND STABVXNQ POE THE ( B y Chester L . C o o p e r ) WASHINGTON.—By t h e grace o f A l l a h , a f e w M i d d l e E a s t e r n n a t i o n s h a r e become r i c h b e y o n d even t h e w i l d e s t d r e a m s of t h e f a b l e d p o t e n t a t e s of a n c i e n t A r a b y . T h r o u g h l i t t l e effort of t h e i r o w n , 65 m i l l i o n p e o p l e — or, m o r e a c c u r a t e l y , t h e i r l e a d e r s — o f S a u d i Arabia, K u w a i t , I r a n , Iraq, A b u Dhabi, Q a t a r a n d L i b y a "earned" '$16 b i l l i o n I n 1973 a n d are expected t o " e a r n " a l m o s t $65 b i l l i o n t h i s year. T h e spice t r a d e was b u t salt a n d pepper c o m p a r e d w i t h c o m m e r c e i n b l a c k gold. T h e roll of t h e dice a n d t h e leaders' greed h a v e c o m b i n e d t o raise Havoc w i t h t h e e n e r g y - i n t e n s i v e , i n t e r d e p e n d e n t economies of Western Europe. J a p a n a n d the U n i t e d States a n d t o Jeopardize t h e d e v e l o p m e n t prospects of scores of countries I n A f r i c a , L a t i n A m e r ica a n d Asia. Because o f q u a n t u m Jumps i n oil prices, w o r l d w i d e i n f l a t i o n la s h a r p l y accelerating. I n t e r n a t i o n a l m o n e t a r y arrangem e n t s , c h r o n i c a l l y f r a g i l e i n t h e m o s t stable o f times, are u n d e r severe stress. T h e specter of a w o r l d w i d e depression is b e c o m i n g a l l t o o real. M e a n w h i l e , l i f e goes on, a t least f o r s o m o — t h e l u c k y ones whose o n l y u r g e n t need la o i l . B u t m i l l i o n s of A f r i c a n s are f a c i n g a n o t h e r , m o r e t e r r i f y i n g crisis. T h e y a r e d y i n g of thirst and hunger. U n k n o w n thousands have p e r i s h e d over t h e last year a n d scores o f t h o u s a n d s h a v e fled f r o m b a k e d fields a n d destroyed h e r d s t o r o t slowly a w a y i n u n f a m i l i a r , f r i g h t e n i n g cities. O n hie r e t u r n recently f r o m t h e subS a h a r a r e g i o n of A f r i c a , S e c r e t a r y - G e n e r a l W a l d h e l m o f t h e U n i t e d N a t i o n s was a g h a s t a t w h a t he h a d witnessed, "peoples a n d c o u n t r i e s c o u l d disappear f r o m t h e face o f t h e m a p , " h e said. " T h i s r e g i o n h a s n o t seen s u c h a disaster i n t w o c e n t u r i e s . " T h e international c o m m u n i t y , or rather a p a r t of i t h a s n o t r e m a i n e d u n c o n c e r n e d . A p p r o x i m a t e l y $350 m i l l i o n i n a i d — f o o d , m o n e y a n d services ( n o t i n c l u d i n g a i r l i f t s ) — h a v e b e e n c o n t r i b u t e d to t h e s t r i c k e n c o u n t r i e s of Senegal, M a l l , M a u r i t a n i a , C h a d , Niger a n d Upper Volte. O f this, t h e U n i t e d S t a t e s , despite d o m e s t i c p r o b l e m s , h a s c o n tributed more t h a n a third. T h e European Economic C o m m u n i t y , racked by balance-ofp a y m e n t problems a n d Inflation, has cont r i b u t e d s l i g h t l y less t h a n a t h i r d . T h e U n i t e d N a t i o n s a n d i t s subsidiaries, n o t including t h e Food a n d Agriculture • O r g a n i z a t i o n , h a s given a p p r o x i m a t e l y 7 p e r cent. T h e F A . O . has p r o v i d e d separate assistance, l a r g e l y f r o m A m e r i c a n a n d E u r o pean contributions. France, West Germany, Canada, C h i n a , Nigeria and t h e Soviet U n i o n have made up t h e remainder. O n r e r e a d i n g t h e roster o f c o n t r i b u t o r s , one h a s t h e f e e l i n g t h a t i t m u s t be i n c o m plete. A r e t h e r e n o t some c o u n t r i e s missing? Some of t h e v e r y r i c h pertiaps? Some M o s l e m oountrlee, since m o s t of t h e s t r i c k e n people s o u t h o f t h e S a h a r a are also Moslems? Some f e l l o w A f r i c a n countries, possibly? W e h a d b e t t e r r e v i e w t h e official d a t a . Strictly speaking, three countries were overlooked: L i b y a c o n t r i b u t e d $7 «0,000— f r o m t h e $2 SI b l U l o n I t collected i n o i l r e v e n u e s last year. K u w a i t c o n t r i b u t e d $300,000— f r o m t h e $2,130 b l U l o n of its o i l e a r n i n g s i n 1973. B u t w h a t of S a u d i A r a b i a , w h i c h e a r n e d t w i c e as m u c h as L i b y a ? N o t a d o l l a r I n 1973, a n d o n l y $2 m i l l i o n so f a r t h i s year. A n d I r a q , w h i c h e a r n e d as m u c h as K u w a i t ? Not a penny. A b u Dhabi, which e a r n e d over $7 b i l l i o n , or a b o u t $23,000 f o r every o n e of i t s i n h a b i t a n t s ? N o t h i n g . A n d Q a t a r , w h i c h e a r n e d a l m o s t $400 m i l l i o n , or about p e r c a p i t a ? Zero. B a h r a i n ? Zero. Algeria? A n o t h e r z e r o A n d w h a t of I r a n , w i t h a l m o s t $4 b i l l i o n i n o i l revenues i n 1973 a n d $15 b i l l i o n p r o j e c t e d f o r t h i s year? A f u r t h e r zero. Altogether, t h e n , t h e Middle Eastern olle x p o r t l n g n a t i o n s h a v e c o n t r i b u t e d less t h a n l per c e n t of t h e t o t a l a i d t o t h e s t a r v i n g people s o u t h of t h e S a h a r a . T h i s is n o t t o say t h a t t h e y r e m a i n e d e n t i r e l y aloof. N o t a t all. T h e y raised t h e price of oil, n o t o n l y f o r t h e r i c h I n d u s t r i a l c o u n t r i e s b u t f o r t h e desperately poor ones as weU. As a consequence, v i r t u a l l y aU of t h e A m e r i c a n financial assistance t o t h e s t r i c k e n c o u n t r i e s of s u b - S a h a r a A f r i c a w i l l be a b sorbed b y t h e Increased cost of t h e i r oil I m p o r t s — a " c o n t r i b u t i o n " b y t h e oU exporters t o t h e needy t h a t s h o u l d n o t go u n n o t i c e d . T o be sure, t h e A r a b League, w i t h a l l d e l i b e r a t e speed, has b e e n discussing easing t h e b o r r o w i n g t e r m s a n d d o u b l i n g t o a b o u t $400 m i l l i o n , t h e c a p i t a l of t h e A r a b B a n k f o r E c o n o m i c D e v e l o p m e n t I n A f r i c a . A n d t h e r e has been t a l k of p r e f e r e n t i a l o i l prices f o r some of t h e d e v e l o p i n g c o u n t r i e s a n d some desult o r y discussion o f e v e n t u a l l y d o i n g somet h i n g a b o u t t h e f a m i n e . B u t , m e a n w h i l e , by t h e grace of A l l a h , t h e o i l flows o u t a n d t h e billions flow in. A n d l i f e goes on, f o r some. $3,600 192 T H E WALL STtiEET JOURNAL Monday. M . y 6, 1974 Oil-Rich Nations Slate $2.76 Billion For IMF Aid Fund . By a W A L L STREET JOURNAL Staff " i Reporter WASHINGTON - Oil-producing nations have offered to lend $2.76 billion to a special, International Monetary Fund pool of currencies to be lent to nations that need help in paying their increased oil-import bills, the I M F disclosed. Ever since the skyrocketing of world oil prices began to threaten international financial trouble for many oil-importing nations, I M F Managing Director H. J. Witteveen has been trying to drum up support for & special oil fund that would lend money to nations in need. He has sought funds from five oil-rich Middle East and African nations and this week will travel to Venezuela on a similar mission. Reporting results of the effort so far, the I M F said the oil-exporting nations have offered to lend to the I M F the equivalent of $2.76 billion for the oil fund. I t said Saudi Arabia offered the equivalent of $1.2 billion, Iran' $720 million and other unidentified nations a total of $840 million. "Additional amounts may be forthcoming from other oil-exporting countries," the 126-nation organization said. The I M F chief called the results of the fund-raising effort "satisfactory and encouraging." Member nations would be entitled to borrow from the special fund an amount about equal to the increase in the oil-import bill resulting from the quadrupling of world oil prices since last fall. The special oil ftind is expected to begin lending after midyear. 193 THE WASHINGTON POST M a y 5, 1974 Courting The Arabs Inter-American Development Seeks New Investors, Bank ras, With Venezuela lending 50' per- 1 However, the& sources allege, West cent of the capital to Honduras and Germany backed off from its key comthe four other countries of the. Central ; hutment on the $asis that the A&ehde This hemisphere's principal developexperience indicated excessive U.S.. American; common market. ment lending insitution is seeking to control oyer the, bank. With that, Euroattract Arab investors and thereby reEcuador, another oil exporter, along pean membership was put off if not. duce the influence of its main source With Argentina and Mexico would lend j precluded altogether. of funds until now, the United States, the other 50 per cent and aksure the Some isolated European and JapaSuccessful attraction of the Arab Hohdurans of markets for the paper. nese investments have been negotifunds would accelerate a drastic transated, and the proposed Common MarFrom Honduras's earnings, it would formation of the institution, the Interket memberships rehiain a goal of the pay back Venezuela, which would thus American Development Bank, which bank, but Ortiz Mena indicates that receive a return far into the future on began with a decision by Venezuela to the Arabs' booming oil profits are now underwrite major bank programs. its present sales of the non-renewable looked upon as a more effective route Venezuela has teamed its fcommitpetroleum. Honduras, he "said, would to diversifying the bank's lending portment of a reputed $1 biHion in oil exfolio. ' gain the biggest paper industry in port earnings witih a call for reducing Latin America, capable of exporting In his talk, Ortiz Mena made no crit.US. influence in the bank. The United icism of the U.S. role in the bank or in elsewhere as welL States is frequently accused of domihemispheric development. Indeed, he The Honduran government recently nating the institution, which has its said, despite all of the talk of failure decreed1 nationalization of foreign headquarters in Washington. surrounding the Alliance for Progress, (largely American) lumbering interests Mexican Antonio Ortiz Mena, presi"the '60s saw substantial change in in preparation for state takeover ef dent of the 24-nation bank, announced Latin America." forest industry. to the staff that Arab funds will be Venezuela's offer to help finance welcomed on the pme terms as those bank programs was made last month of Venezuela and will be used to fiat the bank's annual meeting in Santinance giant industrial projects; ago, Chile. Details of the proposed Ortiz Mena had just returned from trust fund are yet to be negotiated, but. exploratory talks at the Beirut meetVenezuela made clear, that some of the ing of the Arab ,Economic and Social funds would be provided at concesDevelopment Fund. He also visited sional interest rates. Tehran to sound out Iran on possible The Venezuelans have also indicated investment of oil profits in the bank. that they will not accept mortf than a Praising the Venezuelan committoken U.S. role in administration of ment, Ortiz Mena said the conditions these funds." They have urged that make investment in the bank de"Latinization" of the bank and have sirable far this hemisphere's main oil hinted that its headquarters might bet producer are equally valid for the ter be located in Caracas than in Arabs. He did not specify any Arab Washington. commitments, but his words to the The main accusation of U.S. domibank staff implied confidence that such nance turns on the pressures successinvestments would be orthcoming. fully mounted against loans by the • Ortiz Mena indicated that bank bank to the government of the late would borrow from the oil producers Chilean President Salvador Allende. at commercial rates, offering them a Critics say the failure to lend to return more than offsetting inflation. Chile, a member 'in good standing, The 'bank's,role, he said, was to offer made the bank a tool of U.S. foreign '^assurance to the investor of the qualpolicy. Since Allende was ousted by a ity of the projects." bi)/<£tJ military coup last "September, the bank '. The bank has lent $6 million over its • has lent almost $100 million for two 14-year "history, but is often accused of Chilean projects. approaching Latin America's developAccording to sources within the ment t6o timidly: "We are now in a bank critical of its response to U.S. moment when the size of our projects pressures, the failure to lend to Al-should riot frighten us," 'he said. lende cost }he bank another non-hemis, The onetime finance minister of pheric sourfce of funds—Europe. Mexico said the bank must help Latin The bank had proposed to bring EuAhierica to be in the forefront of nuropean Common Market members into clear energy exploitation and to dethe bank on the pattern of the recent velop "the world's biggest food producrecruitment of Canada. They were to tion reserves,," But his main emphasis pledge $500 million in development was on industry, and he described a project for "the first Latin American^ funds for the bank, again with an unstated purpose of ^diluting U.S. influtrans-national corporation." . ence. As explained <by Ortiz, Mena, the bank would oversee creation of a huge cellulose and paper industry in Hondu- By Lewis H. Duiguid Washington Post St&fr Writer 194 T H E MONEY MANAGER M a y 6, 1974 Swiss Central Bank President Sees Oil Deficits As the Biggest Obstacle to Monetary Reform The efforts toward international monetary reform will be complicated by a problem far more serious than the once-chronic United States balance of payments deficits, according to Edwin Stopper, the president of the Swiss National Bank. ^thisproblem is the massive balance of payments deficits resulting from the massive escalation in the price of crude oil by the oil-producing and exporting nations last year, he said. Mr. Stopper, who retired at the end -*of April, told the recent anual meeting of the Swiss central bank that it is assumed that oil-exporting "nations will accumulate balance of payments surpluses during the next five-to-ten years at a rate starting at $60 billion annually. Only a few countries would be able to finance their balance of paymentsdeficits arising from crude .oil purchases for some years through the depletion of their foreign exchange reserves. One of these countries, Mr. Stopper said, was probably Switzerland. The other nations would be forced, as many are now, to borrow heavily to finance payment of their balance of payments deficits. Among these nations are now the United Kingdom, France, Italy and others. In later years the interest payments on these debts will represent another outflow, and thus burden, On these' nations' balance of payments. Mr. Stopper urged international cooperation which would plso help oilproducing countries. This cooperation could justify a reduction in petroleum, prices, which has b e n requested by the United States. A price cut has also been favored by Saudi Arabia; however, it is opposed by other members of the Organization of Petroleum Exporting Countries. However, some oil analysts fear that a lowering of imported oil prices may not be desireable over the longterm for national security reasons. A lower impdrted oil price would increase consumption of imported oil and -discourage investment to develop' domestic petroleum and non-petroleum sources of energy they contend. Lulled into a' false sense of security, the United States, Western Europe and Japan would be even more vulnerable to an Arab oil .embargo such as the one embarked oftQast October. As for the world's financial system, Mr. Stopper said that the United States' warning that the balance of payments problems could become unmanageable should be taken very seriously.. Furthermore, the developments unby the crude ofl price in- creases make an early restoration of fixed exchange rates ' doubtful, /he. added. But private industry least in the. intermediate-term, more exchange rate stability than the floating rate system has brought, Mr. Stopper asserted. A restoration of the fixed rate system could only be achieved by international cooperation to fight inflation, which he called Switzerland's'greatest problem, and by r&luctions of sudden and substantial exchange fates fluctuations, he said. Mr. Stopper added that the. hopes placed on the systems of floating currency rates had not at all, or only partly been realized. Mr. Stopper also urged careful examination into the possibility of commercial banks voluntarily aligning the credit policies and techniques to the system of credit growth limits. The alternative to this cooperation would be for the central banks to obtain authority to institute restrictions on bank credit expansion, he contended. Mr. Stopper added that he hopes that gold wilT again one day resume its place as basis for a new international monetary system. He added while raising the official price of gold would not solve the problem of inflation it would solve a let of other problems. 195 EUROPEAN COMMUNITY APRIL 1974 Oil Price Rises Hit International Monetary System The shock from rising oil prices has been felt in the economies of the entire world. The International Monetary Fund (IMF) has calculated that the "western" industrialized countries will have to pay $50-60 billion more for their oil imports in 1974. For the nine EC countries, the figure is estimated at $23 billion. Such a large capital hemorrhage will further aggravate the economic problems already facing the Community. Taking into account the price rises in manufactured and agricultural goods due to the petroleum product price rises, inflation will exceed 8 per cent annually. In addition, the dearth of supply will probably accentuate the slowdown of economic activity and will raise unemployment. Finally, the accrued cost of oil will probably cause a deficit in the European balance of payments and seriously threaten the still embryonic system of the Community "snake." The French decision to float the franc is a concrete consequence of the oil crisis' influence on monetary affairs [see page 1 7 ] , DISASTER FOR THE THIRD W O R L D Even if the developed countries' strong economies can weather the crisis without long-term catastrophic consequences, the "Third World" countries present a different case. Many developing countries are threatened with economic disaster by the oil price rises. The present increase in prices has already neutralized United Nations (UN) aid given to these countries. (UN aid equals one-fourth of the total aid they receive.) The developing countries import less than one-fifth of the total oil imported by the industrialized countries. But the majority of the developing countries' imports are used in vital sectors, which leaves a narrow margin of maneuver in efforts to economize energy consumption. In addition, the general price rise on the international scale will make developing countries' other imports more expensive. Most other imported products are as vital to these countries as oil. Some developing countries could compensate for these difficulties by increasing prices of their raw material exports. But I the slowdown of world industrial activity will reduce the demand for raw materials, leading to a decline rather than an increase in prices. Other Third World countries which lack raw materials are on the edge of ruin. India, for example, strongly depends on advanced technological industries, especially the petro-chemical industry. But, with its international credits already pushed to the limit, India cannot pay for the crude oil for its refineries. The world cannot ignore this crisis which affects hundreds of millions of people. H O W TO USE THE NEW M O N E T A R Y SURPLUS The Arab world's new position presents the international monetary system with problems it is not equipped to face. In the last 20 years, monetary disequilibrium (payments deficits in certain countries, excesses in others) was corrected by the system of Special Drawing Rights (SDR's) or by bilateral loans between central banks. The Arab oil weapon has turned the situation around. In the last three years, Saudi Arabia has seen its reserves rise from $670 million to $3.7 billion. The World Bank estimates that, by 1980, the Persian Gulf oil-producing states will have reserves of $280 billion, 70 per cent of world reserves. What is to be done with all this money? The economies of these countries, primitive and concentrated on one product, can only absorb a small part of their revenues. It is here that a ray of hope for monetary stability resides. These monetary surpluses could be reemployed in the economies of developed and developing oil-consuming countries. [For an example of such reemployment, see page 18.] The IMF and the World Bank could perfect a system to channel the money toward the developing countries and to the Western markets. At the same time, a short-term stability could be assured by financing national purchases of oil through the sale of gold reserves at market price. These two plans were proposed at the meeting of the finance ministers of the IMF in Rome in January. There is no evidence, however, that the Arab states would approve these proposals, especially since they have had nothing to do with IMF affairs in the past. A WORLD-SCALE CRISIS In any event, the EC member countries should prepare for serious monetary problems. Some EC countries will be able to balance the political capital exit caused by oil price increases—Great Britain, for example, can attract considerable investments and thus find itself in a paradoxical situation of a record commercial balance deficit on one hand and a pound reinforced by monetary reserve increases on the other. Thus, Great Britain may be able to support itself until it has developed its own oil resources (North Sea) in about 10 years. Other Community countries, like Belgium or France, which do not have this capital market capacity, will be worse off. Their balance of payments could feel a chronic deficit that they could not resolve alone. In fact, it appears that even the most favored nations cannot expect to find individual solutions. The monetary crisis is the last in a long list of common problems that demands common policies and international solutions. 196 THE WASHINGTON POST May 10, 1974 Saudis t o K e e p O i l M o n e y Yamani Rejects IMF Plan By Bernard D. Nossiter Washtofton Post Foreign Service LONDON, May 9 —Saudi Arabian minister, Sheikh Zaki Yamani, has rejected—at least for now—a plan by the International- Monetary Fund to protect the world's economy from currency disorders. Since the fund scheme depends heavily on the cooperation of Saudi Arahi? and other oil states with htige revenue surpluses, Yamani's cool response at a press conference here today has placed the plan in jeopardy. The IMF plan would recycle some of 1 this Surplus to developing and industrialized countries hard hit by the nearly fourfold increase in oil prices. The Arab minister told* reporters that Western ext>erts were exaggerating the problem, that oil states would have "much less" than the estimated $50 billion-in extra revenues this year. Later, he said he thought oil state surpluses would qot reach $25 billion. In addition, he said, he did not like the idea of the oil states losing control over their surplus revenues by lending them to an international agency controlled by the West Iran, however, has come out strongly in support of the IMF plan. Above all, Yamani express-1 ed concern over the erosion that Arab loans to the IMF might suffer because of the rapid rate, of inflation in the West. "For the time being," he said, "you do not need" the IMF plan. "We will absorb a large part of the surplus we realize," he said. "We wont be amenable to letting that money recycle to the Western economy for the sake of the Western economy as such," he said. However, tej added, "That does not mean we will never do it." Yamani's position is in sharp contrast to the optimism voiced just last Monday in Detroit by Johannes Witteveen, IMF managing director. Witteveen said that oil exporting states "have taken a very positive attitude to s^v initiative" an<J that he was "hopeful" that the fund scheme would be set up before June 30. Yamani did leave the door open, however, to a modified version of the Witteveen plan. If the IMF would tie loans from oil states to the consumer price index in the United . States, Saudi Arabia-might be interested, he said. The Saudi oil minister dismissed out of hand the moreJ ambitious proposal for monetary and oil price stability! , now being discussed in Washington by Harold Lever, the British Cabinet minister and financial advisor to Prime Minister Harold Wilson. ' Lever prpposes that the United States and five other industrial nations collectively buy and distribute oil- and then serve as a lending agency financed by the surplus of producer states. 197 "I have had a chance to look fears that the ' purchasing at the inside stprf" Yamani power of such credits would said, "and I don't think the be eroded by price inflation in consumers -will adopt ]this the West. • plan." -, ' That is j why he said he He declined to explain furmight be more "amenable" to ther. But he apparently meant an IMF scheme linking • oil that American opposition hias . ' state credits to the American already killed the Lever plan price index. In other words, even before it got off the the Saudis might lend the ground. IMF facility $5 billion if every 10 per cent rise in U.S. prices The one cheerful piece of increased the Saudi investnews that the Harvard-trained ment by $500 million. ' oil minister offered - tyas Ms - The oil minister, whose trim view that crude prices ire ttifo' goatpe' and mustache are now high. The Saudis, the world's internationally known tradelargest oil producers outside marks, Said he expected to nethe United States, had already gotiate a new deal this sumbrought the price of oil down mer with the four American from $17 a barrel to about $10, companies exploiting Saudi SHEIKH ZAKl YAMANI he claimed. Arabia's oil. They are Exxon, *n% should he a Wit lovtfej\": <*, - - problem exaggerated jMobil, Stfirtdard of California ' * •r ' ' h,e said. "I think,it will go furand Texagp. Their joint Saudi ther downr^Bat he declined to todeai-wfth the-currency dis- concern is Aramco in which spell out how. this would be locations threatened by the the Saudis already have 25 per achieved. surpluses the Arabs and other cent interest. Here Yamani runs into op- -oil states are now earning beYamani ,said that the existposition from the shah of Ir$n, cause of the; lfap in; oil prices. who has sought to push oil Western pffieials Have esti- ing deal is : "out of date" and the Saudis need 'oil states, this that prices. The Saudis, however, mated that the f Could force prices down' by yearwill earn $5Q bUl)oii more "completely different arranfeemenls." Oil industry execuopening their taps and in- than thiey cfn |nyest in their tives think he will seek anycreasing sharply their current own^upttfes or ,use to buy wfrwse from 75 to 100 per cent output of about 8,5 million arms, good^and services from of«Aramco in the next few the West, ,% barrels daily. i ea4. Witteveen' ha^ proposed creYamani said his country would not increase production ating k "special facility?' or to the 10 million barfel-a-day temporary loan, agency in the Venezuela Pledges level planned before the Octo- IMF. I t would make sevenber war until the Arab-Israel year loani ,tp .Italy, Britain Money to IMF Plan conflict is settled. But he did, and othjer countries now runReutet hint at an increase above cur- ning big payments deficits be» CARACAS, May 9-Venerent production as one means cause of sharply increased oil ruela has pledged $540 million of further reducing the price. -< -costs. " to the IMF to help countries Funds for this "facility' whose balance of payments Yamani was talking about the "realized" or actual sell- would, under Witteveen's plan, have been seriously affected ing price of oil in the Persian come in part from the oil by the higher price of oil, cenGulf as opposed to the "posted states with big surpluses. tral bank governor Alfredo price" used for fixing royal- Thus the IMF would recycle Laffee said today. ties and taxes. It is now money that Arabs and othei$ Laffee said at a news conaround $11.65 for Persian Gulf can't absorb to countries"%ith ference' that Venezuela's conemergency needs. . • ,r, low-sulphur crude. tribution to the IMF's oil-loan yamani has been in Ldndon -The Saudis, .YamanT sa^d, fund was made on the condioutlets for their tion that it be used preferenprimarily to see financial and wojild lending to the tially to help developing counindustrial leaders whom he •urpjuj hopes to enlist for the rapid Wotld Bari|c, a new Arab-Afri- tries, especially in Latin industrialization of Saudi Ara- efn/bank ,and financing tuf» America. bia. At a closed meeting of tffep t^ewer Saudi develop- The offer was made during a meeting here with IMF manabdut 50 persons yesterday, he ment loan program. also voiced his coolttass to- .\AWrt frdtn losing political aging director Johannes Witteward the IMF plan. 1 * " coritrol over oil money loaned veen who was present at the , The meeting was proposed t& fcn IMF facility, Yamani press conference. 198 Hobart Rdwen THE WASHINGTON POST Ttffi END of , the Arab oil embargo still leaves the industrial world with a terrible dilemma and the poor countries facing a disaster of unmanageable proportions. Although it has become fashionable in banking circles to suggest that financial gimmicks of one sort or another can "solVe" the problem, it is important for the public to keep in mind that loans and investments— while great for the banking business—solve neither the difficulty of growing trade deficits nor the loss of purchasing power due to the higher price of oiL There are two facts that should be remembered when anyone tells you that the energy i crisis is over because the Arab oil embargo has been lifted: First, despite some easing in the auction price for oil in the Persian Gulf, the "mainstream" of supplies, as oil consultant Walter Levy points out, still ranges upward of $7 a barrel, compared to $3 as recently as October 1973, $1.25 in 1971 and 90 cents before that. Thus, the world oil bill for 1974 is something like $65 to $75 billion higher than last year's. Moreover, the secretary general of the Organization of Petroleum Exporting Countries, Dr. Abderramman Khene, forecast on Wednesday that the cartel will boost prices after the current freeze expires in July. Oil prices are "artificially low," Dr. Khene alleges. The OPEC governments, Watching the rate of inflation around the world climb, are talking of a "take" in taxes and royalties that will yield them about $12 a barrel instead of the present average of $7.50. Second, as George W. Ball cautions, the end of the embargo "must still be regarded as provisional—for the embargo cannon will continue to be loaded and ready for firing until the Arab-Israeli dispute is finally settled which—even if we are lucky—is not likely to occur for another two to three years." SO, EVEN with the oil embargo lifted, the oil problem remains. For the less-developed countries which last year had a combined trade deficit of $11 billion, the staggering oil price increase means that th^y will wind up with a deficit of $20 to $25 billion in 1974. For the industrial nations, as West German central banker Otmar Emminger pointed out here the other day, the situation varies. But even the supposedly wealthy United States faces an Arab oil "tax" which wilj cut consumer purchasing power by perhaps $15 billion this year. And if prices go up, the situation Will be worse. Sorope and Japan are feeling pressure to boost exports to earn more foreign exchange. Former Com- March 31,1974 merce Secretary Peter Petersoft, now head of Lehman Brothers, says that this "may wipfe out thp advantage the United States increasingly enjoyed during 1973 from an under value dollar and restore roughly the same condtions that existed prior to Aug. 15, 1971, when American goods encountered serious problems of price competition ip world markets." Emminger, it should be said, thinks that the major nations will not engage in a cutthroat competition for export markets typifie*) by exchan|e-rat# wars or "beggar-thy-neighbor" pilicies. But Japan—which xqftift import virtually 100 per cent of its oil—already Jhas indicated that it will, junk the plans oace made to improve the standard of living at home and return to the old emphasis of an, export economy to improve its foreign exchange earn-; ings. That can'only mean a return to the bitter fights' among Japanese, American and European manufacturers to obtain and secure outlets for their goods. Where does all of this leave ug? First of alj, we must ignore the advice of such as Roy Ash, h$ad of,the Office of Management and Budget, that a& allocation controls should be dropped once imports reach last August's levels. That would be stupid and short-sighted. We must accept as reality that the Arb oil.weapon has not been discarded, only temporarily suspended. Second, we have to make Project Independence be- Economic Impact lievable, rather than something—as Peterson says— "which currently suffers from a credibility gap." The United States government, if it truly believes that price is the real problem, can bring pressure on the Arab monopolists only by setting specific production schedules and goals for oil shale, tar sands, offshore oil, solar energy, and so on, that will diminish our dependence on Arab oil. If we yield to the temptation suggested by Ash to believe that the energy crisis is over, all necessary effors to achieve major conservation in the use of oil will go down the drain. ' IN A NEW analysis called "Implications of World Oil Austerity" which is gaining wide attention in Washington circles, Levy comes to the conclusion that there must be a substantial cut in world oil consumption until the latter part of he 1970s, witty the burden of reduced production falling on Saudi Arabia, Kuwait and Abu Dhabi. Those are the countries in the cartel which are 199 Hobart Rowen Will Worldwide Oil Austerity Continue? under the least pressure to generate increased revenue and also the ones least able—because of their small populations—to absorb added goods and services from the Western World in exchange for the^r oil. Whether these qguntries would agtee to reduce* output while Iran, Iraq and others are expanding is an unanswered question. But high oil prices unquestionably will force some kind of austerity in oil consumption on the'West, Economic Coiincil Chairman Herbert Stein, in a thoughtful speech on Project Independence, said this past week t£at "we will find it prudent to hold oil im- ports to a lower level than a free market woulcj bring about and to try to avoid an increase in the import share of our energy supply." This is necessary not only because we no longer , can afford all of the oil we, would like to use, tyit because the cartel has demonstrated it is an unreliable source. This will require some new disciplines. It means smaller and more economical cars—by legislative order if necessary-—and a conservation program to cut , energy wastage of the same order of urgency that once was the accepted ethic in wartime. 200 PETROLEUM 1973-Jan Distillat 3.92 6.16 2.46 2.76 2.75 2.73 2.82 5.53 2.98 April 2.84 May June 2.90 2.84 2.77 3.05 6.25 7.05 7.64 July 3.15 7.32 Aug 3.25 6.87 3.39 3.39 3.38 7.58 8.39 4.21 : ... Dec 1974-Jan Feb March The Morgan Guaranty Survev monthly by Morgan Guaranty Trust Company York © 1974 Morgan Guaranty Trust Company of New York MAY (Cents per gallon) Gasoline Feb Oct. . . Nov of New Consumer pricest Crude March Sept. published PRICES Imports* (Dollars per barrel) 1974 3.54 3.81 8.52 5.28 6.71 9.09 11.84 13.23 17.02 11.08 17.99 2.90 3.52 6.80 7.76 1 1.95 9.35 13.76 201 Those oil deficits— pick a number M . S. MOIKICISOIUI Latest official and semi-official calculations on just how the oil deficit will be shared out are, if anything, even more frightening than the total numbers involved. Here is a framework for readers to make their own calculations. T rying to forecast this year's oil deficits has become all the rage, and the Bank of England streaked in with its contribution on 15 March, when it published its latest Quarterly Bulletin. An attraction of this game is that the guesses can be amended from month to month to keep speculation on the boil. But although there is nothing certain about the numbers (except that they are going to be very large), there have been very important changes recently in the underlying assumptions that are being made. One of them is the official recognition that developing Countries will be unable to secure the financing they would need to maintain investment, output and employment; and another is that the industrial countries will therefore face deficits even bigger than those previously predicted. The details of the way that official estimates have changed and some of the ways in which they differ from each other are summarized in the tables at the end of this article. It will be seen that the financt ministers of the I M F accepted as a basis for discussion, in Rome in January, an OECD guesstimate that OPEC might run a current surplus of about $55 billion this year offset by current deficits of about $32 billion for OECD and about S23 billion for the oil-importing developing countries. However, these and subsequent official estimates are not forecasts in the ordinary way. They are simply suggestions of what might happen in given circumstances, and these assumptions include a good deal of polite diplomatic fiction. One such assumption is that it may prove possible to maintain January's oil price levels throughout the year while at the same time maintaining the growth of real output in the industrial world at between 3 and 4%. It is improbable that both these conditions can be satisfied at the same time, and if one of them is not, then the size of OPEC's suggested current surplus would shrink. Impact on the LDCs Another polite fiction was that oil-importing developing countries might somehow be able to find around $23 billion to finance their projected current deficit this year, but that fiction, at least, was dropped by the time that OECD's Working Party I I I met in Paris in mid-February. Dr Otmar Emminger, the chairman of the OECD group, disclosed merely that the industrial countries' anticipated deficit was expected to be about $40 billion rather than about S32 billion, but he declined to go into the embarrassing details of what this implied. What it implied, first, was the official acceptance that the oil-importing LDCs would probably be unable to secure more than about S15 billion for thefinancingof their current deficits this year, and that they therefore face a considerable risk of recession and political instability. The second implication was not merely that the industrial countries faced an even bigger deficit than originally guessed, but that most of them face larger deficits even than is being officially conceded now. This is because the February estimates retained, among other diplomatic fictions, the one that the US might be running a current deficit of around $4 billion this year. But if the US current account ends in approximate balance, as seems more likely, then the other industrial countries would face between them a combined current deficit of close to $45 billion, or about 50% more than the combined current deficit being predicted for them 202 only a month earlier in Rome. No wonder that the Jeluils were not emphasized, and no wonder either that t-rance, Italy and the UK have been so quick to rush - into the front of the queue for large Eurocurrency borrowings (not to mention lesser fry like Greece, which secured 5250 million in March, equivalent, on foreign exchange earnings, to a single S2-5 billion borrowing hy a country like the UK). The forecasts of oil deficits will no doubt be changed again, or several times, over the course of this year, and it will be interesting to compare the results when they are known with the guesses that were made. But some assumptions seem reasonably safe: 1. That there may either be some fall in oil prices or else a greater fall in oil imports than now being estimated, and that OPEC's current surplus may therefore prove somewhat less than the $60 billion being suggested by the Bank of England or even the $55 billion suggested by OECD, although that surplus will still be very big; 2. That oil importing developing countries may go short of oil,'or finance, or both; and 3. That the brunt of whatever the world's oil deficit turns out to be will probably fall on the industrial countries other than the US and Canada even more heavily than most public statements have so far suggested. The tables below allowreadersto join the game with their own guesstimates: C a r a t payaaeate, 1974 $ billion at Jan. at Sept. 1974 1973 prices prices* US -It Omada balance - i Japan -6 1* France -31 * Germany 2* Italy balance -31 UK. -3* -7* 10 OECD -32 non-oil LDCs -15 -23 5 55 OPEC at Jan. 1974 prices balance balance -8 -3J -6 -8/9 -40f -15 55f •Official Rome estimates, January, i Official Paris estimates, February. Possible impact of higher o0 prim, 1974 (rise in cost of oil imports at 1973 volumes) $ billion OECD Bank of England US 9-4 8i UK 4-3 4* Japan 8-3 7J 5-4 Germany 4| France 4-6 4J Italy 4-7 3| OPEC surplus 55 60 203 NEW YORK TIMES April 3, 197^ O I L BILLIONS FOR THE FEW - SAND FOR THE STARVING By: Chester L. Cooper WASHINGTON - - By t h e g r a c e o f A l l a h , a f e w M i d d l e E a s t e r n n a t i o n s h a v e become r i c h beyond, e v e n t h e w i l d e s t dreams o f t h e f a b l e d p o t e n t a t e s o f a n c i e n t A r a b y . Through l i t t l e e f f o r t o f t h e i r own, 55 m i l l i o n p e o p l e - - o r , more a c c u r a t e l y , t h e i r leaders - - of Saudi A r a b i a , Kuwait, I r a n , I r a q , Abu D h a b i , Q a t a r a n d L i b y a " e a r n e d " $16 b i l l i o n i n a l m o s t $65 b i l l i o n t h i s 1973 a n d a r e e x p e c t e d t o " e a r n year. The s p i c e t r a d e was b u t s a l t a n d p e p p e r compared, w i t h commerce i n b l a c k g o l d . The r o l l o f t h e d i c e a n d t h e l e a d e r s 1 greed, h a v e combined t o r a i s e h a v o c w i t h t h e e n e r g y - i n t e n s i v e , interdependent economies o f W e s t e r n E u r o p e , Japan and t h e U n i t e d S t a t e s and t o j e o p a r d i z e t h e d e v e l o p m e n t p r o s p e c t s o f s c o r e s o f c o u n t r i e s i n A f r i c a , L a t i n A m e r i c a and A s i a . Because o f q u a n t u m jumps i n o i l p r i c e s , w o r l d w i d e i n f l a t i o n i s s h a r p l y accelerating. I n t e r n a t i o n a l monetary arrangements, c h r o n i c a l l y f r a g i l e i n t h e most s t a b l e o f t i m e s , a r e u n d e r s e v e r e s t r e s s . The s p e c t e r o f a w o r l d w i d e d e p r e s s i o n I s b e c o m i n g a l l t o o r e a l . M e a n w h i l e , l i f e goes o n , a t l e a s t f o r some - - t h e l u c k y ones whose o n l y u r g e n t n e e d i s o i l . But m i l l i o n s o f A f r i c a n s a r e f a c i n g a n o t h e r , more t e r r i f y i n g c r i s i s . They a r e d y i n g o f t h i r s t and h u n g e r . Unknown t h o u s a n d s have p e r i s h e d o v e r t h e l a s t y e a r and s c o r e s o f t h o u s a n d s h a v e f l e d f r o m b a k e d f i e l d s a n d d e s t r o y e d h e r d s t o r o t s l o w l y away i n u n f a m i l i a r , frightening cities. On h i s r e t u r n r e c e n t l y f r o m t h e s u b - S a h a r a r e g i o n o f A f r i c a , S e c r e t a r y - G e n e r a l W a l d h e i m o f t h e U n i t e d . N a t i o n s was a g h a s t a t w h a t he h a d w i t n e s s e d . " P e o p l e s and c o u n t r i e s c o u l d d i s a p p e a r f r o m t h e f a c e o f t h e m a p , " he s a i d . " T h i s r e g i o n has n o t seen such a d i s a s t e r i n two c e n t u r i e s . " The i n t e r n a t i o n a l c o m m u n i t y , o r r a t h e r a p a r t o f I t , has n o t remained unconcerned.. A p p r o x i m a t e l y $350 m i l l i o n i n a i d - f o o d , money a n d s e r v i c e s ( n o t i n c l u d i n g a i r l i f t s ) - - h a v e b e e n contributed, t o the s t r i c k e n c o u n t r i e s of Senegal, M a l i , Maurit a n i a , Chad, N i g e r and. U p p e r V o l t a . Of t h i s , t h e U n i t e d S t a t e s , 204 - 2 - d e s p i t e d o m e s t i c p r o b l e m s , has c o n t r i b u t e d more t h a n a third. The E u r o p e a n Economic C o m m u n i t y , r a c k e d b y b a l a n c e - o f - p a y m e n t p r o b l e m s a n d i n f l a t i o n , has c o n t r i b u t e d s l i g h t l y less than a t h i r d . The U n i t e d N a t i o n s a n d i t s s u b s i d i a r i e s , n o t i n c l u d i n g t h e Food a n d A g r i c u l t u r e O r g a n i z a t i o n , has g i v e n approximately 7 per c e n t . The F . A . O . has p r o v i d e d , s e p a r a t e a s s i s t a n c e , l a r g e l y f r o m A m e r i c a n and European contributions. F r a n c e , West Germany, Canada, C h i n a , N i g e r i a a n d t h e S o v i e t U n i o n have made up t h e r e m a i n d e r . On r e r e a d i n g t h e r o s t e r o f c o n t r i b u t o r s i one has t h e f e e l i n g t h a t i t m u s t be i n c o m p l e t e . A r e t h e r e n o t some Some countries missing? Some o f t h e v e r y r i c h , p e r h a p s ? Moslem c o u n t r i e s , s i n c e m o s t o f t h e s t r i c k e n p e o p l e s o u t h o f t h e S a h a r a a r e a l s o Moslems? Some f e l l o w A f r i c a n c o u n t r i e s , possibly? We had. b e t t e r r e v i e w t h e o f f i c i a l d a t a . S t r i c t l y s p e a k i n g , t h r e e c o u n t r i e s were o v e r l o o k e d : Libya c o n t r i b u t e d $760,000 - - from the $2.2 b i l l i o n i t c o l l e c t e d i n o i l revenues l a s t y e a r . Kuwait c o n t r i b u t e d $300,000 - - from the $2,130 b i l l i o n of i t s o i l earnings i n 1973. But w h a t o f S a u d i A r a b i a , w h i c h e a r n e d t w i c e as much as L i b y a ? Not a d o l l a r i n 1973? and. o n l y $2 m i l l i o n so f a r this year. A n d I r a q , w h i c h e a r n e d as much as K u w a i t ? Not a p e n n y . Abu D h a b i , w h i c h e a r n e d o v e r $7 b i l l i o n , o r a b o u t $23., 000 f o r e v e r y one o f i t s i n h a b i t a n t s ? Nothing. And. Q a t a r , w h i c h earned, a l m o s t $400 m i l l i o n , o r a b o u t $ 2 , 6 0 0 p e r c a p i t a ? Zero. Bahrain? Zero. Algeria? Another zero. And w h a t o f I r a n , w i t h a l m o s t $4 b i l l i o n i n o i l r e v e n u e s i n 1973 and. $15 b i l l i o n p r o jected. f o r t h i s year? A f u r t h e r zero. A l t o g e t h e r , then, the Middle Eastern o i l - e x p o r t i n g nations have c o n t r i b u t e d , l e s s t h a n 1 per cent o f t h e t o t a l a i d t o t h e s t a r v i n g people south of the Sahara. T h i s i s n o t t o s a y t h a t t h e y remained, e n t i r e l y a l o o f . Not a t a l l . They r a i s e d , t h e p r i c e o f o i l , n o t o n l y f o r t h e r i c h i n d u s t r i a l c o u n t r i e s b u t f o r t h e d e s p e r a t e l y p o o r ones as w e l l . As a c o n s e q u e n c e , v i r t u a l l y a l l o f t h e A m e r i c a n 205 - 3 - f i n a n c i a l assistance t o the s t r i c k e n countries of subSahara A f r i c a w i l l be absorbed, by t h e increased, c o s t o f t h e i r o i l i m p o r t s - - a " c o n t r i b u t i o n " by t h e o i l e x p o r t e r s t o t h e n e e d y t h a t should, n o t go u n n o t i c e d . To be s u r e , , t h e A r a b League,, w i t h a l l d e l i b e r a t e s p e e d y has been d i s c u s s i n g e a s i n g t h e b o r r o w i n g t e r m s and d o u b l i n g t o a b o u t $400 m i l l i o n , , t h e c a p i t a l o f t h e A r a b Bank f o r Economic Development i n A f r i c a . And. t h e r e h a s b e e n t a l k o f p r e f e r e n t i a l o i l p r i c e s f o r some o f t h e d e v e l o p i n g c o u n t r i e s and. some d e s u l t o r y d i s c u s s i o n o f e v e n t u a l l y d o i n g s o m e t h i n g about the famine. But,, meanwhile., b y t h e g r a c e o f A l l a h , , t h e o i l f l o w s o u t and. t h e b i l l i o n s f l o w i n . And l i f e goes orij f o r some. THE WASHINGTON POST April 3, 1974 VENEZUELA PLEDGES DEVELOPMENT A I D V e n e z u e l a ^ whose c o f f e r s have been s w e l l i n g b e c a u s e of higher o i l prices., yesterday told, the Inter-American D e v e l o p m e n t Bank m e e t i n g i n S a n t i a g o t h a t i t w o u l d g i v e a t l e a s t $ 1 . 2 b i l l i o n t o b e used, t o s e t up a t r u s t f u n d , t o f i n a n c e development p r o j e c t s I n L a t i n America. A t t h e same t i m e . , V e n e z u e l a a n d P e r u c r i t i c i z e d t h e U n i t e d S t a t e s ' dominant r o l e i n the bank's a f f a i r s Agence France Presse r e p o r t e d . Venezuelan Finance M i n i s t e r Hector Hurtado t o l d the b a n k m e e t i n g t h a t when L a t i n A m e r i c a n c o u n t r i e s contribute more o f t h e b a n k ' s c a p i t a l . , "no c o u n t r y i s g o i n g t o be a b l e t o c l a i m f o r I t s e l f the r o l e of leader or o v e r s e e r . " The U n i t e d . S t a t e s c o n t r o l s more t h a n 40 p e r c e n t o f t h e b a n k ' s 3 7 - 2 1 1 O - 74 - 14 206 -2- board of governors, w i t h the remaining votes 22 L a t i n A m e r i c a n c o u n t r i e s and Canada. s h a r e d by U . S . T r e a s u r y S e c r e t a r y George P. S h u l t z t o l d , t h e m e e t i n g t h a t t h e U n i t e d S t a t e s welcomed " t h e i n i t i a l p o s i t i v e response o f t h e o i l p r o d u c e r s o f t h i s h e m i s p h e r e and i n p a r t i c u l a r V e n e z u e l a - - who have announced t h e i r i n t e n t i o n s t o provide major help t o s i s t e r nations.11 -- S h u l t z s a i d t h a t because o f h i g h e r e n e r g y p r i c e s , t h e I n t e r - A m e r i c a n Development Bank, w h i c h makes development l o a n s t o L a t i n A m e r i c a , must "husband t h e s c a r c e c o n c e s s i o n a r y funds . . . f o r t h e p o o r e s t . " The IDB a l s o s h o u l d p u t g r e a t e r emphasis i n i t s l e n d i n g on e n e r g y p r o j e c t s and. member c o u n t r i e s a l s o s h o u l d a l l o c a t e more o f t h e i r own i n t e r n a l i n v e s t m e n t funds t o w a r d e n e r g y , he s a i d . S h u l t z a l s o v o i c e d c o n c e r n t h a t t h e w o r l d ' s raw m a t e r i a l s producers might form c a r t e l s t o a r t i f i c i a l l y r a i s e the p r i c e s of t h e i r exports. He a l s o c i t e d , " e x p o r t t a x e s and. o t h e r r e s t r i c t i o n s aimed a t i n s u l a t i n g d o m e s t i c m a r k e t s f r o m t h e g e n e r a l upward t r e n d o f p r i m a r y - p r o d u c t p r i c e s . " He n o t e d t h a t r i s i n g f o o d p r i c e s i n t h e U n i t e d S t a t e s have t r i g g e r e d s t r o n g s e n t i m e n t s t o w a r d i s o l a t i n g t h e U . S . economy f r o m t h e r e s t o f t h e world.. THE WASHINGTON POST March 1 4 , By: 197^ James L . Rowe, Jr. MORE DEVELOPMENT A I D ASKED OF O I L COUNTRIES The heads o f t h e f i v e m a j o r i n t e r n a t i o n a l f i n a n c i a l o r g a n i z a t i o n s y e s t e r d a y s a i d t h e i r o r g a n i z a t i o n s need some of the "increased f i n a n c i a l assets of the o i l - e x p o r t i n g c o u n t r i e s " t o h e l p d e v e l o p i n g c o u n t r i e s pay t h e i r h i g h e r energy b i l l s . The heads o f t h e o r g a n i z a t i o n s , .including the Inter- 207 -2- n a t i o n a l M o n e t a r y Fund. and. t h e World. Bank, n o t e d t h a t t h e h i g h e r energy b i l l s not o n l y t h r e a t e n t h e balance of payments s i t u a t i o n s o f t h e d e v e l o p i n g c o u n t r i e s , b u t a l s o j e o p a r d i z e " t h e o r d e r l y e x e c u t i o n of development programs and t h e g r o w t h p r o s p e c t s o f t h e i r e c o n o m i e s . " L a s t month, I r a n announced, t h a t i t would, make a v a i l a b l e $ 1 b i l l i o n o f i t s s u r p l u s o i l revenues t o a s p e c i a l IMF-World. Bank f u n d w h i c h would, h e l p c o u n t r i e s pay t h e i r h i g h e r o i l bills. However, r e p o r t s f r o m T e h r a n s a i d t h e I r a n i a n i n v e s t ment would be made a t a c o m m e r c i a l r e t u r n of 7 t o 8 p e r c e n t . The agency c h i e f s s a i d y e s t e r d a y t h a t a c o n s i d e r a b l e p o r t i o n o f b o t h t h e l o n g - t e r m and s h o r t - t e r m a i d t h e d e v e l o p i n g c o u n t r i e s w i l l need, "should, be made a v a i l a b l e on concessional terms." They emphasized t h a t "advanced, c o u n t r i e s have a c o n t i n u i n g r e s p o n s i b i l i t y for providing aid resources." They p o i n t e d out t h a t " t h e o i l - e x p o r t i n g c o u n t r i e s now have a g r e a t e r c a p a b i l i t y t o share t h e burden of the a d d i t i o n a l i n t e r n a t i o n a l a i d e f f o r t , b o t h t h r o u g h t h e i r own c h a n n e l s and t h r o u g h c o o p e r a t i o n w i t h existing institutions." B e s i d e s IMF d i r e c t o r Johannes W i t t e v e e n and W o r l d Bank P r e s i d e n t R o b e r t S. McNamara, A n t o n i o O r t i z Mena o f t h e I n t e r A m e r i c a n Development Bank, Abdelwahab L a b i d i o f t h e A f r i c a n Development Bank and S h i r o I n o u e o f t h e A s i a n Development Bank met March 12 " t o assess t h e i m p a c t o f t h e c u r r e n t i n t e r n a t i o n a l e n e r g y s i t u a t i o n on t h e d e v e l o p i n g member c o u n t r i e s o f t h o s e institutions." The I n t e r - A m e r i c a n Development Bank issued, a on t h a t m e e t i n g y e s t e r d a y . statement The f i v e e x e c u t i v e s a g r e e d t h a t " i n t h e l i g h t o f t h e e x p e r t i s e and e x p e r i e n c e o f t h e i r r e s p e c t i v e i n s t i t u t i o n s i n e f f e c t i v e l y channeling resources t o the developing w o r l d , t h e y have t h e c a p a c i t y t o p l a y an i m p o r t a n t and t i m e l y r o l e i n t h e international aid effort. "To p e r f o r m t h i s f u n c t i o n , a d d i t i o n a l funds a r e r e q u i r e d by t h e s e I n s t i t u t i o n s and a s p e c i a l e f f o r t s h o u l d be made t o m o b i l i z e such r e s o u r c e s f r o m t h e i n c r e a s e d f i n a n c i a l a s s e t s of the o i l - e x p o r t i n g c o u n t r i e s , " i t s a i d . 208 Financing the oil deficits V* II. Johanna Wiilcvwn Managing director, International Monetary Fund, Washington D.C. The enormous deficits of the western industrial world could lead to savagely nationalistic reactions. It is to help try and avoid these that the managing director of the Fund has devised the new special drawing facility to help countries through this period. Here he describes the plan and its aims, and he sounds a warning. U ncertainty and change, it is a truism to say, are no strangers to the international monetary system. In recent years, however, and more particularly in recent months, the pace of changc has accelerated. There have been large movements in the relative value of major currencies and a general departure from the system of fixed exchange rates that has prevailed since the war. Gold has ceased to be bought and sold at its official price, and gold priccs in the free market have reached levels that would have seemed unthinkable even two years ago. Now the dramatic developments in the energy situation have introduced new elements of uncertainty and the prospect of substantial changes in economic relationships. The enormous increase in oil prices presents countries with many difficult decisions, both in their domestic and in their external policies. Besides imparting an additional push in the direction of cost inflation, increased energy costs will have a deflationary effect on real demand. Externally they will give rise to a substantial disequilibrium in the global balance of payments. This combination of circumstances will place strains on the monetary system far in excess of any that have been experienced since the war. To withstand these strains with a minimum adverse impact on economic trade and growth requires close co-opcration between governments and a willingness to subordinate short-term national interests to the longer-term general good. To help achieve this the International Monetary Fund must provide its member countries with guidance and support —to help ensure that appropriate policies are adopted and, where necessary, to assist in financing structural adjustment. Undoubtedly, inflation will' continue to be a major problem in the year ahead. Even before the increase in oil prices, inflation was running at an unacceptably high level in the developed countries. Now the prospect is for rates of price increase in doublefiguresfor many, perhaps most, of them, in the developing world the situation is similar and for some countries worse. Even in those countries which have pursued reasonably sound domestic policies imported inflation has pushed the price level up at historically high rates. There has thus been a dangerous acceleration of inflation throughout the world, which at the present time shows no signs of abating. W Enromoney April 1974 How much deflation? It is, of course, much easier to inveigh against inflation than to suggest effective and workable policies to control it. At the present time policy choice is particularly difficult because of the deflationary effect on real demand of the new oil prices. These prices will bring about a substantial transfer of purchasing power from oilimporting countries to oil exporters. Since the spending capacity of the latter is much less than that of the former, at least in the short term, the result will be marked contraction in real demand. In its economic effect, therefore, the oil-price increase is similar to a tax increase or a sudden growth in savings. How large this deflationary effect will be depends on a number of factors: the extent to which the labour force seeks and obtains compensating increases in wages; the size of the consequential change in business profits; the scope for reduction in consumers' savings; the speed with which oil-producing countries expand their imports; the extent to which increased saving in the oil-producing countries can be channelled into higher investment in the consuming countries and so on. Within limits, a measure of deflation may be welcome in reducing excess demand; but where the deflationary impact of high oil prices is more than is needed to remove existing pressures on resources governments may need to take some offsetting action. The task of domestic management will be, as always, to strike the right balance between stimulation and restraint. Policy choice is even more difficult at the present time because of the considerable uncertainty concerning the magnitude of the 'oil factor' on demand. Furthermore, since rates of inflation are already high, and confidence is brittle, the penalties for miscalculation are probably greater than usual. Apart from posing difficult domestic policy choices, the oil-price increases also create a need for balance-ofpayments adjustment, an area which is a particular concern of the Fund. If oil prices remain at the levels established last December, the combined current surpluses of the oil-exporting countries could, in 1974, be as high as S65 billion. These surpluses will have to be matched by deficits of equivalent amounts for the oilimporting countries taken as a group. The developing countries alone face an additional import bill approaching $10 billion, afigureroughly equivalent to their total 209 receipts of official development assistance. Faced with these deficits, there is a danger that the external policies of the oil-importing countries may come into conflict with each other. It would be inappropriate for the oil-importing countries to use deflationary demand policies to try to eliminate the additional current deficit caused by the rise in oil prices. Such policies would only shift the balance-of-payments problem from one oil-importing country to another and might have cumulative depressing effects on the world economy. Equally unfortunate would be an attempt to solve balance-of-payments problems by import restrictions. This would not only, again, shift the problem from one oil-importing country to another, but would also give rise to serious trade conflicts and reduce the flow of international trade in a most harmful manner. Of course, the presentflexibilityof exchange rates should be used to facilitate adjustment. But if a number of large countries were to try by this means to reduce their current account deficits to an extent that was inconsistent with the unavoidable total deficit of oil-importing countries, the outcome might be a return to beggar-my-neighbour policies. It is gratifying that the Committee of Twenty at its Rome meeting showed itself to be fully aware of these dangers. In the present situationfloatinghas several advantages and is probably unavoidable. But given the volatility of exchange markets, and the need for many countries to accept large deficits on current account, there is a clear need for constructive management of thefloatingregime. Whatever happens, there are bound to be strains on the mcchanisms whereby offsetting capitalflowsare induced tofinancethe enormous current account in balances to be expected this year. The Eurocurrency market will have an extremely important role to play in attracting surplus funds from oil-producing countries and lending them to countries in deficit. However, in view of the preference of oil-producing countries for short-term deposits, and the need of deficit countries for at least medium-term loans, there will be a very heavy burden on this market, about which there is already some concern. It seems improbable, therefore, that all deficit countries will find it possible to borrow from the market to the required extent and on reasonable terms. It is to meet these unfilled needs that I have proposed a special new facility, limited in time, and related to the higher costs of imported oil. Avoiding economic nationalism The facility would be designed to deal with an emergency situation and would not be a permanent feature of the Fund. It is proposed that the facility should be related to higher oil costs incurred in 1974 and 1975, taking into account the relative ability of countries tofinancetheir current account deficits by net capital imports, or by reducing the level of their net international reserves. The maximum amounts drawable in the first year would constitute, within limits related to quotas, an important proportion of the impact effect of oil-price increases, but this proportion would decline in 1975. The conditions for use of the facility would be specific to the drawings under it. Countries would be expected to undertake the following policies, for example, in regard to the exchange rate and incentives for capital inflows that would facilitate the appropriate adjustment. It should be possible to use the text of the Committee of Twenty communique as a basis for reaching agreement on conditions to be applied to drawings. The relevant part of this reads as follows: 'In these difficult circumstances the Committee agreed that in managing their international payments countries must not adopt policies which would merely aggravate the problems of other countries. Accordingly, they stressed the importance of avoiding competitive depreciation and the escalation of restrictions on trade and payments. They further resolved to pursue policies that would sustain appropriate levels of economic activity and employment, while minimizing inflation. They recognized that serious difficulties would be created for many developing countries and that their needs forfinancialresources will be greatly increased; and they urged all countries with available resources to make every effort to supply these needs on appropriate terms'. To an important extent the fund will be able to finance drawings under a new facility from its existing resources. Hoover* if there is a heavy demand to draw, the Fund will need to supplement these by borrowing. Although one would naturally think in this connection of borrowing frbm the oil-exporting countries, funds could also be obtained from those oil-importing countries which receive a large capital flow and which are relatively less affected by oil price increases. A breathing space The purpose of the new facility is not to obviate the need for adjustment, but to provide a breathing space which will enable countries to avoid inappropriate adjustment policies. This breathing space should be used for consultations on the nature of the needed long-run adjustment and to cover the transitional period during which the necessary policies are put into effect. To the extent that the current account deficit should be financed, the Fund should encourage its members to adopt policies that will help attract the necessary capital inflows. To the extent that some improvement in the current account is necessary, the Fund should endeavour to see that this is not achieved through excessive currency depreciation or unjustified exchange restrictions. There will, of course, be difficult policy decisions involved in the adjustment process—not only concerning the nature of the policies that are applied, but also concerning the extent. Both under-adjustment and overadjustment carry their different dangers. The task of the Fund must be to try and help its member countries to chart this difficult middle course. The dangers of a failure to chart such a course are recession on the one hand and a worsening of inflation on the other. The dancers are the perpetual Scylla and Charybdis of economic policy; but on this occasion the whirlpool and the rock seem to be uncomfortably close together. 210 T H E WASHINGTON POST April 12, 1974 Joseph Alsop From Energy Crisis to Dpllar Crisis NEW YORK—Maybe it is a bad mistake to come up here to $sk the insiders on the money market about the future effects of the miscalled "energy crisis." It makes you feel that the Watergate-besotted political community in Washington resembles nothing so much as a party of drunkards in a graveyard, boozing away among the corpses. The reason for this dire, perhaps extreme sensation is really pretty simple. The wisest and most conservative ipen in the economic andfinancialcommunities have begun to talk helplessly about the threat of an onrushing, Worldwide financial calamity in many respects as serious as the Great Depression of the '30s. If these apprehensions have any Inundation, the! leaders of both politicil parties and all other memben of the political community ought to begin worrying, too, along with the Insiders on the money market. The worst of it is that by any logical test, the apprehensions of threatened calamity appear to be well founded. , Here one mptt, begin by noting that the "energy #isis!' is miscalled, because It is a apohey crisis rather than an energy crislfc^t results exclusively from the enohnous increase- in the .'(fyclng eountrlea, there ii a rather gen* era! tendency to argue>that "tne sysprice of crude oil in recent months. This has created an entirely new situa- tem can take it." tion for all of the world's leading fiIn this respect, David Rockefeller, nancial-industrial powers, including head of the Chase Manhattan Bank, the U.S., since these are also the big stands almost alone. This is because he oil-importing powers. has been saying forthrightly, albeit privately, tha} he cannot see how the exBy the beat estimates of the leading isting financial system can possibly expert in the field, Walter J. Levy, the stand the double strain ahead. oil-importing countries will end this ' The first pert of the double strain year owing the oil-producing countries will be inability to pay their bills, and no less than $50 billion. This will be therefore the continuously increasing net debt, please remember, after subtracting the costs of everything kthe oil indebtedness of the U.S., Japan and the other leading financial-industrial importing countries can persuadaythe oil producera to buy from them, ajl'the ' nations in Western Europe. The second part of the double strain will be the way from perfumes to bomber plane*. immensity of the sums owed to the oil producing countries—tens of billions As stated in t M previous report In this apace, all the tigns further suggest upon tens of billions, In fact, all sluicthianet debt will be In the nature of a ing about in search of Investments. added to it in 1075—and so on Indefinitely, unlets tomathlng gives* way somewhere with a rending crash. On this matter of aometbint giving way somewhere, there la a, dmsioq. of opinion. Among the greii American banks, whoae deposits may be vastly and profitably awollen by the evermounting funds owed to the oil pro- The pptimists suggest that a way out " will be found by selling the oil producing countries large chunks of the economies of the big oil importing countries. This raises an interesting policy question, to begin with. Fat do we really want great numbera of the prlp** pal financial and industrial« In the U.S. to be owned by 4 Iranians? But aside from the policy question, the eptimists' way out also raises a practical question. On their system, the oil producing countries will makf overseas investments in jusjt yaari, 1974 and 1975, ^n amounts abotft $10* billion higher than >va|M of all the overseaf mulated by the U»S. sine* I t ^ f t i e pH' p roducert'JotfeJgn K ^ n g a $y tifc and But no one makfa investment* overseas or* "without jgxpfebtiog* reasonable return. a return Is now thought to be aPc^ng: 10 par cent per annum. At the of 1&76, therefore, the c4 importing fcOtmtriftB will have to face another yearot going into debt fif fehergyty tfyt (funount of $50 billion. And tfay will jUaofwe the oil producers'" k^Mx* Mk* $10 billion In intrnmt-ltywmiHmtial The year following, oCinterest and/or dividends w£H then rise to btiltai. And So It will irtarrily conat leajt in thecfl^rButin practice»4t cannot possibly c o o k i e ihtbis ^amfar. Unless oil prices edme down draattoaUy, eomethinc really wi^l give way aotnewhere. 211 FROM FINANCE MAGAZINE, JUNE 1974 Arab Lands Amm) in Cast? Quadrupling of price of oil begins to flood Middle East with Incredible Riches. The recipients' initial reaction has been to seek refuge in traditional shortterm money markets, juicy real estate deals in New York and Paris. But the sheiks will wind up holding so many chips, the world financial system could be ruined unless they unbend and lend at longer term, meeting maturity needs of deficit oil-consuming lands. In due course, the Arabs might even develop an appetite for common stocks, but that could still be a long time off. By H. LEE SILBERMAN 4 6 / ^ N E THING you can be sure about V - J the Saudi Arabians. They have no intention of being a patsy for anybody, aimlessly sloshing money around the world." Speaking is a Wall Street financial executive, recently returned from a trip to Jeddah, the financial center of the huge Moslem land. He might just as well have been speaking for all of the soon-to-be incredibly wealthy Middle Eastern oil producing countries. Since the Arab oil producing countries quadrupled the price of oil last fall, the annual cash flow to that part of the world has swelled by over $100 billion. Of that, the countries are expected to wind up with an estimated $60 billion after paying all of their bills this year, up from a $4 billion surplus by the same lands in 1973. By 1975, however—just one year later—total monetary reserves of oil producing nations, including such other oil-rich Arab lands as Iran, Kuwait, Iraq, United Arab Emirates and Libya, are likely to exceed $145 billion—and $210 billion by the end of 1976. These are mindboggling amounts, expected to mate44 rialize in only three years. Saudi Arabia alone is likely to accumulate at least $50 billion over the three years. With oil-payment checks reflecting the higher prices recently starting to pour into Arab coffers in some volume, the Middle Eastern countries are now having to make increasingly difficult decisions concerning the disposition of their embarrassment of riches. " A r a b oil money historically has been invested at short term in Treasury bills in the U.S., in sterling or i n the E u r o d o l l a r and E u r o currency in markets abroad," says the Wall Street financial man. "That was no sweat because the amounts were modest—on the order of $10 billion or so. But now with their cash flow starting to pile up," he continued, "concentrations in the short end could be self-limiting, forcing down rates. That means we can expect some lengthening of maturities, though they will still probably stay relatively short, at least for starters." The maturity preferences of Arab investors are actually a matter of considerable concern to international bankers and monetary officials. The reason is that as countries that buy the oil began to run up sizable balance-of-payment deficits because of the higher oil prices and funding most of these bills through the international banking system, that mechanism itself is in jeopardy of a breakdown. The problem, David Rockefeller, chairman of Chase Manhattan Corp., and its subsidiary Chase Manhattan Bank recently explained, is that "banks have been taking this short maturity money and relending it to oil-consuming nations for periods of five to seven years." Such a process "obviously makes a very unbalanced and precarious maturity structure," M r . Rockefeller warned in a recent address to the Spring meeting of the 212 prestigious U.S. Business Council. The Chase chief executive emphasized ihe need to develop mechanisms whereby the "huge surpluses of the oil producers can be recycled back to deficit oil consumers." He expressed the hope that "countries in the Middle East, as they become more familiar with the recycling process, will at least agree to place funds at longer maturity." Other solutions for resolving the problems outside the banking system have been proposed. Johannes Witteveen, managing director of the International Monetary Fund, for example, has called on the oilproducing countries to advance some $2.7 billion to a special new "oil window" at the IMF which in turn would lend the funds to the deficit ridden oil-importing lands. Chase Manhattan itself has become increasingly involved in the Middle East. The global banking or- ganization is setting up a merchant bank to manage securities underwritings in Saudi Arabia and a commercial bank in Iran — both jointly owned with local participants; Chase has also established branches in Egypt, the United Arab Emirates and elsewhere. It has a long way to go, however, to catch up with its New York archrival, First National City Bank, which has long operated branches both in Jeddah and Riyadh, capital of Saudi Arabia as well as in Abu Dhabi. Bahrain and Qatar among other places in the Middle East. The more recent inundation of the area with a rising tide of oil money has triggered a rush to those Arab lands by major banks from the U.S., France, Japan and elsewhere. In recent months, First National Bank of Chicago announced opening a branch in Dubai while its hometown competitor, Continental Bank of Illinois, was buying into a Bahrain Bank. But the most concerted activity is taking place in Beirut, the Arab world's traditional financial center. Prominent U.S. banks that now hold important interests in Beirut banks are New York's Chemical Bank and Fidelity Bank of Philadelphia. The Lebanese capital is also the center for the creation of merchant banks, in which Western banks are playing a role as partners or advisors. One such bank is Arab Finance Corp., which while 56% Arab owned, also has New York's Manufacturers Hanover Trust Co. and banks in Tokyo and Paris as partners. It is only a matter of time in the view of U.S. investment experts, before many of the Arab countries direct a significant portion of their newly gained oil billions into medium and longer term investments. Recent experience in Saudi Arabia shows that such direct investments are initially made at home — for schools, government buildings, roads, hotels, office buildings, apartment houses and the like. But because countries like Saudi, Kuwait and Iran are underdeveloped industrially, there is a limit as to the longterm financing they can absorb. The ultimate aim of each country's planners, according to a well posted New 213 Y o r k banker, is to accumulate enough profitable investments outside its borders that will yield sufficient income to replace its oil revenues as they run out. While still on a modest scale, longterm foreign investments by Middle Eastern countries are beginning to build up, in real estate, selected securities and some direct investments in industry. Newspaper financial pages in recent months have headlined such developments as the purchase of a large office building on Fifth Avenue, New York, by Shah Mohammed Riza Pahlevi of Iran; a $27 million investment by a group of Kuwaitis in a planned luxury office and bank building on the Champs Elysees in Paris, to be called the House of Kuwait; and the acquisition of about $1 million in raw land for development in California by Adnan M . Kashoggi, a Beirut-based Saudi Arabian, who also purchased two California banks. Other major deals involving pooling investments and businesses are in the works. It is reported, for example, that the Saudi Arabian Government has talked to Chase Manhattan about the possibility of Chase managing a pool of $200 million in Saudi Government funds for investment in Saudi business and in joint ventures with foreign partners whom Chase would find. Earlier this year the Kuwait Investment Co., one of several owned jointly by the Kuwait Government and individual Kuwait investors, bought Kiawak Island off Charleston, S.C., for a reputed $17 million in cash; the company plans to spend more than $100 million developing it as a residential resort over the next 15 years. The Arabs' emphasis on real estate is understandable because it is visible and tangible, attributes cautious investors can readily appreciate. Arab investors, moreover, have been realizing a fabulous return on real estate investments at home: real estate in the center of Jeddah is said to have trebled in value over the past 12 months alone. As a result of this kind of appreciation, a lot of oil money is being sunk right into the land at home. A Saudi student, temporarily in the U.S. relates, admiringly, a personal encounter in a surburban area on the outskirts of Jeddah. " I had long known the section to be sparsely settled and consisting of older scattered residences, but I had not been out that way for six months or so. Imagine my surprise to discover the area completely transformed into a modern planned neighborhood, with wide paved streets, shops and homes. I frankly didn't recognize the place, in a city where I have lived all my life!" Experiences like these buoy the sense of pride and mission of the Saudis and add to their zeal to put their newly earned billions to good use. "When I see something like this," the Saudi continues, " I am overcome by the conviction that we will play a catalytic role not only in the Arab world but in the world of finance as well. There are many things we will want to do as our planning evolves; a few years from now, £ ... we will see Arab money move into quality stocks, when conditions in the U.S. economy and markets become more promising. I look for considerable emphasis in joint ventures abroad — many of them, I expect, in the United States. We will approach these opportunities, I am sure, with the concept of having a benevolent and stabilizing effect on world finance. For the time being, the major focus of Saudi investment planners is on the country's infra-structure as well as that of the Middle East in general. The emphasis thus is on such fundamentals as roads, power generation and transmission, schools and the like. The government at the same time has begun to lay the groundwork for the development of industry that, it is believed, will benefit the country most. This is the building of a full-fledged petrochemical industry to refine the crude after it is brought to the surface, thereby enabling the country to expand its export earnings even more significantly through the shipment of the more valuable finished products instead just the oil itself. Next to its own infra-structure, the Saudis are increasingly involved in strengthening the basic economic underpinnings of its Arab neighbors. Toward this end the government is setting up its own Islamic Bank with no less than $1 billion capital for aid to the Arab world. It is also sponsoring a Cairo-headquartered Arab African Bank, which will channel Arab funds to African countries. In these efforts Saudi Arabia and Egypt have drawn closer together in a combination harnessing Saudi's financial resources and pioneering zest and Egypt's more mature economic and social structure; Egypt itself produces no oil. The relationship is made even more secure because of Saudi's reliance on the fertile Egyptian Sudan as the country's breadbasket, a tie it recently knotted with the guarantee of a $2.5 billion loan to Cairo. As the Arab world begins to flex its new-found oil wealth, major international banks have come conspicuously to the fore to join with Arab banking interests, to help smooth their path in the world. Investment banking houses based in the U.S. and elsewhere are not quite as much in evidence in this process, at least at the time being, probably because of the Arab countries' predeliction at this stage in their financial evolution to invest their surplus oil funds mainly through the banking system. There seems to be little doubt, however, that the securities industry, both in New York and London, will bulk larger in the picture as the Arab investors grow more comfortable with longer-term debt and equity investments. " I am quite confident that we will see Arab money move into quality stocks, when conditions in the U.S. economy and markets become more promising," says the Wall Street financial executive. "Right now, the tendency is for Arab investors to carefully assess equity opportunities and the market process, while their general approach toward the stock market is one of considerable caution." Then again, whose isn't? • 214 T H E WASHINGTON POST M a r c h 31, 1974 Hobart Rowen T h e Oil Crisis Will Continue' The Arab oil weapon has temporar- , that "Israel alone" will bear the reily been laid on the shelf, within easy sponsibility for "more severe oil measreach by the managers of the export* ures, in addition to the other varipus ers' cartel. It has not been abandoned, resources which the Arab world can and it would be a mistake, ior the master in order to join the battle of American public to delude Itself into destiny." thinking that the Vienna announce- ' Plainly, this is a threat to use not ment of the lifted embargo has more only oil itself, but oil money, as it piles than marginal meaning. up, as a bludgeon over the West By So long as prices for oil remain skymoving large blocks of capital in and high-^triple what they were prior to out of money markets, for example, a the embargo-—and so long as producconcerted drive by the oil cartel countion levels are carefully controlled by tries could shake Western currency the oil-producing states, the oil crisis markets. Demand for payment in gold, will continue. from those who have limited supplies of gold, could also weaken the finanOf course, it will be difficult to suscial underpinnings of the West. And tain public concern about the oil crisis large-scale industrial and commercial if gasoline becomes somewhat more investments in industrialized countries readily available—albeit at prices could provide the Arab nations with a nudging 70 cents a gallon in the East degree of leverage over economic But the most difficult problem cre- prospects and Job opportunities. ated by higb oil prices—the potential It is not at all far-fetched to visualfor economic recession in the industriize a scenario in which the embargo alized world—remains unsolved. might be threatened again unless the As much as $50 billion to $60 billion industrialized countries step up their must be transferred from the oil-conaid programs for the hard-pressed Afsuming nations to the oil cartel this rican countries who have given the year to pay for the increased costs of Arabs political support. i oil—a sum which threatens vast discloFaced with the Arab nations' clearcations here and abroad. cut success in the initial round of the v No one has yet figured out how the oil war, it is disconcerting to see the consuming nations will pay the bill— potential for joint actioii by the conor how the exporting nations will use suming nations fade away in a welter or invest the vast sums they receiveof acrimonious debate between Presionce they're paid over. dent Nixoh and Europe. But the terms of the lifted embargo, Europe—dominated by France— as made public in Vienna, carefully esseems determined to pursue bilateral chew any guarantee of increased prodeals with the Arab nations. If the duction which would tend to assure a United States were to sacrifice princisoftening in price. Iran and Algeria, to ple to be assured of a steady flow of the contrary, have been arguing loudly Arab oil, it could elbow the French for yet another increase in price. and British or anyone else out of the The remaining potency of the oil way, especially with Iran and Saudi weapon, moreover, should be seen Arabia, offering them as much money from the Arab statement which wqrns and technology and certainly more se- curity than any combination of K i r * I pean nations., Because it has not succumbed to blackmail, the United States has so far not chosen this course. Hopefully, the Nixon administration will not b* vkA icked by the new harsh language i§. the cartel's Vienna announcement, o* by a political need for some new dlplo* matic "success" to .offset Watergate troubles. f We can anticipate a flood of faifljr optimistic assessments from the majofr banks and the big oil companies wha are heavily engaged with the produc ing countries in oil and money .matters. It isn't reasonable to Iodic' 16 bankers or oil presidents for a re-state* ment of the need for independence frofll Arab oil. i. But if that crucial drive gets lost lnf a misplaced euphoria over a slight jig. gle in the use of the Arab oil weapon,' it will be a shame. They have the abft* ity to turn the oil supply valves on attt off at will. They make no pretense o{ their willingness to use their oil an$ new found wealth as political black* maiL A policy that doesn't recognize this as a fact is suicidal. / We hardly needed to be told that t h * embargo will be "reviewed" June 1; Only a year ago, Saudi Arabian Minister Zaki Yamani was saying that oil, would never be used as a political weapon Now, we know (or should" know) that no assurance from the Mideast exporting countries means anything. , .. The oil cartel has created a vast uncertainty over a vital supply, with thW combination of oil and money forgfetf into a devastating weapon. So far, th» Western World has evolved no efffo* tive response. 215 Oil-Cash Recycling Plans Vary I T CLYDE H. FARNSWORTH iptotel to The New York Tbnc* , PARIS—The quadrupling of -oil prices at the end of last year has caused economic < and financial upheaval in the world. The petroleum-exporting nations are accumulating money at a rate that has been put at $6-billion a month. A number of plans have been offered to "recycle" surplus funds of the oii-exporting nations into productive uses to avoid reductions in consumption and even a ' world recession. The two plans most widely discussed have been formulated by H. J. Witteveen, managing director of the International Monetary Fund, and Harold Lever, a Cabinet Minister and financial adviser to Prime Minister Wilson of Britain. Another has been advanced by David T. Kleinman, professor of finance at Fordham University. Discussions Planned Some of the plans for recycling money will be discussed in Washington next Tuesday at a meeting of the Group of Ten, a forum of the 10 leading industrial powers that has been resurrected to deal with , the oil' financing crisis. The Group of Ten was disbanded in - March, 1973, when the world monetary system went into a pattern of floating rates. The proposal by . Mr. -Witteveen, a former Dutch Finance Minister, seeks to persuade Middle East states to lend some of their oil earnings directly to his institution, the International Monetary . Fund, which would xelend to countries in need. On a recent tour of the oil states he was able to get •subscriptions for only $2.8inillion, a, minor amount in .relation to the magnitude of the oil countries' income. * American officials are convinced that given the right interest rates and the right exchange rate guarantees, the Witteveen plan could become an important recycling vehicle in, the. future. Mr. Lever proposed a mechanism for collective purchases of Middle East oil by the industrialized nations of the West. His pjan envisages an agency that would buy the oil at a negotiated price and sell just about at cost to the main consuming nations. Revenues from a surcharge on these resales would b . lent or given to developing countris. The mechanism'was described in British circles as an alternative to the Witteveen plan. The British think it might prove more acceptable because of certain technical features having to do with the role of the monetary asset known as Special Drawing Rights. However, Sheik Ahmed Zaki al-Yamani, Oil Minister of Spudl Arabia, has warned that any efforts to purchase oil collectively could result in .further increases in prices. The oil states have been cool to both the Witteveen and Lever ideas because they in-, volve a loss of Control over the countries' money. While some of the oil nations' new wealth is used to buy goods in the West and for investment in Europe and the United States, most goes into the money markets, which means that it is placed in short-term securities at relatively high interest rates. It is highly volatile money. Until now commercial banks have been the chief recyclers, borrowing the shortterm funds and lending them out at longer term for productive use by business. The volatility of the money, however, creates unusual risks. David Rockefeller, for one, chairman of the Chase Manhattan Bank, warns that commercial banks were not equipped to handle the recycling job. Plan by Kleinman The latest plan was offered by Professor Kleinman, who presented his ideas in Paris last month at a meeting of the Young Presidents Organization. Professor Kleinman, who as a consultant, to the United States Agency for International Development worked out a plan for restructuring Brazil's capital market in 1967, believes the problems can be solved by giving free rein* to market forces. He proposes to create capital markets in developing countries to attract surplus funds of oil-producing states, stimulate more rapid economic growth of the poor countries and increase exports of industrial nations. Mr. Kleinman claims the plan would promote the rapid economic development of the Third World, establish a new monetary equilibrium and generate enormous demand for capital and other goods from the industrialized world. He envisages development of financial institutions such as Those created in Brazil In the late nineteen-sixties. Credits on liberal terms would be provided for underwriters and market makers in each country, as well as for entire regions. Monetary Correction System Debt securities providing a "real" interest rate after cost-of-living increases are taken into account would be offered. This monetary correction system, which was included in Professor Kleinman's program for Brazil in 1967, is the key to attracting surplus oil funds. Oil money that is now being invested may get what is known as a negative interest rate if market rates are less than inflation rates. So with a higher rate of return, there would be an incentive for oil states to shift their funds to the developing countries' financial centers. The securities that are is- J sued—both debt and equity —would finance newly or- I ganized public and private enterprises in participating | countries and would be traded on local and regional stock exchanges. 216 FROM THE NEW YORK TIMES, MARCH 2 0 , 1974 Arab Oil Strategy Economics, Business and Politics Mixed in Aiming at Embargo Goals By LEONARD SILK Some day the Arab oil em- to do this, you should have to bargo, which now has been give us some powerful incenlargely suspended against the tives." United States, will make a great Although the embargo case is case at the Harvard Business far from complete, here is a preSchool. It could break new liminary version of how it looks. ground in that Situation: You are a leading largely unexplored Arab oil-producing state and a Economic no - man's - land member of the international AnalysU where economics, cartel, the Organization of Pebusiness and poli- troleum Exporting Countries. tics meet. The es- With your fellow Arabs, you sence of the case was stated by have been embargoing oil shipan Arab oil sheik to Peter G. ments to ,the United States, the Peterson, the former Secretary Netherlands and other countries of Commerce who is now chair- that, you assert, have aided Isman of Lehman Brothers, the rael against the Arabs. your fellow members of big New York investment bank- theWith Organization of Petroleum ing house. "You taught us in Exporting Countries you have your business schools," said the quadrupled oil prices. To make Arab sheik, "that we should the embargo and price increase maximize our profits. Do you stick, you had cut oil producwant us now to repeal the laws tion back by about 15 per cent. of supply demand? If we are Now, in response to American efforts to work out peace terms with Israel, you have lifted the embargo against the United States. You must now think through your broad future strategy. Lasting Development Objectives: Your major objectives are: to maximize profits, maximize capital accumulation, recapture territory from the Israelis, and to maintain your security against internal and external Arab radicals, against Western imperialists, against Soviet Communists. Finally, you want to achieve lasting economic development of your country. Customers: Your principal customers are the United States Western Europe, Japan and a crowd of energy-poor, less developed countries. The United States has enormous military power Europe not much, the less developed countries still less. But the Soviet Union also has military power — air force, missiles, tank — not to mention their ships and submarines in the Indian Ocean. The United States has a good relations with Israel, the Soviets bad. The United States has Henry Kissinger. The United States is freer to wheel and deal between Arabs and Israelis than the Russians are. Problem: How much oil should you produce and how much should you charge for it? These are interdependent questions. If you go back to producing as much oil as you did before the October war, you could break the present oil price, and maybe break up the cartel. As it is, the price of crude 217 oil has been softening. The posted price is $11.65. At the peak of the oil scare, prices in the Middle East got up toj $22 a barrel. Until recently,; light Arabian crude had been going for $9 to $11. Now some independent oil importers say they are abfe to buy at $8. How can you keep prices from falling too much? Proposal: Restrict production below the October level. Do this by maintaining your embargo against tihe Netherlands, Denmark, Portugal, South Africa and Rhodesia, charging that they are all unfriendly to the Arab cause against Israel.: This will justify the hold-downs on total production and help maintain the price of crude.! It may also yield political benefits, since the industrialized countri) s seem to put economic needs above all else. Problem, What if W t i r ' M j low cartel members fncre^fee1 production in order to ' maximize profits, letting you carryl the burden ot cutbacks? proposal: Threaten to increase your own production, which would break the price. Alternatively, threaten to make a political deal with the United States at the expense of your colleagues. Problem: The industrialized countries claim they can't pay the huge oil bills. They assert that high oil prices are worsening their inflation, which reduces your real gain. Proposal: Warn them that you will raise the price of oil still higher unless they get inflation under control. Tell them that they can't cheat you out of your just price. Problem: But they may be unable to control inflation, and if inflation gets out of hand, the money they owe yo will be worthless. Proposal: Buy gold. Will Gold Really Help? Problem: But what if you get all the gold? Actually, you can afford it. The artel's oil revenues will go up by $65-billion to $75-billion just this year, and keep on climbing. But does it make any sense just to bid up the price of gold higher and higher? Will that really help your economic development? Your gross national product is growing fast. The combined G.N.P. of all the Arab countries is going up from $36-biIlion in 1973 to $74-billion in 1974. In Qatar, per-capital G.N.P. will soar from $5,800 Jast year to $17,400 this year. In Abu Dhabi, it will hit $45,000 per person this year — compared to a mere $6,127 in the United States. But what happens to your G.N.P. when the oil runs out? Proposal: Invest your petrodollars in income-earning assets You can absorb only so much breed galloping inflation and corrupt or ruin the working! class. Invest more money abroad. ' Problem: What if foreigners nationalize your investments? Proposal: As one wise old sheik said, "The most illiquid investment is a demand deposit at the Bank of America." Your dollar holdings can not only be blocked but the purchasing value of the dollar will surely decline over time. Therefore, consider a range of alternatives: Diffusing your money through Arab-controlledl banks in the Vest, recycling petrodollars, tnrough an "International Petrorevenue' Fund," financing economic de- velopment in the poor countries of Africa or Asia through an oil exporters' International Bank for Development. You don't need to use the Western world's International Monetary Fund or World Bank. Problem: But recycling or running an aid program sounds terribly complicated and risky. The West never did it very well. Why should we now carry the burdens and risks of soft aid? Isn't there a safer way to stay rich and further our own development? Proposal: Improve relations with the United States and other industrialized countries. Relax the embargo. Set up joint Government and business development programs in such kreas as food, education, housing, desalinization, as Peter Peterson and George Ball, the former United States Under Secretary of State, have proposed. Negotiate tax treaties, mutual investment guarantees. Build programs for long-term development of energy, shale, soiar power, etc., for the time when your petroleum runs out. Work out pricing and production policies that will serve the interests of both oil-exporting and oil-importing countries. World inflation and world recession or depression, combined with breakdown of trade and hostility among nations, won't do the West or you any good. Problem: You sound too rational. But if we had been rational, we would never have got where we are today. How can we trust the West, those neocolonialists who never did anything for anybody but themselves? Proposal: Hang on to the oil weapon. Threaten to reimpose the embargo if necessary, and use it ad lib for either economic or politcial purposes, or ' both. Keep the oil price high enough to keep profits flowing in, but not so high as to accelerate shifting to other energy sources. Hold the cartel together at all cost. If the industrialized countries show serious signs of conserving on oil and substituting other high-cost technologies too soon, step up your oil production and cut the price. Make them come across politically. Insist on military protection. Keep cool. Remember what you have achieved so far. And remember what the great German strategist, Karl von Klausewitz, virtually said: "War and business are not merely political acts, but also political instruments, a continuation of political relations, a striving for the same ends by other means." 218 T H E NEW YORK TIMES A p r i l 8, 1974 M M FAIL TO AGREE OH AID 1 importers ^Decide to Set Up ' FundforPoorer Countries ; • bat Differ on Donations My JUAN * ONIS /kMt^tDTtMNWTottTlaM* OCNEV^ April 7~Tbe oil ' jortingbountries decided to* set Upaepoc^l fund *> •"ponir devetop&g ut they failed to tfl r jpouch money t# ; He program. flrWletfeda* 1H-natfcn T Vweziielaand Aigefirmly spoosofad the fund, Saudi -Arabia,.Kuwait and Arab members resi*t6d'a firm decision., Jamahid Amdutgar, Iran's Ifinistet of Finance said that fctt couhtry Was ready to give tfre fund SlSO-milHqn as an Initial contribution, but He said Out the organization'* ntfjois' terial meeting here today had ; kft all contributions voluntary. NO $*dflc Aid Offer An official statement said that the fund wtyHd not go i$to operation until seven member countries had ratified the articles governing its establishment and operation. Cotfqfende sources said that only Iran, Venezuela, Algeria and Libya had clearly indicated that they were' ready to ratify the agreement. As a result, the oil exporting countries will be going to . the special .session of $be United Nations General Assembly that opens Tuesday in New York to discuss raw material and industrial inflation without a concrete offer of aid for the developing nations. President Houari Boumedfene fund for the developing counof Algeria, who has been the tries. principal sponsor of the special The dispute between Saudi don, had been interested in Arabia and Iran shows up in ngthening the third world policy debates over oil pricing. by spreading some of the The Saudi Arabian position Is that prices now are too high wealth of the oil export and that the best contribution among the poorer members. Large developing countries the producers could make to the such as rwngltdwht welfare of developing and inZaire and Brazil, ancT many dustrial countries would be to other smaller countries that do reduce prices. not have oil, have been hurt Iran has been among the majority of oil exporters that opby the shop crease in oil prices that Is the poses any lowering of prices. source of new wealth for the These countries note that Saudi •it ~ Arabia has not taken any iodiThe Arab producers of the gdusOstejM to lower the prices Persian Gulf region are the major recipients of increased in- Among the non-Arab memcome, particularly Saudi Arabia, bers of the Organization of Oil world's laignt oil exporter. Exporting Countries, little enBut Saudi Arabian sources thusiasm for the fund was said that Sheik Ahmed Zaki shown by Indonesia, a countiy al-Yamani, Saudi Arabia's Min- of 120 million people, as many ister of Petroleum, had made as the total of all the Arab no commitment on any con- members. Indonesia exports tribution to the new fund dur- 1.4 million barrels a day comingtoday'sfour-hour meeting. pared with Saudi Arabia's 8.5 There is a strong ritalry be- million barrels, and members tween Saudi Arabia and Iran, of the Indonesian delegation Shall Mohammed said that all the earnings from initially proposed Indonesian oil exports could be pent of i special utilized yithin ,|he cfcmtyT 7 219 BUSINESSWEEK: March 16.1974 Middle East The banking scramble for Arab dollars The flood of oil dollars into the Middle East is bringing with it a matching influx of Western bankers, financial advisers, and just plain promoters-all eager to help the Arabs invest and manage their Croesus-like wealth. U. S. bankers are combing the area so intensively for business that they are practically bumping into each other. A few weeks ago, when a senior vice-president of New York's Chemical Bank took a swing through Middle East capitals, he reportedly found prospects waiting for Chase Manhattan's Chairman David Rockefeller, who was just a few days behind him on the same circuit. U . S. banks a r e o p e n i n g new branches in the area and buying into local commercial banks, and they are setting up joint-venture merchant banks with Arab partners as well. Bank bids. Beirut, the Arab world's traditional financial center, is attracting much of the attention. Philadelphia's Fidelity Bank recently bought 80% of Banque de la Mediterange, Beirut's largest, and is selling off all but 20% to Arab investors. Chemical Bank last year bought 80% of Beirut's Rubiya Bank, and Irving Trust is negotiating to take over a bank there. The banking boom is also spilling over to Persian Gulf sheikdoms that were little more than sleepy sandpiles a few years ago. First National City Bank of New York has branches in Bahrain, Dubai, Abu Dhabi, and Qatar, and two in Saudi Arabia-the only U. S. bank branches allowed in that country so far. Continental Bank of Illinois is about to buy into a Bahrain bank, and First National Bank of Chicago will soon open a branch in Dubai—as will France's Paribas, and a flock of Japanese banks. Kuwait bars foreign-controlled banking operations, but is getting a merchant bank with minority American and European shareholdings (page 61). Even Egypt, which nationalized its banking system years ago, is allowing Chase Manhattan to set up a representative office and eventually, branches. Bank of America, which has had a branch in Beirut for years, is expanding in the Middle East mainly through its 30% share in the Bank of Credit & Commerce International, which it set up in Luxembourg two years ago with Arab partners. The venture has 10 branches in the Persian Gulf emirates, owns an interest in the national bank of Oman, and recently bought 80% of Lebanon's Bank Chartouni. These and other banks in the area are bracing for the huge surge of payments for oil that is about to hit the Middle East, reflecting last December's sharp increase in oil prices. At the outset, most of the money will bypass Middle East banks, both locally owned and foreign, which operate mainly in local currencies. Instead, Arab governments are expected to "recycle" the bulk of their dollar earnings directly into deposits and short-term investments in London, Zurich, New York, and markets (page 42). Fueling a boom. Gradually, though, local economies will feel the effects of stepped-iip spending by Arab governments. That, in turn, will fuel the biggest business boom the Middle East has ever seen, and local commercial banks will reap a bonanza of deposits and loan business with Arab individuals, importers, contractors, government agencies, and other customers. Although Lebanon has no oil, Beirut will get its share. Says Bankers Trust representative Muhammed Saleem: "Beirut bankers have a saying: The flow of money to Beirut will be like opening a can of beer. We will get only the foam, but the foam will be enough to keep us working full time." The Lebanese capital is a center for the latest development on the Middle East financial scene-the creation of merchant banks designed to tap Arab funds for medium- and long-term lending and equity investments, with Western banks playing a role as partners or advisors. Several such banks are sprouting in Beirut: • Arab Finance Corp., 56% Arabowned. I t will have as partners Kuwait Investment Co.; Credit Libonaise, a Lebanese bank; the Beirut-Riyadh Bank, with mixed Lebanese-Saudi o w n e r s h i p ; the B a n k of Tokyo; France's Banque de l'Union Europeene; and Manufacturers Hanover Trust Co., with an 18% share. • Investment & Finance Bank, owned by Britain's Hambros Bank, France's Renault, and Japan's Mitsui Bank and Nomura Securities. • American Express Middle East Development Co., set up by American Express Co. six months ago. I t has already helped a British insurance broker, Bland, Welch & Co., buy a stake in a Middle East insurance company owned by Saudi Arabian construction tycoon Suliman Olayan, and aided in the financing of construction equipment for Saudi Arabian operations of San Francisco constructor Bechtel Corp. Now, American Express and two other banks—one American and one Japanese-are joining with Olayan in trying to set up a merchant bank in Saudi Arabia to concentrate primarily on financing business ventures and "infrastructure" projects, such as petrochemical plants. Still another vehicle for mobilizing Arab investment money-this one entirely Arab-owned-is First Arabian Corp., incorporated in Luxembourg with a $10-million initial capital by a group of Arab banks. New York's Kidder, Peabody Co. has played an advisory role at the outset. Finding projects. The Beirut-based Arab Finance Corp. will be headed by Dr. Chafic Akhras, a Syrian who worked with the United Nations and set up his own consulting firm staffed with economists, engineers, and technicians. Part of that staff will move over to the new merchant bank to help in identifying investment projects. The bank's first venture, according to Michael C. Bouteneff, Manufacturers Hanover vicepresident, will be a syndicated medium-term financing for a project in an Arab country. But the bank also expects to channel Arab money into ventures outside the area. "There are not too many opportunities in the Arab world," explains Bouteneff. "There are plenty in other developing countries, but at present the Arabs are not ready to take the risks. So initially most of the money will go to the industrial world. But the return there is relatively low, so gradually they will move into developing areas as they gain more experience, in order to gain a much higher return." Despite the Middle East's big potential as a source of investment capital, the new financial institutions will have to move cautiously in testing the capacity of fledgling markets. A warning occurred last year when Renault floated a bond issue, denominated in Lebanese pounds, in Beirut and soaked up all the available funds. Recalls Mehli Mistri, manager of the Beirut branch of First National City Bank of New York: "The interbank rate shot up to 33% almost overnight, and only now is it settling down to 11% or 12%." • 220 TIME M a r c h 4, 1974 INVESTMENT The Arabs Are Coming An embargo may still be keeping Arab oil out of the U .S.—but not the gigantic amounts of investment capital that the Arab countries are accumulating by selling that oil elsewhere. Over the years, the Arabs have piled up American holdings estimated to be $10 billion to $15 billion. Now such thinly populated countries as Kuwait, Saudi Arabia and the Persian Gulf sheikdoms are pulling in more money through oilprice boosts than they can possibly absorb at home, and are channeling still more cash into the U S. The money is being placed discreetly, without publicity, in outlets that draw little attention—chiefly bank deposits and blue-chip real estate. There are two reasons. One is simply that Arabs tend to be ultra-conservative investors who are fearful of being cheated if they venture into anything the letst bit speculative. Also, the Arabs are well aware of the political climate in the U.S., and so the Arabs are determined to maintain a low investment profile. Still, the pickup in Arab investment has been noticeable. "Every day we get offered vast sums, like $200 mil- lion at a time, to be invested in things like Treasury bills," says a California banker. Adnan Kahsoggi, a Saudi, has moved beyond U.S. bank deposits to buy U.S. banks. Over the past two years, he has purchased controlling interests in two headquartered in Walnut Creek, Calif.: Security National, which has assets of $115 million, and the Bank of Contra Costa, with assets of $22.8 million. In the real estate field, the mixed public-private Kuwait Investment Co. last year committed itself to put up $10 million, half the equity of a $100 million urban complex in downtown Atlanta, two blocks from Peachtree Street. The project will include a Hilton hotel, offices and a shopping mall. Kuwait Investment reportedly has also bought a South Carolina island intending to build a luxury resort. Best Addresses. Kuwaitis and Saudis are also buying feed lots, agricultural land and New York City office buildings, almost all at the best addresses in town, such as Wall Street and Fifth Avenue. Raymond Jallow, chief economist of the United California Bank and himself an Iraqi, says he knows of several shopping centers and office buildings that Arabs have bought in California, ranging in price from $1 million to $10 million. Dr. Jallow expects such investment to increase "twentyfold in the next two years." Most experts are convinced that the Arabs will eventually move beyond such cautious investments to ones that have more political clout. One reason: they genuinel>, though wrongly, believe that U.S. support for Israel stems partly from a Zionist hammerlock on U.S. business, and are eager to break it. One industrial area that the Arabs are certain to aim at is so-called "downstream" oil activity—refining and marketing in consuming nations. Kuwait is already considering buying a large chunk of Gulf Oil stock (from whom is not clear). The pacesetter for Arab investment is likely to be the "First Arabian Corp.," an Arab version of First Boston Corp. that was organized by Roger Tamraz, Middle East representative of the U.S. investment firm of Kidder, Peabody. First Arabian will soon open offices on Park Avenue expressly to channel Arab funds into the U.S. Tamraz says that he plans to take over an American bank (one just below the big ten) on behalf of his clients, then bid for an industrial firm that he will not identify beyond saying that its brand name is a household word. He sees these moves as test cases that he will stage-manage carefully, probably clearing every step with Secretary of State Henry Kissinger and Treasury Secretary George Shultz. The Arabs will get further help in locating U.S. investments from American banks that are setting up throughout the Middle East. I n the past six months, Americans have bought controlling interest in three banks, and bought into three others in Beirut alone. The U.S. bankers believe, in the words of one, that "the only thing worse than the Arabs investing in America is the Arabs deciding not to." His point: a vast mass of Arab capital pitching aimlessly from country to country and industry to industry could disrupt economies and financial markets throughout the West. In order to avoid that, stable, long-term investments must be found for the Arabs, and the best are in the U.S. 221 T H E W A S H I N G T O N POST A p r i l 10, 1974 Joseph Alsop A 'RiVer of Money' NEW YORK—In March-April, the insiders on the money market tell you that $10 billion of oil-producing governments' profits will be looking for ihvestment opportunities around the, world. "The oil producers9 total profits for the first 12 months of the new higher prices are estimated The people who are searching for places to put this vast amount of at about $100 billion ,money are the major oil companies, .like Exxon in this country and Royal Dutch Shell abroad. Initially} most "probably, they will select short-term needed American money to finance 'obligations. Eventually, something a their courageous effort to .withstand Adolf Hitler alone. In short, insiders f bit more solid and more permanent . on the money market, pale-faced and .mil be wanted. ' Rudyard Kipling once wrote an en- confused, are mumbling about a jtire poem about the unseen, worldwide wholly new situation. <fl9ws of money as an underground The figures already cited, moreover, river more powerful than the Amazon, are only a beginning. By the best estithe Mississippi or the Nile. What we mates available, the oil-producing are now seeing, in Kipling's terms, is the first great flood of high water on countries will need to find places to i»> vest about $50 billion before 12 months tlje underground river, resulting from" have passed. the miscalled "energy crisis." • To give an idea of the extent of the high water, you have to bear in mind that the value of all the overseas investments of the United States is currently estimated at about $90 billion. In just two months, therefore, a small number of oil-producing governments will invest one-ninth of the amount that thousands of immensely rich American individuals and corporations have invested abroad over a period of about three-quarters of a century. The comparison is almost ludicrous • 3»iith the British overseas investments ,at the beginning of World War II, •.when the British so desperately 37-211 O - 74 - 15 In other words, the high water on the underground river is going to continue. The $50 billion is net, too. It is the,amount, in fact, that the Persian Gulf countries and other oil producers will have left over after they've spent every cent they can think of spending, on everything from private luxury to national defense. The oil producers' total profits for the first 12 months of the new higher oil pric.es are estimated at about $100 billion. Given their small average populations and their real needs, it is probably optimistic to suppose that they can find ways of spending half ' this amount on goods and services provided by the big oil importers like the United States, the Western Europeans and Japan. But suppose the hopeful forecast is correct. The current value of the Mellon-controlled Gulf Oil Co., for' instance, is no more than $5 to $6 billion. That means, for instance, that every que of the major U.S. oil pompanieacan be legitimately purchased by just one year of the oil producers' newstyle profits. Or look at it another way, on the simple assumption that the oil producers will want their profits to earn a currently normal return. On this assumption, the big oil comsumers like the United States will' have to find $4.5 billion—additional to what they will need to pay for new oil —in Order to give the oil producers the money that their first year's investments ought to earn. And next year's net profits for the oil producers are again forecast to be around $50 billion, since there is no foreseeable end to the high water on the underground river. No wonder, therefore, that the older insiders on the money market have begun to whisper the najne "Kreditanstalt." The Kreditanstalt was the great Austrian bank whose failure lead to the collapse of the old world monetary system and thus to the second and worst phase of' the Great Depression nearly 50 years ago. Besides Watergate, in short, we have some other things to worry about! 222 Channels for Oil Money Flows to Developing Countries February 1974 Introduction The huge s i z e o f o i l r e v e n u e s h a s l e d t o i n c r e a s e d i n t e r e s t i n the i n s t i t u t i o n a l arrangements a v a i l a b l e t o channel o i l revenues i n t o development. The p r e s e n t p a p e r r e v i e w s a v a i l a b l e i n f o r m a t i o n a b o u t a i d e f f o r t s o f some o i l p r o d u c e r s a n d d e s c r i b e s t h e i n s t i t u t i o n s w h i c h e x i s t o r have b e e n p r o p o s e d t o c h a n n e l f l o w s o f o i l money i n t o t h e d e v e l o p i n g w o r l d . I n c o n s i d e r i n g t h i s q u e s t i o n , i t may be w o r t h w h i l e r e c a l l i n g t h a t the o i l producing c o u n t r i e s represent r a t h e r s m a l l economies i n s p i t e o f t h e l a r g e o i l r e v e n u e s . Even i f t h e y a l l were t o p r o v i d e f i n a n c i a l f l o w s t o d e v e l o p i n g c o u n t r i e s o f 1 p e r c e n t o f t h e i r G-NP i n 1 9 7 4 , t h i s w o u l d amount t o t h e r e l a t i v e l y m o d e s t amount o f $ 1 . 5 b i l l i o n . A n o t h e r p o i n t t o be k e p t i n m i n d i s t h a t some o f t h e s e c o u n t r i e s a r e r a p i d l y e x h a u s t i n g t h e i r o n l y known n a t u r a l resources. I t i s t h e r e f o r e i m p e r a t i v e f o r them t o i n v e s t t h e o i l r e v e n u e s i n s u c h a way t h a t t h e y w i l l p r o v i d e i n c o m e when o i l i s no l o n g e r a v a i l a b l e . One may t h e r e f o r e e x p e c t f l o w s a t commercial terms, i . e . OOF-like f l o w s or p r i v a t e investment to p l a y a s u b s t a n t i a l r o l e i n t h e f i n a n c i a l f l o w s f r o m some o i l producers to the developing c o u n t r i e s . The p r e s e n t p a p e r d e a l s w i t h t h e s u b j e c t u n d e r f o l l o w i n g headings: 1. A c t u a l f i n a n c i a l flows 2 . Funds a n d o t h e r O D A - t y p e 3 . OOF-type f i n a n c i a l 4. P r i v a t e 1. financial Actual financial the institutions institutions institutions. flows The a i d programmes o f E g y p t , K u w a i t , L i b y a a n d S a u d i A r a b i a have been d e s c r i b e d i n t h e " F l o w s o f Resources t o Developing Countries, 1973". The p r e s e n t n o t e i s , t h e r e f o r e , l i m i t e d t o a d d i t i o n a l , most r e c e n t i n f o r m a t i o n . (i) Kuwait I n O c t o b e r 1973 K u w a i t d e c i d e d t o resume i t s f i n a n c i a l a i d t o J o r d a n w h i c h had been i n t e r r u p t e d i n September 1970. T h i s h a s a m o u n t e d i n t h e p a s t t o £16 m i l l i o n ( $ 4 0 m . ) a n n u a l l y and i s e x p e c t e d t o c o n t i n u e a t t h i s l e v e l . 223 I t i s r e c a l l e d t h a t f o l l o w i n g the d e c i s i o n taken a t the Arab Summit M e e t i n g i n Khartoum i n Autumn 1967 K u w a i t has u n d e r t a k e n t o p r o v i d e a n n u a l l y KD47.5 m i l l i o n ($160 m i l l i o n a t t h e 1973 exchange r a t e ) t o Arab c o u n t r i e s w h i c h had s u f f e r e d f r o m t h e war w i t h I s r a e l . A l r e a d y b e f o r e t h a t d a t e K u w a i t had been p r o v i d i n g s u b s t a n t i a l amounts t o o t h e r Arab c o u n t r i e s i n t h e f o r m o f d i r e c t government l o a n s ( i n d e p e n d e n t o f t h e l o a n s t h r o u g h the Kuwait Fund), These l o a n s amounted t o KD120 m i l l i o n ($405 m . ) "by t h e end o f 1968. B u t no such l o a n was e x t e n d e d i n 1969 and 1970 and t h e r e i s no e v i d e n c e t h a t any has been made i n r e c e n t years. I n 1973 K u w a i t has p r o v i d e d some r e l i e f a s s i s t a n c e t o Niger ($0.35 m . ) . A t t h e end o f 1973 t h e IBRD r a i s e d a n o t h e r KD25 m i l l i o n ($85 m . ) i n K u w a i t i n t h e f o r m o f a p u b l i c bond i s s u e . The bonds have a l i f e o f 15 y e a r s and an i n t e r e s t r a t e o f 7 i p e r cent. I t was t h e 6 t h bond i s s u e by t h e IBRD i n K u w a i t w h i c h i n c r e a s e s t h e t o t a l amount r a i s e d i n t h a t c o u n t r y by t h e IBRD t o $439 m i l l i o n . Kuwait thus remained the f i f t h l a r g e s t purchaser o f W o r l d Bank b o n d s . (ii) Lebanon B e i r u t i s p l a y i n g an i n c r e a s i n g r o l e as an i n t e r n a t i o n a l financial centre. The Lebanese a u t h o r i t i e s have encouraged bond i s s u e s by f o r e i g n b o r r o w e r s i n Lebanese c u r r e n c y . I n 1973 f o r e i g n bond i s s u e s r e a c h e d a t l e a s t LL 250 m i l l i o n ($100 m . ) o f w h i c h LL 50 m i l l i o n ($20 m . ) were r a i s e d by t h e European I n v e s t m e n t Bank, A l g e r i a b e i n g a n o t h e r b o r r o w e r . W o r l d Bank bonds i n Lebanese pounds have r e a c h e d t h e v a l u e o f $30 m i l l i o n . (iii) Libya W i t h a c a p i t a l s u b s c r i p t i o n o f 15 m i l l i o n u n i t s o f a c c o u n t ($18 m . ) L i b y a i s t o g e t h e r w i t h E g y p t t h e l a r g e s t c o n t r i b u t o r t o t h e A f r i c a n Development Bank. I n 1973 i t p r o v i d e d a $8 m i l l i o n g r a n t f o r v a r i o u s p r o j e c t s i n Chad ( i m p r o v e m e n t o f a s l a u g h t e r h o u s e i n S a h r , c o n s t r u c t i o n of a h o s p i t a l i n P o r t Lamy and a n o t h e r one i n Mao, c o l l e g e s i n t h e c a p i t a l and i n L a r g e a u ) and c l o s e t o $2 m i l l i o n f o r f a m i n e - s t r i c k e n c o u n t r i e s i n A f r i c a (Upper V o l t a $ 0 . 7 m . , Chad, M a l i and M a u r i t a n i a $0.35m. e a c h ) . L i b y a has r e c e n t l y a g r e e d t o p a r t i c i p a t e i n t h e c o n s t r u c t i o n o f a number o f f a c t o r i e s and an o i l r e f i n e r y i n Togo. L i b y a has p a r t i c i p a t e d i n t h e c r e a t i o n o f t h e M a l t a Dev e l o p m e n t C o r p o r a t i o n t h r o u g h i t s N a t i o n a l I n v e s t m e n t Company. A l g e r i a was a u t h o r i s e d i n 1973 t o r a i s e $51 m i l l i o n i n t h e f o r m o f L i b y a n D i n a r bonds. (iv) Saudi Arabia W i t h f o r e i g n exchange r e s e r v e s i n 1973 a m o u n t i n g t o some $5 b i l l i o n and e x p e c t e d f o r e i g n c u r r e n c y e a r n i n g s i n 1974 i n t h e n e i g h b o u r h o o d o f $20 b i l l i o n S a u d i A r a b i a i s becoming a m a j o r f i n a n c i a l power. S i n c e 1967 S a u d i A r a b i a has p r o v i d e d a n n u a l l y an amount o f r i y a l s 662 m i l l i o n ( a t p r e s e n t exchange r a t e s $186m.) t o E g y p t , J o r d a n and S y r i a . The same amount i s i n c l u d e d i n t h e 1973/74 budget. However, a c c o r d i n g t o t h e p r e s s , Kin,-; F a i s a l i s 224 " b e l i e v e d t o have d e c i d e d t o p r o v i d e $ 1 " b i l l i o n as a i d t o E g y p t and S y r i a . ( l ) (v) reconstruction Iran F o l l o w i n g e a r l i e r p r o p o s a l s t h e Shah o f I r a n i n F e b r u a r y 1974 p l e d g e d a b o u t $ 1 b i l l i o n t o r e l i e v e b a l a n c e - o f - p a y m e n t s problems o f d e v e l o p i n g o i l - i m p o r t e r s . His proposal contains three elements: - a $2-3 b i l l i o n fund w i t h p a r t i c i p a t i o n o f o i l e x p o r t e r s and m a j o r i n d u s t r i a l i s e d c o u n t r i e s t o be managed i n c l o s e c o - o p e r a t i o n w i t h IBRD and IMF. T h i s p r o p o s a l w i l l be d i s c u s s e d a t t h e OPEC m e e t i n g i n J u n e ; - p u r c h a s e b y I r a n o f IBRD b o n d s ; - a l o a n t o I M F ' s p r o p o s e d new l e n d i n g facility. I n a d d i t i o n I r a n has a g r e e d t o s e l l o i l t o I n d i a on c r e d i t to invest i n j o i n t ventures i n India. 2. Funds and o t h e r QDA-type and institutions S e v e r a l o i l p r o d u c e r s have e s t a b l i s h e d o r a r e i n t h e p r o c e s s o f e s t a b l i s h i n g f i n a n c i a l i n s t i t u t i o n s aimed a t p r o v i d i n g concessional aid to developing countries. They a r e described i n the f o l l o w i n g paragraphs. A. Bilateral aid (i) institutions K u w a i t Fund f o r Arab Economic Development (KFAED) The K u w a i t Fund, t h e f i r s t d e v e l o p m e n t f u n d i n t h e A r a b W o r l d , was c r e a t e d i n December 1 9 6 1 as an autonomous agency o f t h e K u w a i t Government. I t s p u r p o s e i s t o a s s i s t Arab s t a t e s t o d e v e l o p t h e i r economies b y p r o v i d i n g f i n a n c i a l a n d , t o a l e s s e r extent, technical assistance. The F u n d ' s p o l i c y i s t o p r o v i d e loans a t concessional terms t o s p e c i f i c p r o j e c t s which are l i k e l y t o have a f a v o u r a b l e i m p a c t on t h e b o r r o w e r ' s economic d e v e l o p m e n t and p r o m i s e a s a t i s f a c t o r y r a t e o f f i n a n c i a l r e t u r n . ( 1 ) S a u d i A r a b i a and o t h e r o i l p r o d u c i n g c o u n t r i e s a l s o s u p p o r t e d the E g y p t i a n war e f f o r t w i t h s u b s t a n t i a l amounts. A l o n e i n t h e f i r s t h a l f o f O c t o b e r 1973 $920 m i l l i o n was made a v a i l a b l e o f w h i c h S a u d i A r a b i a p r o v i d e d $300 m i l l i o n , K u w a i t 250 m . , L i b y a 170 m . , Q a t a r and Abu D h a b i 100 m i l l i o n each. I n F e b r u a r y 1974 S a u d i A r a b i a a l s o p r o v i d e d a $16 m i l l i o n g r a n t f o r m i l i t a r y a s s i s t a n c e t o Uganda. 225 The s t a t u t o r y c a p i t a l o f t h e Fund i s K u w a i t D i n a r 200 m i l l i o n ($676 m. a t t h e 1973 exchange r a t e ) o f w h i c h 101 m i l l i o n has been p a i d i n . By March 1973, i . e . a t t h e end o f i t s e l e v e n t h f i n a n c i a l y e a r , t h e KFAED had c o m m i t t e d 39 l o a n s a m o u n t i n g t o KD103 m i l l i o n ($348 m . ) t o 12 r e c i p i e n t c o u n t r i e s and 10 g r a n t s t o t a l l i n g KD&76 m i l l i o n ( $ 2 . 6 m . ) . Cumulative l o a n d i s b u r s e m e n t s had r e a c h e d KD74.7 m i l l i o n ($252 m . ) by t h a t t i m e and r e p a y m e n t s KD18.9 m i l l i o n ($64 m . ) . The m a i n r e c i p i e n t s o f l o a n s have been Sudan ( 1 5 $ ) , T u n i s i a ( 1 4 $ ) , E g y p t ( 1 3 $ ) , M o r o c c o , J o r d a n and A l g e r i a w i t h a b o u t 10$ each. The d i s t r i b u t i o n by s e c t o r s shows a s t r o n g c o n c e n t r a t i o n on t r a n s p o r t a t i o n and s t o r a g e ( 3 9 $ ) , f o l l o w e d by a g r i c u l t u r e ( 2 8 $ ) , power ( 2 0 $ ) and i n d u s t r y ( 1 3 $ ) . The g r a n t e l e m e n t o f l o a n s ( c a l c u l a t e d w i t h a 10$ d i s c o u n t r a t e ) v a r i e s a c c o r d i n g t o t h e r e c i p i e n t and t h e s e c t o r . I t i s highest i n agriculture w i t h a w e i g h t e d a v e r a g e o f 48 p e r c e n t and l o w e s t i n i n d u s t r y (29$ g r a n t e l e m e n t ) . Some p r o j e c t s have been j o i n t l y f i n a n c e d w i t h t h e W o r l d Bank Group. S i n c e 1963 t h e D i r e c t o r - G e n e r a l o f t h e K u w a i t Fund has been M r . A b d e l a t i f Y. Al-Hamad. M r . Al-Hamad i s a l s o Managing D i r e c t o r o f t h e K u w a i t I n v e s t m e n t Company (see b e l o w ) , Chairman o f t h e Compagnie Arabe e t I n t e r n a t i o n a l e d ! I n v e s t i s s e m e n t (see b e l o w ^ , and on t h e Board o f D i r e c t o r s o f t h e A r a b Fund (see b e l o w ) . D u r i n g 1 9 7 1 / 7 2 , t h e K u w a i t Fund managed t h e a d m i n i s t r a t i v e and f i n a n c i a l a f f a i r s o f t h e n e w l y c r e a t e d Arab Fund. (ii) K u w a i t Development Fund f o r n o n - a l i g n e d countries A c c o r d i n g t o an o f f i c i a l announcement o f 1 s t O c t o b e r 1973 t h e K u w a i t Government has d e c i d e d t o s e t up a Development Fund No f u r t h e r d e t a i l s have been f o r the non-aligned c o u n t r i e s . made p u b l i c . (iii) Abu D h a b i Fund I n e a r l y 1973 Abu D h a b i s t a r t e d t o s e t up a Fund w i t h an i n i t i a l amount o f D i n a r 8 m i l l i o n ($27 m . ) . Total authorised c a p i t a l i s D i n a r 50 m i l l i o n ($169 m . ) . Yemen ( A . R . ) , S y r i a , I n the beginning T u n i s i a and Sudan w i l l be t h e f i r s t r e c i p i e n t s . l o a n s s h a l l be e x t e n d e d f o r 7 t o 10 y e a r s a t an i n t e r e s t r a t e o f 3.5 to 4.5 per c e n t . The Fund i s i n t e r e s t e d i n j o i n t o p e r a t i o n s w i t h t h e W o r l d Bank Group. Managing D i r e c t o r i s M r . Hassan Abbas Z a k i , a f o r m e r E g y p t i a n M i n i s t e r o f Economics, who has been p r i n c i p a l f i n a n c i a l a d v i s o r t o S h a i k h Zayed, r u l e r o f Abu D h a b i , s i n c e 1970. 226 B. Multilateral (i) institutions A r a b Fund f o r Economic and S o c i a l Development The agreement e s t a b l i s h i n g t h i s Fund was r e a c h e d i n May 1968 b u t t h e f i r s t m e e t i n g o f t h e b o a r d t o o k p l a c e o n l y i n November 1972. The Fund i s a j o i n t A r a b f i n a n c i a l i n s t i t u t i o n w i t h headquarters i n Kuwait. Managing D i r e c t o r i s M r . Saeb J a r o u d i , f o r m e r M i n i s t e r o f Economic Development i n t h e Lebanon and b e f o r e t h a t c h i e f e c o n o m i s t o f t h e K u w a i t Fund. The Members h i p o f t h e Fund i s composed o f A r a b League c o u n t r i e s ( * ) . The A r a b Fund has a c a p i t a l o f KD100 m i l l i o n ($338 m . ) and a b o r r o w i n g a u t h o r i t y o f KD200 m i l l i o n ($678 m . ) . The m a i n c o n t r i b u t o r s a r e K u w a i t ($101 m . ) and L i b y a ($41 m . ) . Saudi A r a b i a has s t a t e d i t s i n t e n t i o n t o j o i n b u t has n o t y e t c o n tributed. The Fund i s i n t e n d e d t o o p e r a t e i n Member c o u n t r i e s o f t h e A r a b League o n l y and i n p a r t i c u l a r t o ( a ) f i n a n c e p r o d u c t i v e i n v e s t m e n t on s o f t t e r m s ( w h i c h may v a r y a c c o r d i n g t o ( b ) encourage p r i v a t e and t h e p r o j e c t and t h e r i s k i n v o l v e d ) ; p u b l i c i n v e s t m e n t and ( c ) p r o v i d e t e c h n i c a l a s s i s t a n c e and expertise. As o f J a n u a r y 1974, KD20 m i l l i o n ($68 m . ) had been committed. I n p a r t i c u l a r , t h e Fund has r e c e n t l y a g r e e d t o l e n d A l g e r i a $50 m i l l i o n ( a t 2 . 5 p e r c e n t i n t e r e s t o v e r 30 y e a r s ) t o b u i l d an o i l - l o a d i n g t e r m i n a l a t A r z e w . This p r o j e c t i s . a l s o s u p p o r t e d b y Germany and t h e ' W o r l d Bank. (ii) S p e c i a l A r a b Fund f o r Africa I n J a n u a r y 1974 t h e A r a b c o u n t r i e s d e c i d e d t o c r e a t e a $200 m i l l i o n S p e c i a l Fund f o r A f r i c a . The Fund i s t o be e s t a b l i s h e d i n March 1974 t o s u p p o r t t h e p u r c h a s e o f o i l by A f r i c a n c o u n t r i e s and t o d e v e l o p o i l r e s o u r c e s i n A f r i c a . A n o t h e r s t a t e d p u r p o s e o f t h e Fund i s t o compensate A f r i c a n c o u n t r i e s f o r t h e economic l o s s t h e y have s u f f e r e d f r o m b r e a k i n g off relations with Israel. The m a i n c o n t r i b u t o r s t o t h e S p e c i a l Fund w i l l be S a u d i A r a b i a ($25 m i l l i o n ) , K u w a i t ( * * ) and A l g e r i a ($20 m i l l i o n e a c h ) . The U n i t e d A r a b E m i r a t e s and Q a t a r w i l l pay $10 m i l l i o n e a c h , Lebanon p l a n s t o c o n t r i b u t e $ 1 . 5 m . , and E g y p t , S y r i a and B a h r e i n $1 m. e a c h . The L i b y a n c o n t r i b u t i o n , i f a n y , i s n o t known. Loans o u t o f t h e S p e c i a l Fund a r e t o have t h e following conditions: 1$ i n t e r e s t r a t e , 3 y e a r s g r a c e , 5 y e a r s repayment. Loan r e c i p i e n t s w i l l be s e l e c t e d by t h e OUA i n c o n s u l t a t i o n w i t h t h e A r a b League. The Fund m i g h t be u l t i m a t e l y l i n k e d t o t h e A r a b Bank f o r A f r i c a (see b e l o w ) . (*) A l g e r i a , B a h r e i n , E g y p t , I r a q , J o r d a n , K u w a i t , Lebanon, L i b y a , M a u r i t a n i a , M o r o c c o , Oman, Q a t a r , S a u d i A r a b i a , S o m a l i a , Sudan, S y r i a , T u n i s i a , U n i t e d A r a b E m i r a t e s ( i n c l . Abu D h a b i ) , Yemen A . R . , Yemen P . D . R . (**) I n F e b r u a r y 1974 K u w a i t announced t h a t i t w o u l d i n c r e a s e i t s c o n t r i b u t i o n t o t h e S p e c i a l Fund f r o m $20 m. t o $30 m. 227 (iii) A r a b T e c h n i c a l A s s i s t a n c e Fund f o r Africa A t t h e same m e e t i n g i n J a n u a r y 1974, t h e A r a b c o u n t r i e s d e c i d e d t o s e t up a $15 m i l l i o n T e c h n i c a l A s s i s t a n c e Fund. I n a d d i t i o n t o t h e above f u n d s w h i c h a r e c l e a r l y i n t e n d e d t o p r o v i d e ODA-type f l o w s , a number o f development banks a r e a t v a r i o u s stages o f c r e a t i o n . I t i s n o t known t o what e x t e n t t h e s e i n s t i t u t i o n s w i l l c o n c e n t r a t e on l e n d i n g a t m a r k e t r a t e s (IBRD s t y l e ) as opposed t o c o n c e s s i o n a l l e n d i n g (IDA s t y l e ) . Somewhat a r b i t r a r i l y t h e y have been i n c l u d e d i n t h i s s e c t i o n r a t h e r t h a n u n d e r OOF-type i n s t i t u t i o n s b e l o w . ( i v ) A r a b Bank f o r I n d u s t r i a l and A g r i c u l t u r a l ment i n A f r i c a Develop- The c r e a t i o n o f t h i s Bank was d e c i d e d upon a t t h e 6 t h Arab Summit M e e t i n g i n A l g i e r s i n 1973 on t h e i n i t i a t i v e o f Kuwait. A c c o r d i n g t o an announcement c a p i t a l s u b s c r i p t i o n s have a l r e a d y begun a l t h o u g h t h e s t a t u t e s o f t h e Bank have n o t y e t been drawn u p . The c a p i t a l o f t h e Bank w h i c h had been v a r i o u s s t a t e d as $125 m . , $195 m. and $500 m. was f i n a l l y f i x e d a t $206 m. a t t h e C a i r o M e e t i n g o f Arab F i n a n c e M i n i s t e r s i n M i d - F e b r u a r y 1SP4. A c c o r d i n g t o t h e I r a q Mews Agency, I r a q had d e c i d e d t o make t h e l a r g e s t c o n t r i b u t i o n w i t h $30 ra. f o l l o w e d by S a u d i A r a b i a w i t h $25 m i l l i o n , K u w a i t ( * ) , A l g e r i a , and t h e U n i t e d Arab E m i r a t e s each w i t h $20 m i l l i o n . Other Arab s t a t e s are p a r t i c i p a t i n g w i t h sums r a n g i n g f r o m $2 m i l l i o n t o $10 m i l l i o n , ( v ) A r a b Bank f o r Development i n Asia A p r o p o s a l t o e s t a b l i s h a s i m i l a r bank f o r A s i a r e p o r t e d l y under c o n s i d e r a t i o n . (vi) is I s l a m i c Development Bank I n December 1973, 25 I s l a m i c s t a t e s s i g n e d an agreement t o e s t a b l i s h an I s l a m i c Development Bank w i t h a c a p i t a l o f $1 b i l l i o n . The c r e a t i o n o f t h e Bank whose head o f f i c e w i l l be Jedda was l a r g e l y due t o S a u d i A r a b i a n i n i t i a t i v e and a s p e c i a l c o m m i t t e e has been f o r m e d f o r t h i s p u r p o s e u n d e r t h e S e c r e t a r y - G e n e r a l o f t h e S a u d i A r a b i a n based I s l a m i c C o n g r e s s , M r . Tanku A b d u l Rahman. S u b s c r i p t i o n s have been announced so f a r by Q a t a r ($20 m . ) , Lebanon ($5 m . ) and J o r d a n ( $ 1 . 2 m . ) . (*) I n F e b r u a r y 1974 K u w a i t announced t h a t i t w o u l d i n c r e a s e i t s c o n t r i b u t i o n t o t h e A r a b Bank f r o m $20 m. t o $50 m. 228 (vii) OPEC Development Bank A p r o p o s a l t o e s t a b l i s h an OPEC Development Bank w i l l be d i s c u s s e d a t Q u i t o , E c u a d o r , on June 10, 1974. The c a p i t a l o f Members t h e p r o p o s e d bank has been r e p o r t e d as $1 o r 2 b i l l i o n . w o u l d be t h e OPEC members: I r a n , K u w a i t , Saudi A r a b i a , L i b y a , Abu D h a b i , A l g e r i a , I n d o n e s i a , V e n e z u e l a , N i g e r i a , I r a q , Q a t a r , E c u a d o r , Gabon. 3. OOF-type f i n a n c i a l institutions A number o f i n s t i t u t i o n s have been c r e a t e d t o i n v e s t p u b l i c funds from the o i l - p r o d u c i n g c o u n t r i e s abroad a t commercial t e r m s and l a r g e l y u s i n g t h e methods o f p r i v a t e i n v e s t m e n t f l o w s . A l i s t o f such i n s t i t u t i o n s w h i c h have come t o t h e a t t e n t i o n o f the D i r e c t o r a t e i s given below. A r a b A f r i c a n Bank (a) Head O f f i c e Cairo Established 1964 Capital £ 1 0 , 0 0 0 , 0 0 0 ($25 m . ) Shareholders (Egypt) Kuwait M i n i s t r y o f Finance and I n d u s t r y E g y p t i a n P u b l i c O r g a n i s a t i o n o f Banks P u b l i c and p r i v a t e i n t e r e s t s f r o m o t h e r A r a b and A f r i c a n c o u n t r i e s S p e c i a l E g y p t i a n l e g i s l a t i o n g i v e s t h i s bank t h e status o f an i n t e r n a t i o n a l o r g a n i s a t i o n . tb, L i b y a n A r a b F o r e i g n Bank Head O f f i c e Established Tripoli ? Capital LD 20 m i l l i o n Shareholders ($68 L i b y a n Government million) T h i s bank p a r t i c i p a t e s i n f i n a n c i a l i n s t i t u t i o n s Uganda, Chad, M a u r i t a n i a , Lebanon and E g y p t . in K u w a i t I n v e s t m e n t Company Group (c) (i) K u w a i t I n v e s t m e n t Company Head O f f i c e ' Established Kuwait ? Capital KD 7 . 5 m i l l i o n Shareholders ($25 million) K u w a i t Government Other Kuwait i n t e r e s t s A p p a r e n t l y t h i s company has e n t e r e d i n t o a c o o p e r a t i o n agreement w i t h A m e r i c a n E x p r e s s . 50?o 34% 33f° 331° 229 (ii) Banque S e n e g a l o i C u w a i t i e n n e Head Office Established 1974 Capital 1 billion Shareholders (d) afInvestissement Dakar F CFA ( $ 4 million) 50$ 25$ 25$ K u w a i t I n v e s t m e n t Company Government o f S e n e g a l P r i v a t e Senegal i n t e r e s t s A r a b I n v e s t m e n t Company ( S o c i e t e Arabe d ' I n v e s t i s s e m e n t s ) Head Office Established d e c i s i o n December Capital £100 m i l l i o n Shareholders 1973 ($250 m.) Egypt Saudi A r a b i a Kuwait Abu D h a b i Qatar Sudan I n v e s t m e n t s t o be c o n c e n t r a t e d on a g r i c u l t u r e a n d Shipping; t h e company w i l l be open t o p r i v a t e A r a b investors wishing to r e p a t r i a t e c a p i t a l . (e) Arab I n t e r n a t i o n a l (i) Established Capital Joint ($75 m . ) Egyptian interests Libyan i n t e r e s t s Company b e t w e e n L o n r h o and A r a b I n t e r n a t i o n a l Head o f f i c e : Established ? 1973 Capital Shareholders (f) Inter- 1973 £30 m i l l i o n Shareholders (ii) Bank Group I n t e r n a t i o n a l A r a b Bank p r e v i o u s l y t h e E g y p t i a n n a t i o n a l Bank f o r F o r e i g n T r a d e a n d D e v e l o p m e n t Head O f f i c e Cairo Lonrho I n t e r n a t i o n a l A r a b Bank Banque L i b a n o B r £ s i l i e n n e Head office Established Capital Shareholders Beirut SAL Bank 230 Private financial institutions The f o l l o w i n g ( i n c o m p l e t e ) l i s t d e s c r i b e s a number o f p r i v a t e j o i n t f i n a n c i a l i n s t i t u t i o n s w h i c h have been e s t a b l i s h e d l a r g e l y t o c h a n n e l o i l money i n t o p r o d u c t i v e i n v e s t m e n t s i n both developed.and developing c o u n t r i e s . 1. UBAF Group (a) U n i o n de Banques A r a b e s e t F r a n g a i s e s Head O f f i c e Established 1970 Capital FF.100,000.000 Shareholders (UBAF) Paris C r e d i t Lyonnais Banque F r a n g a i s e du Commerce Ext^rieur P r i v a t e French i n t e r e s t s S u b - t o t a l European interests 31.98$ 8.00$ 0.02$ 40.00$ A r a b Bank ( J o r d a n ) Banque E x t e r i e u r e d ' A l g ^ r i e Commercial Bank o f S y r i a L i b y a n A r a b F o r e i g n Bank R a f i d a i n Bank ( I r a q ) C e n t r a l Bank o f E g y p t A r a b A f r i c a n Bark ( A r a b m u l t i national ) Banque du Maroc A l a h l i Bank o f K u w a i t R i y a d Bank ( S a u d i A r a b i a ) Bank o f J o r d a n Sudan Commercial Bank Banque N a t i o n a l e de T u n i s i e J o r d a n N a t i o n a l Bank S o c i £ t £ T u n i s i e n n e de Banque Banque A u d i S . A . L . (Lebanon) Banque G. T r a d ( C r e d i t L y o n n a i s ) (Lebanon) A l a h l i Bank L i m i t e d ( D u b a i ) Bank o f B a h r e i n and K u w a i t C e n t r a l Bank o f Yemen (Sanaa/Yemen Arab R e p u b l i c N a t i o n a l Bank o f Yemen ( P e o p l e ' s D e m o c r a t i c R e p u b l i c o f Yemen) 6.2$ 3.8?0 1.9$ 1.9$ 1.1$ 0.8$ 0.6$ 0.61o 0,6$ •. • . 0 3$ 0.5$ o,-;$ 0.1 $ 0.1$ 0.1$ 231 Yemen Bank f o r R e c o n s t r u c t i o n and D e v e l o p m e n t (Sanaa/Yemen Arab R e p u b l i c ) Banque A r a b e L i b y e n n e M a u r i t a n i e n n e p o u r l e Commerce E x t £ r i e u r e t l e D^veloppement ( M a u r i t a n i a ) P r i v a t e Arab I n t e r e s t s S u b - t o t a l Arab office (o) 1972 Capital £2,000,000 £5,000,000) ( t o be r a i s e d to UBAF P a r i s Arraab F o r e i g n Bank Libyan A M i d l a n d" "Bank ""•.la " 50% 25% U n i o n e d i Banche A r a b e ed E u r o p e e - UBAE Head o f f i c e : Rome Established 1972 Capital L.15 Shareholders (a) - London Established Shareholders 0.1$ 0.001% interests U n i o n de banques a r a b e s e t F r a n g a i s e s UBAF L i m i t e d Head 0.1 billions U n i o n de Banques A r a b e s e t Frangaises - U.B.A.F. Banco d i Roma Banca N a z i o n a l e d e l L a v o r o Societa Finanziaria Telefonica p e r A z i o n i - STET I s t i t u t o Ligure Interessenze I n d u s t r i a l i e C o m m e r c i a l i SpA (Finsider) Societa I t a l i a n a per Condotte dfAcqua I s t i t u t o d i C r e d i t o per l e Imprese di Pubblica U t i l i t a - I . C . I . P . U . 51% 9.5 9.5 6% U n i o n de Banques A r a b e s e t E u r o p ^ e n n e s UBAE Head office Luxembourg ( b r a n c h i n Establsshed 1973 Capital DM.30,000,000 Shareholders Franfurt) A r a b Bank L i m i t e d ) A r a b Bank O v e r s e a s L t d . ) Bayerische Vereinsbank Commerzbank A . G . Commerzbank I n t e r n a t i o n a l S . A . Westdeutsche Landesbank Girozentrale U n i o n de Banques A r a b e s e t Frangaises - U.B.A.F. 33 1/3% 33 1/3% 33 1/3% 232 (e) U n i o n de Banques A r a b e s e t Nippones - UBAN Head o f f i c e Tokyo and Hong Kong Established 1973-1974 Capital $25,000,000 Shareholders Bank o f Tokyo Long Term C r e d i t Bank o f Japan M i t s u i Bank Nomura S e c u r i t i e s Sanwa Bank UBAF P a r i s 5 A r a b Banks 2. FRAB Group (a) F r e n c h - A r a b Bank f o r I n t e r n a t i o n a l I n v e s t m e n t s (Banque F r a n c o Arabe d ' I n v e s t i s s e m e n t s I n t e r n a t i o n a u x ) (FRAB Bank I n t e r n a t i o n a l ) Head o f f i c e Established Capital Shareholders Paris 1970 F F . 5 0 , 0 0 0 , 0 0 0 ( t o be r a i s e d FF.100,000,000) to Societe G^nerale (France) S o c i e t y G ^ n ^ r a l e de Banque (Belgium) Swiss Bank C o r p o r a t i o n ( S o c i £ t £ de Banque S u i s s e ) Banco U r q i n j o ( S p a i n ) 36% S u b - t o t a l European S h a r e h o l d e r s 50$ 7% 6% 1% FRAB-Trading and C o n t r a c t i n g Company 7.7$ K u w a i t I n v e s t m e n t Company 4% Kuwait Foreign Trading Contracting and I n v e s t m e n t Company 4$ N a t i o n a l Bank o f K u w a i t 1.595 A1 Sagar and B r o s . 1.14% P r i v a t e I n t e r e s t s , A1 Sagar Group 3.30% Other Kuwait F i n a n c i a l I n s t i t u t i o n s ( i n c l . K u w a i t I n s u r a n c e Company Commercial Bank o f K u w a i t ) 2.60% Other p r i v a t e Kuwait i n t e r e s t s 12.16% S u b - t o t a l Kuwait I n t e r e s t s 36.40% 233 2.2% 1.2 fo Bahrein Abu D h a b i Dubai Sharjah 1.8% UOfo S u b - T o t a l o t h e r Arab G u l f Interests 6.21o L i b y a (Sahara Bank, L i b y a I n s u r a n c e Company) Bank o f T u n i s i a Societe Nationale d 1 I n v e s t i s s e ments ( T u n i s i a ) 0>) European Arab Holding Head Luxembourg office Established 1972 Capital L.Frs. Shareholders 1 billion A m s t e r d a m - R o t t e r d a m Bank N . V . Amsterdam; C r e d i t e n s t a l t Bankverein, Vienna; D e u t s c h e Bank A . G . , F r a n k f u r t am-Main; M i d l a n d Bank L i m i t e d , L o n d o n ; S o c i e t e G e n e r a l e de Banque, Brussels; Societe Generale, P a r i s ; S u b - t o t a l E u r o p e a n Bank I n t e r n a t i o n a l Company 45% E g y p t i a n N a t i o n a l Bank o f F o r e i g n T r a d e and D e v e l o p m e n t Abu D h a b i Fund f o r A r a b Economic Development, Banque N a t i o n a l e d ' A l g e r i e , N a t i o n a l Bank o f E g y p t ; n a t i o n a l B a n k - o f 10 j ••.-.• t , L i b a n a i s v ;:> /.• I s Commerce, I:-," ; H i s r , L e - ••,. ; ( Llbanai; J", . . a n o n ; Ilrt: a l Commercial Bank, L i b y a ; M a r o c a i n e du Commerce Byterieur, N a L i o n e l C o m m o r c i a l Bank, S s . u l i Aivbia^, S u b - t o t a l Arab FRAB-Bank Shareholders International 45% 234 European Ara"b Bank Head o f f i c e Brussels Established Capital Shareholders European A r a b H o l d i n g Others E u r o p S i s c h e A r a b i s c h e Bank Head o f f i c e Frankfurt Established Capital Shareholders European A r a b Others Holding C A I I Group Compagnie Arabe e t I n t e r n a t i o m l e Society Holding Head o f f i c e : d'Investissements Luxembourg Established Capital Shareholders US$30,000,000 D r e s d n e r Bank A . G . (W. Germany) O s t e r r e i c h i s c h e LSnderbank ( A u s t r i a ) Banque de B r u x e l l e s ( B e l g i u m ) Banco do B r a s i l ( B r a z i l ) Canadian I m p e r i a l Bank o f Commerce Banco C e n t r a l ( S p a i n ) Bank o f A m e r i c a (USA) Banque N a t i o n a l e de P a r i s ( F r a n c e ) Banque N a t i o n a l e de P a r i s I n t e r c o n t i n e n t a l (France) Algemene Bank N e d e r l a n d EV Banca N a z i o n a l e d e l L a v o r o ( I t a l y ) Sumitomo Bank ( J a p a n ) S o c i 6 t £ F i n a n c i f e r e Europeenne (Luxembourg) B a r c l a y s Bank LTD. U n i o n de Banques S u i s s e s Government o f Abu D h a b i N a t i o n a l Commercial Bank ( S a u d i Arabia) Bank o f K u w a i t and t h e M i d d l e E a s t (Kuwait) G u l f Bank ( K u w a i t ) K u w a i t I n v e s t m e n t Company 235 Banque du L i t a n e t d ' o u t r e m e r N a t i o n a l I n v e s t m e n t Company ( L i b y a ) Banque C e n t r a l e P o p u l a i r e ( M a r o c ) Banque M a r o c a i n e p o u r l e Commerce 1'Industrie Banque N a t i o n a l e p o u r l e L e v e l o p p e m e n t economique (Maroc) Q a t a r N a t i o n a l Bank Banque N a t i o n a l e de T u n i s i e U n i o n B a n c a i r e p o u r l e Commerce e t 1'Industrie (Tunisie) (b) Banque A r a b e d ' I n v e s t i s s e m e n t s Head o f f i c e : Paris Established: 1973 Capital : FF.50,000,000 Shareholders : Internationaux CAII 99.9% Banco C e n t r a l ( S p a i n ) Banque du L i b a n e t d ' o u t r e m e r ( L e b a n o n ) Banque N a t i o n a l e de P a r i s ( F r a n c e ) Banque N a t i o n a l e de P a r i s i n t e r continentale Banque N a t i o n a l e de T u n i s i e Banco de B r a s i l . Bank o f K u w a i t and t h e M i d d l e E a s t KSG C a n a d i a n I m p e r i a l Bank o f Commerce S o c i e t e F i n a n c i & r e Europeenne S t a t e o f Abu D h a b i K u w a i t I n v e s t m e n t Company S a u d i N a t i o n a l C o m m e r c i a l Bank N a t i o n a l I n v e s t m e n t Company O s t e r r e i c h i s c h e LSnderbank U n i o n B a n c a i r e p o u r l e Commerce et 1'Industrie U n i o n de Banques S u i s s e s Inter£ts prives particuliers I t i s i n t e n d e d t o o b t a i n more by Arab f i n a n c i a l I n s t i t u t i o n s . 4. participations I n v e s t m e n t a n d F i n a n c e Bank ( I N F I ) (Banque d 1 I n v e s t i s s e m e n t e t de f i n a n c e m e n t Head office 1974 Capital £Lib SAL) Beirut Established Shareholders BAII 1,500,000 Banque A u d i SAL C a i s s e C e n t r a l e de Banques P o p u l a i r e s Hambros Bank L i m i t e d M i t s u i Bank L i m i t e d Nomura S e c u r i t i e s Co. L i m i t e d G-roupe R e n a u l t P r i v a t e Arab i n t e r e s t s 35% 8% 8% 8% 8% 8% 25% 236 T H E NEW YORK T I M E S M a r c h 13, 1974 The Petrodollar Flow Kuwait and Abu Dhabi, appear to recognize this. j professor at Georgetown Uni-j versity in Washington, notes j Professor Oweiss- noted that that the Arabs have already; Saudi Arabia has proposed to reduce the current price ofj sit up four major financial con-i Persian Gulf oil "once justi-1 sortia in collaboration withj fiable political and economic j By LEONARD SILK American and European interdemands of Arab countries are I There is a school of eco-i tries pay out to the oil-producmet and once rich oil-consumnomics whose fundamental :ing — countries, because the i t - ests. tenet is that everything happens money will flow back to the One is the Union des Banques iing countries pursue a policy!1 for the best Among the his- oil-consuming countries as in- et Frangaise (U.B.A.F.), estab-l of genuine cooperation with the toric claims for this principle vestments or to pay for good&ti lished in Paris in 19709 with developing countries." are the following: flit doesn't matter if the. out- jmOre than $700-million in asfllf the taxes of flow of money to pay for oil sets. This is 40- per cent owned He added that Tit is not m j „ , the rich are cut, causes a temporary cut in con- by Credit Lyonnais the big the economic interest ot oil* ,benefits will sumption in the oil-consuming French bank, but it is controlled exporting countries to push Economic ^ Analysis ^ J m m ^ countries, because this will con- by 14 Arab banks. U.B.A.F. has the price of oil beyond the interval in which demand is institute a form of saving, and larly, if the rich the "petrodollars" will then in- subsidiaries in London, Rome, elastic." or the jniddle class build more crease the world's stock of Frankfurt, Luxembourg and ' The_ sharp increases in oil new houses, this will benefit capital, furthering growth and Tokyo; partners of these sub- prices will mean a huge transsidiaries include several big fer of real income and wealth the poor, because the standing damping down inflation. 4 European banks and the Bank] from the West—a real lowering stock of existing houses will Volume to Be Great of living standards. . trickle down to the poor. (The However, the volume of pet-1 of Tokyo. trickle-down theory is one of rodollars may be too great for The three other consortia! As economists of the First [ the major contributions of this the world monetary system to' [are: National City Bank put it, "The school of Panglossian eco- handle. The whole system could flTfte Banque Franc-Arabe) discomfort of facing up to this nomics.) harsh truth has engendered ild'lnvestissement Internationbreak down. 1 <1A fall in output, income aux (E.R.A.B.), chartered in lusions—notably that, for conand employment is good be- J. Carlin Englert of New York Paris in 1969 by the Kuwait suming countries, the adjustcause it will restore the econ- University has made fresh esti- Investment Company in part- ment can be eased by more mates of the money flows from nership with the French SoctetS rapid inflation' or by governomy to a sound basis. 11 major industrialized nations flFor every seller of stock, to defray the costs of higher- Gten6rale and the Society de ment intervention in the marketplace." I there is a buyer. Strong hands priced petroleum and petroleum I Banque Suisse; . flThe European Arab Bank, But the real transfers of in^ [will take over the assets once products this year. He found, come and the potential 'dis-l started in 1972, with headquar'held by the week. that the United States, Canada, ' ^Equilibrium is the law of Japan, West Germany, France, *. ters in Luxembourg, which is ruption of the world economv [economic life. If people spend Britain and five other European made up of 16 Arab financial threaten to exacerbate bOtn| more money for food, they will countries would see their oil institutions (including E.R.A.B.) global inflation and recession. Hopes for Price Cuts have less to spend for "other bills increase from $42.6-billion and seven European banks; things, so inflation will not re- in 1973 to $108.7-billion in, flAnd la Compagnie Arabe It is the belated recognition sult. If one nation loses mone- 1974. et Internationale d'lnvestisse- of the gravity of these dangers reserves, another nation ment, incorporated in Luxem- —not only to the industrialized [will gain them, so the world What will the Arab oil states' bourg in January, 1973, which nations but to the oil-producing monetaiy system will not suffer do with their money? Much, of - (is owned by 24 Arab and other states as well—that has given ^ ibraks, including the Bank of rise to hopes that the Arab [from either inflation or defla- it will indeed flow west. America, West German, states rtieeting hi Tripoli today Ibrahim M. Oweiss, a tion. Italian, Japanese and French may be ready to lift the oil To those principles of sym- of Egypt who is an. [institutions. [embargo and expand produc-! metry, balance and divine autojtion. The Western nations and maticity, the oontemporary folArab Business Sought Japan are also hoping for some lowers of Dr. Pangloss (Voltaire In addition to these major price cuts. named him "Professor of MetaArab combines, many Western The United States has pressed physico - Theologio - Cosmobanks and brokers are compet- hard for such concessions -to lonigology") have added the ing for Arab business, led by the Western nations, while following doctrines: the First National City Bank France has been following a flit doesn't matter how much; of New York, with branches go-it-alone line, seeking to money the oil-consuming coun-| in Beirut, Saudi Arabia, Bahrain make her own deals with fhfe and Dubai, and the Chase Man- Arabs. hattan Bank, with bran-hes Jh Even if the Arabs end the Beirut and Bahrain. Chase embargo, however, the threat (Manhattan and the Morgan to the world economy will not Guaranty Trust Company of evaporate over night. Inflation New York are the largest hold- is raging, and the Western poers of Saudi Arabian Govern- litital and economic alliance is ment deposits. severely strained — possibly But the flow of capital from' ^ T h e deciples of Dr. Pangloss the oil-consuming to the oii-j'should remember that their producing countries is so huge'(shattered. las to threaten hyperinflation master barely missed losing his I in the Western economies. head in the Inquisition and I The, more moderate Arab wound up living humbly on [countries, such as Saudi Arabia, the farm of Candlde. If the Theory of Panglossian Economics Is Right—and It's Not—All Is Well 237 9l|t Journal of {Bommmr APR 4 1374 Euromarket Challenge: Recycling Arab Funds By ALENA WELS Journal of Coinmercc Staff (First of a Series) LONDON — Johannes Witteveen, the managing director of the International Monetary Fund, is currently touring the Middle East oil producing countries with the hope of enlisting their support in helping the world deal with sharply higher energy costs. The Shah of Iran has already pledged some support. But officials and bankers here are well aware that the main job of recycling the $35 billion to $60 billion in excess oil revenues this year will fall on the banking community. The opportunities for profit to the "City," London's financial district, are huge and banks here are carefully cultivating their already extensive ties with the Arab world. There are, however, serious pitfalls for financial institutions of which even the most euphoric and confident bankers are acutely aware. A. T. Mitchell and P. C. Day. assistant general managers of Barclays Bank, expressed their serious concern in an interview that the banking system just wasn't geared to handle the influx of Arab money. A lot of banks with balance sheets under pressure will face the exposure of borrowing short-term Arab funds to lend on longer and longer terms. These funds, they cautioned, could be pulled out and, if the worst came to the worst, the Arabs could bypass the banking system altogether. Britain. France, Italy, Denmark, Austria and various other countries are already tapping the Eurodollar market for bUlions of dollars at a time when Arab 3 7 - 2 1 1 O - 74 - 16 oil revenues are only beginning to flow. Heaven knows where interest rates would be. bankers here say, if very considerable funds weren't coming into the market, primarily to the three largest U. S. banks. City Delighted The City is deligjitetf with the speed and secrecy with which the $2.5 billion clearing bank loan to the British Government was carried off. It epitomizes to hankers here the strength and flexibility of the London money market, supported as it is by a flexible Treasury and a cooperative central bank. There was tremendous interest, they said, from Japanese as weti as A m e r i c a n banks. What's more, they insisted, broken arms weren't as nearly in evidence in London as they were in Paris after the $1.5 billion loan to the French Government. Be that as it may. the" Bar clays spokesmen believe that rhe nationalized French banks could be in a better position in the future than Hie private British institutions when the crunch comes. They say, however, that resistance to taking deposits en sfcort-tetm wiH grow and will force a lot of money into lonrger term. It could be that the Arabs in time will have to deposit their funds for-as much as seven years in order to get a quote at all. David Montagu, chairman and chief executive officer ot the consortium bank Orion, which participated in die British government loan through its ties with National Westminister, conceded that the banking system wiH have a iot of adapting to do to meet the "unbelievable" demand for long-term tunds. If exchange rates continue to float, raising substantial risks in individual currencies, there wilt fee tremendous room for multicurrency financing. Orher bankers predicted that simplified multicurrency units will be developed that could be a great inducement to Arab investors and could be a sizable factor in reducing uncertainty and, as a result, inflation. They view the Rothschild composite unit, known as Eurca, as far too complicated. Two Eurco bond issues were launched last year with very disappointing results. The unit is composed of nine currencies weighted by gross national product and adjustable daily. Questioned as to what would happen if the Arabs were to withdraw their Xunds from London ai some future date, Mr. Montagu said that there are very few places where such sums can be invested and that they are bound to return to the "melting pot" in some form or fashion. It is his impression that the fculk of the Arab funds wiU be going into the Eurocurrency markets and that the oil pro-duceis wiU be coming to 4he consortia for longer-term financing. David Benson, the director in charge of corporate finance for Kleinwort, Benson Ltd. points out that •the banking end of the Euromarket lias been operating well in the face of a very large demand lor funds. The Arabs are handling themselves "in a mature way," he indicated, and are aware that they must Insure themselves against being victims ot their own success. They are particularly concerned to form relationships with banking institutions of "undoubted quality" and aren't in any particular hurry to consolidate relationships. This leaves room for every kind of tie with the Arab world, he said. Orion, like e\ ervone else, is looking closely at the Arab countries. A • personal" tie doesn't seem necessary, Mr. Montagu explained, because most of Orion's shareholders have their own presence in the Arab countries. 238 T H E WASHINGTON POST Hvbart J a n u a r y 20, 1974 Rawen Oil, Gold, the Dollar I N THE LAST 10 weeks, the major European currencies have plummeted about 13 per cent in value against the dollar, which now is within hailing distance of the foreign exchange levels set by the Smithsonian Agreement of December 1971. Excluding the British pound (which is in a seriously weakened condition), the dollar, is within about 5 per cent of the levels set at the Smithsonian for major currencies. (Including Britain, the dollar is withm 1.65 per cent of the Smithsonian averages.) Or, to pUt i t another way: the dollar has totally recovered from what Georges Pompidou called the "third devaluation"—the panicky erosion of last spring and summer—and about half of the 10 per cent devaluation of February 1973. Meanwhile, the price of gold has skyrocketed to a record $136 an ounce, and it would surprise no one if it goes even higher. I n both cases, we are witnessing a dramatic response to the energy crisis, which threatens the oil-importing world with a financial upheaval. The United States, as the Chase Manhattan Bank points out, looks like such a "safe haven" compared with Europe and Japan that the dollar has gained in value even faster than it dropped during the crisis i n confidence in 1973. Moreover, European bankers who who were worrying about a massive "dollar overhang" around $90 billion last year have just quit talking about it: they win neea every one of those dollars—and more—to pay the massive oil bill that the cartel of producing nations has ' laid on their doorsteps. The dollar problem, i n effect, has taken a 180-degree turn: there is no longer a deadly surplus, but a prospective shortage. Central bankers, meeting for the past x few days in Rome, are arguing not about propping up the dollar—but how most efficiently to keep it from going too high. These same forces explain the stunning advances in the gold market. Once upon a time, when gold was' going up, the dollar would be going down, and vice versa. But the dimensions of oil price escalation forced on the consuming countries by the producer cartel could point to a new role for gold in providing additional resources necessary to foot the oil bill. IN THE SPACE of just two years—from 1972 to 1974, the world is faced with an oil bill rising from $21.6 billion to something just short of $100 billion. Of the latter figure, Europe, Japan and the United States would have to shell out $87 billion at current prices, assuming consumption at 1972 levels. As Treasury Secretary George Shultz said in Rome on Thursday, it is impossible for such a "staggering" result to take place. vAt current prices, oil imports and consumption will fall. New sources ,of energy will be developed. But there will remain, nevertheless,- a huge bill to pay, and serfous secondary effects, Shultz warned, on the supply of products' ordinarily derived from petroleum, such as fertilizer. Beyond that, there lies great uncertainty about what happens to trade, money flbws and balance of payments positions. "We must be realistic," Shultz said, "and recognize that the present problem is literally unmanageable for many countries." Unless the problem is made manageable—and that means a rollback of-the cartel-ordained prices—the world could ^encpunter a wave of devaluations in an effort to cope with the enormous oil costs. As former Federal Reserve Board economist Daniel Economic Impact H. Brill put it, "If major oil-importing countries try to cover their soaring fuel bills by competitive devaluations to get a little larger share of a diminishing world trade market, we could be in for a repetition of the Thirties." WHERE DOES GOLD come in? If major currencies are devalued, the oil cartel countries might respond , by insisting on exchange rate "guarantees, or payment /•in gold. Already, Europe is full of talk of an official $150 gold price as part of a "package" plan to expand world liquidity. ' t Since the present, theoeretical official price is only $42.22 an ounce, those countries "with substantial gold reserves would triple the resources available to pay their future bills for imported energy, i The American dollar, ,of course, had been enjoying steady gains before the energy crisis broke into full view as a result of great improvement in the U.S. balance of trade and balance of payments accounts. In turn, that improvement was due to the better competitive edge given to American exports by the double devaluation of the dollar, plus a much better See IMPACT, 239 Hobart Rawen Oil, Gold, Dollar IMPACT,•core on Inflation at home than recorded in most other industrialized countries. The oil crisis—although it causes discomfort and higher prices here—simply Underscores the strength of the U.S. economy relative to the rest of the world. Since we are dependent on Imported oil for only a fraction of our needs, higher oil costs will worsen our balance of trade to a lesser degree than Japan's or I that of any country in Europe. Beyond that, while the real growth of the U.S. economy may be sliced to a small figure (or even tp zero), the degree of recession here is likely to be much less severe than in Japan and Europe. The contrast With the catastrophe in Britain is stark. THEREFORE, the prospect—ivow ironic for Arab policy-makers!—is that surplus revenues built up by the oil-producing nations will flow mostly back to the United States, seeking safe investment, directly or through the Eurodollar market. There is not a little bitterness in Europe over the way things seem to be working oyt. A few have wondered, -seeng the relatively insulated American position, whether the U.S. government is hot secretly content with a situation which shows Europe helpless and dtartraught, the Common Market a shambles, while the U.S. dollar regains its former prestige. It is certainly true that the United States stands to come off best of any major country, regardless of the future Arab squeeze and what it may portend. But officials here know that the United States can not prosper in the midst of a world depression. They take seriously IMF Managing Director H. Johannes Witteveen's warning, like Brill's, that failure to fiiKj common approaches could bring the world to the kind of disaster that befell it in the 1930s, with the less developed countries suffering the most. It would be illusory for anyone to think that because the dollar is strong in exchange markets, the U.S. will be home free. It won't. © 1974, -Ru Washington Post Co 240 T H E W A L L STREET JOURNAL February 11, 1974 Arab Oil and the Currency Crisis B y W I L L I A M C . CATES When a Secretary of the United States Treasury finds it necessary to characterize an International monetary development as "literally unmanageable" for many countries, as Secretary Shultz did in Rome on Jan. 17, things must be pretty bad. They are. By most estimates the gap between exports and imports of Saudi Arabia, Kuwait and the other Persian Gulf sheikdoms alone, which had already swelled to some $10 billion last year, will shoot up to $50 billion in 1974, against a trade deficit of about the same amount facing Western Europe and Japan. If left unchecked, or uncompensated by a counterflow of loans or investments, this transfer of over $4 billion a month could clean out all of the monetary reserves of Europe and Japan within 23 months. Even if the gold component of these reserves were re-prlqed at $120 an ounce, they would last for but 33 months. The crisis that looms so directly ahead differs from those of the past three years in more than just direction and degree. So long as the United States was running the deficit and others the surpluses, we could in a pinch, and we did, stop paying out reserves and simply let other countries accumulate dollars or revalue their currencies or both. Looking back, despite hard feelings among finance ministers, remarkably little harm was done to world trade. I n other words, because the U.S. dollar was both a reserve currency and the standard denominator for world trade, we could cover our sins or misfortunes by supplying more dollars. This is not the case when the shoe is on the other foot. With European and Japanese currencies weakening, exporters to those countries, including oil exporters, will demand and receive dollars, for which the suppliers of last resort are the European and Japanese central banks. Since these dollars come from finite reserves, the present crisis is unique not only for its magnitude but also for the fact that it cannot be papered over. It is unique as well for its suddenness. Given time, economies, like people, can adjust to almost anything, and had the oil price increase come upon us in 50 cents a barrel increments over the past decade, national economies as well as the world's trade and payments system could have taken it in stride. As is, automatic market forces will not have time to perform their function, and agonizing decisions will have to be made rapidly. Reality and Illusion For this reason it is worthwhile to try to sort illusion from reality in the proposals and prognostications that have already been put forth. ILLUSION: An International body, be it the I M F , the OECD, the Common Market or a meeting of oil-consuming nations, later joined by oil-producing nations in Washington can set up a nice system to handle the problem. R E A L I T Y : While it is sometimes easy to organize a grand coalition of nations to fight fascism, communism, capitalism, papism or Zionism, when it comes to jobs and money, international agreement is well nigh Impossible. A modern day exception was the Smithsonian Agreement on new currency parities reached in December 1971, and there, not only were the nations represented manageable in number and the sacrifices required marginal, but we had the benefit of Secretary Conhally, whose "tough" tactics have ever since been lambasted by well meaning people. ILLUSION: Floating exchange rates will take care of the problem, providing they do not constitute competitive devaluation. (The distinction Is becoming hard to discern, but we know the first is good and the second is bad.) R E A L I T Y : Floating rates, the New Testament of the free market economists, can cope The Western world to- gether with Japan face a trade and monetary crisis of serious proportions within a matter oi months. No assemblage oi nations will find, let alone agree upon a solution. ^ very nicely with modest marginal changes In a nation's trading position, but not with a deluge. For one thing, the favorable trade effects of devaluation can take as long as two years to become evident. For another, as Arthur Laffer pointed out on these pages Jan. 10, any benefits of devaluation are largely offset by inflation in the devaluing country. ILLUSION: The oil crisis demonstrates and enhances the need for meaningful trade negotiations. R E A L I T Y : The administration first proposed trade negotiations when the U.S. balance of trade was in terrible shape, allegedly due to Japanese aggressiveness and European protectionism. Now it Is the Europeans and Japanese who face bankruptcy. Is now the time to tell the former to dismantle their Common Agricultural Policy and regional preferences and the latter not to Invade our markets but pick on the Europeans instead? Apparently it is, and in addition, according to our trade negotiators, it is time to start working on rules which would prevent nations, including presumably the U.S. and Canada, from limiting their exports of oil, wheat, soybeans, or whatever else gets scarce. I n today's crisis atmosphere such an ambitious round of trade negotiations would at best be a failure and at worst result in the hardening of national positions to the ultimate detriment of free trade. To summarize: The Western world together with Japan face a trade and monetary crisis of serious proportions within a matter of months. No assemblage of nations will find, let alone agree upon, a solution. Nor can we expect the "market mechanism" to cope with an adjustment of this velocity and magnitude. In such a climate the free trade platitudes of yesteryear will provoke at best derision, at worst reaction. But no crisis arises without providing the opportunity for leadership, and this opportunity is knocking, however quietly, at the door of the U.S. government. Logically the problem would resolve itself if the Arab governments were willing to hold and then use European and Japanese currencies in payment for their oil. However, this is unlikely, given the immediate prospects for these currencies on the exchange markets, and it would be foolhardy to ask any favors from the Arabs. What is needed, therefore, is a financial in- termediary. The U.S. alone can fulfill this function. If our government declares itself willing to accumulate substantial amounts of European and Japanese currencies, thus stabilizing their values at levels which, before the oil crisis, we regarded as quite reasonable, the Arabs would receive dollars, the Europeans and Japanese would be spared loss of their reserves and ultimate bankruptcy, and world trade could continue to function smoothly. Though this sounds simple, if not simplistic, such a policy is fraught with technical and political difficulties; for example, does the U.S. support the pound or lire on the eve of a British or Italian election which may result in a Socialist or Communist government? The difficulties being endless, an intervention policy will not be popular with those who have to administer it (although our currency "swap" network with other central banks already totals $18.98 billion). But, at present levels, the yen and most European currencies are a businessman's risk, and even If we sustained book losses on a few, much as other countries lost for a time on their holdings of ' our dollars, the effect on the American taxpayer would not be noticeable, certainly not in comparison with the consequences of the rapid shrinkage of world trade which faces us today. In return we can insist on a few important quid pro quos, among them no arms deals with the Arabs and no imposition of quotas or other serious trade restraints. Careful Explanation Needed Obviously such a course of action can be undertaken only after the most careful explanation to Congress, as the opportunity for demagogic attack in this complex area is unlimited. One can almost hear the epithet "Marshall Plan" reverberating in the Senate chamber. At the same time steps must be taken, including removal of withholding taxes and provision of ironclad guarantees against expropriation of foreign investors, to ensure that the American capital market can play its essential role in the overall financial intermediation. Assumption by the United States of positive leadership and specifically a financial intermediary role would not only avoid or mitigate an immediate currency crisis, it would expedite the necessary adjustment to a new pattern of trade and investment flows. Such a pattern will entail vastly Increased investment in countries which can in turn purchase products made in the U.S., Europe and Japan. This probably means Eastern Europe and Russia, plus any developing countries viable and stable enough to absorb and utilize substantial outside investment. Thus, the reduction in consumption by the wealthy industrialized nations, brought about through the oil price increases, can become investable funds which, properly handled, will be a boon to all concerned. While the execution is far more complex than the recipe, failure by the United States to grasp this nettle of economic, and with it strategic, leadership could indeed result in "unmanageable" consequences for the trading world, including ourselves. Mr. Cates, an economic consultant, was Deputy Assistant Secretary of the Treasury during the first Nixon administration. An editorial related to this subject appears 'today. 241 FROM THE NEW YORK TIMES, MARCH 7 , 1974 IKuwait to Invest Riches in Arab Channels used to ease balance of payBy JUAN de ONIS ments deficits arising from Spttltl to Th* »nr York Times higher oil prices. j KUWAIT, M^rch 6—Kuwait Neither the Special Developintends to deploy h6r oil riches ment Fund nor the financing primarily through channels by the I.M.F. of oil deficits under Arab control and will from oil-producer loans waa not contribute to special funds viewed with favor by Mr. proposed by the Shah pf Iran AtSd, whose country Is a major and the International Monetary financial power in the Arab Fund to meet the. world's oil world. payments crisis. He said that Kuwait was| "We will make our own conparticipating in discuss! tribution to the world, big or among member countries of small, through our own instithe Organization of Petroleum tutions," $aid Abdel-Rahman Exporting Countries on the Salem al-Atiki, Kuwait's Mincreation of a bank to make ister of Finance and Oil, in development loans, and he said an interview. Kuwait was prepared to join Last month, the Shah of Irah In a four-point, $5-bllllon reproposed that the 12 major plenishment of the funds of the International Development Asoil exporting countries and 12 sociation, an affiliate of the large industrial countries, inWorld Bank. cluding the United States, set up a special development fund, But the major part of receiving $2-billkm to $3-biliion Kuwait's international finana year, to make loans on "soft" . . . . „ am«r. Pr»« cial . aid will be put at the terms to poorer countries. Abdel-rahman Salem al-Atild .service of Arab countries, and The proposal was hailed, byto assist other Moslem counRobert S. McNamara, president! The shah said Iran was pre- tries, particularly in Africa, !of the World Bank, and H. pared to provide $l-billion, part Mr. Atiki said. Johannes Witteveen, managing of which would go to the "Nobody looked at the director. of the International proposed fund, while the Arabs before," Mr. Atiki said Monetary Fund, as a proposal j rest would be used to buy "why does everybody expect of "great vision." Both institu- World Bank development bonds us now to be the godfather?, tions offered to manage the] and make a $700-million loan to tft* fJJf.F., which could be Continued i 242 Kuwait to Invest Her Oil Wealth lh Channels Under Arab Control possed to be too highly priced?' We will not accept instructions he asked. from anybody on how we use "Oil is a commodity affected by th$ law of supply and deour money." "This part of the world has mand, and its prices should be been neglected for centuries equitably matched with the cost and its wealth has been car- of equivalent commodities that ried away by foreigners with- produce energy," he said. out giving it a hand for de- Earlier than most other oil velopment," he said. Mr. Atiki exporting countries, Kuwait faced in the early nineteenadded: ' I f there seems to be a sixties the build-up of oil incapital surplus now, it Is' not come to levels above domestic beonjpe we have more than development and welfare needs, we need, but it is because we which are budgeted" at about lack 'the ability to consume $1.5-billion. these;, amounts so quickly In a With an outward looking policy, Kuwait has been a very short period." Kuwait's estimated oil reve- leader among the Arab counnues this year, at current oil tries in establishing Investment prices, ape $9-biHion to $10- institutions designed to put Dillion for a country of 850,000 Kuwaiti funds to work abroad. people, with oil as the only These institutions, both proflargB domestic resource. it making and for development •fro* massive revenue, re- lending, include the Kuwait flecting an increase of more Fund for Arab Economic Dethan 300 per cent in oil prices, velopment, the Kuwait Investmay rise further when Kuwait ment Company, and the Kuwait acquires,. as is planned, a 60 Foreign Trading, Contracting per cent equity in the ]Kuwait and Investment Company. They Oil 'Company, now owned joint- have made loans and investly by Gulf Oil and British Pe- ments of more than $500*million abroad. troleum. Mr. Atiki said that he conKuwait has been the movii sidered the present level of force in the establishment government take from taxes the Arab Fund for Economic and t royalties of $6.96 a barrel and Social Development, a sort for Kuwaiti crude oil as "still of regional development bank, which made Its first three loans too low." He said that Kuwait Is pre- last year, totaling $30-million. sd to market directly her New loans to Egypt and Alper cent share of oil pro- geria totaling $200-<nillion will duction from the Kuwait Oil be announced this month. Company, which was three mil- Kuwait has pushed the crealion barrels a day until pro- tion of an Arab-African Bank duction was cut back after the that was set up with a $200OctQfcr Middle East war, if the milHon* capital in Cairo in foreign partners do not meet January, and is planning to Kuwait'* terms for "buy back" oin in major investments in pricgfL Sgypt and the Sudan for projThese demands were be- ects ranging from oil pipelines lieves to be in the vicinity of to highways and major agri$10 barrel. The companies cultural and livestock development. havCpffered $8.50. "I-think oil prices on the "It is going to take a lot of world market should go even money to get this part of the world to stand on its feet," said higher," said Mr. Atiki. "tpay $21 for a Swiss-made Mr. Atiki, whose combined role shirt and $90 a sack for im- as Finance and Oil Ministef ported rice. So why is my bar- puts him at the center of rel of oil the only thing sup- Kuwait's financial management. r ! 243 BUSINESS WEEK. February 16, 11 Money: Where the Arabs will invest their new oil wealth " I t ' s going to be a helluva task but an interesting one, if you are in international banking," says Richard Vokey, vice-chairman of London merchant banker H i l l Samuel & Co., Ltd. Hill Samuel's "task" is the awesome but potentially lucrative one of helping recycle an estimated $50-billion a year of surplus A r a b oil revenues back through the world's capital markets to the nations that consume oil. Not surprisingly, H i l l Samuel will have considerable competition. Commercial and merchant banks from the U. S., Britain, the Continent, and Japan are rushing to get a piece of the action. There will be plenty of it. The oil-exporting countries will be able to spend less than half of their fabulous earnings, expected to total around $90-billion this year, for imports of capital equipment and consumer goods. Libya, Saudi Arabia, and the Persian Gulf sheikdoms, which will pile up the biggest surpluses, have not even decided what to do w i t h the remaining unspent funds, according to Beirut bankers. But for lack of other profitable alternatives, it is virtually certain that they will have to deposit, lend, or invest a good part of the money in the major Western capital markets. Says banker Vokey: "They will put their money where they get the best deal." Oil consumers, in their turn, will have to borrow in these very capital markets to help finance their purchases of Arab oil. Thus, France is swinging a $1.5-billion medium-term credit line in the Eurodollar market via a consortium of banks headed by France's Societ6 G6n6rale. The French will draw on the money when needed to offset a projected $3.7-billion balance-of-trade deficit that will be created largely by soaring oil-import costs. The Arabs w i l l supply some of the money that the French need. Says an official of the Paris-based Union des Banques Arabes et Francaises (UBAF), jointly owned by Arab and French banks: "We are bound to subscribe to this loan, and thus we will serve as a conduit for Arab funds finding their way back into European hands." Via Now York. I n addition to the Eurodollar market, some Arab funds will flow to national money markets on the Continent and in Britain through the purchase of such securities as British Treasury bonds. Eventually, a big share probably will surge into the New York money market because the U. S. economy, less affected by the energy crisis than most, looks like the safest haven for investors. To keep the Arab dollars circulati n g - a n d give American bankers a larger role in handling them-Washington last month lifted U. S. restrictions on capital outflows. The French already are tapping New Y o r k . The F r e n c h n a t i o n a l telecommunications agency plans to float a $75-million bond issue in the U. S. I n the next few months, says a French Finance Ministry official: " I think you will see a whole lot of French com- panies making loans of this kind." The Arabs also are expected to step up the real-estate investments they have been making in the industrialized nations, and some Arab money w i l l probably go into corporate stocks. Economic effect. The reverse flows of money from the Arabs to the world's capital markets w i l l go a long way toward offsetting the deflationary impact that the oil-payment deficits would otherwise have on the economies of the consuming countries. Still, the sloshing of huge amounts of Arab money through financial markets may make the job of managing the world's economies a rough one. Explains a top economist of the Organization for Economic Cooperation & Development: " I f Italy and France don't attract Arab funds to compensate for their oil bills, they are going to have to mount an expansionary monetary and fiscal policy. And i f the U. S. attracts more than its share, it w i l l have to adopt a restrictive policy." To ease such problems, French Foreign Minister Michel Jobert reportedly proposed to Arab governments that part of the payments they receive for oil be left on deposit in banks of consuming countries. Tragically, the developing countries, w i t h gloomy economic prospects and thin capital markets, have little hope of attracting Arab funds. And they lack the credit to borrow in the major capital markets or the ability to pay commercial interest rates. Managing Director Johannes Witteveen of the International Monetary Fund (IMF) proposes to help them w i t h an expanded credit facility that would be financed mainly by Arab funds. Meantime, Saudi Arabia is setting up its own Islamic Bank w i t h $l-billion 244 capital for aid to the Arab world, and a Cairo-headquartered A r a b A f r i c a n Bank will channel Arab funds to A f r i can countries. Actually, the recycling of Arab funds is not yet into top gear because there is a two-month lag between the loading of tankers in the Persian Gulf and the flow of tax and royalty revenues into Arab coffers. The big bulge of revenues from the Dec. 23 oil-price hike will start pouring into Arab treasuries next month. Lota to learn. Investing huge chunks of that money will be no easy task. "The Arabs are terribly worried about their money and what they can do w i t h it," says Burhan Dhajani, who heads the Beirut-based Union of Arab Chambers of Commerce. Traditionally, the Arabs have been very cautious with their funds-investing heavily i n short-term instruments. Their natural caution has been buttressed by a number of sobering financial experiences, including heavy losses in the debacle of U. S. offshore mutual funds. Arab investors "have been had in the past," notes William Higman, a director of a newly-formed London bank, the Arab & Morgan Grenfell Finance Co., which is jointly owned by Jordan's Arab Bank and London's Morgan Grenfell & Co. But, notes Higman, "they have learned a lot." W i t h the assistance of countless eager financiers, they w i l l learn a lot more. Vokey of Hill, Samuel notes that the Arabs generally have bought Eurobonds in the relatively safe secondary market. Now, he says, "a lot of bankers are hoping they will get active in the primary market" as original lenders- A lot of bankers are hoping the Arabs will get active in the primary market an activity that involves considerably more sophistication. Indeed, the Kuwait Investment Co., owned by the Kuwaiti government and private shareholders, already is active as a comanager of new Eurobond issues. New partners. Europeans and Americans are setting up merchant banks in Beir u t to tap Arab money nearer its source, while Western and Japanese commercial banks are flocking into the gulf states. And bankers from all parts of the world also are jostling each other in their rush to set up joint-venture financial houses with the Arabs, headquartered in such European money centers as Paris and Brussels. The Union des Banques Arabes et Francaises, which opened its doors on Rue Ancelle in the Paris suburb of Neuilly i n 1970, has assets of more than $l-billion. Arab participants, including banks from Kuwait, Bahrain, Oman, Libya, and Tunisia, own 60% of the shares, and France's Credit Lyonnaise and Banque Francaise de Commerce Exterieur hold the rest, UBAF operates branches in London, Frankfurt, and Rome, is opening another in Hong Kong w i t h Japanese banks, and is considering yet another in New York. Other such joint ventures include Frabank International in Paris, European Arab Bank in Brussels, and Cie. Arabe et I n t e r n a t i o n a l de Investissement in Luxembourg, in which Bank of America has a holding. Says an UBAF official: " A t the summit meeting in Algiers last December, the Economic Council of the A r a b League called for Arabs to withdraw funds gradually from Western banks. This won't happen overnight, but in a year I think you will see a change in the flow of funds to Arab affiliated banks." And Suliman Olayan, a Saudi Arabian entrepreneur w i t h interests in construction and oilfield contracting, explains why such joint ventures will also attract private Arab business. "When I go to see these people, they speak my language, they know who I am. I can get in to see the president." • 245 THE WALL Arab STREET Investors As O i l Money Pours in, Mideast Lands .Search For Places to Put I t While Much. Is Still Banked, States Now Seek to Invest I n Real Estate, Businesses E x i t Gnomes, Enter Sheikhs B y PRISCILLA S . M E Y E R of T H E W A L L STREET JOURNAL Staff Reporter The flow of oil money into A r a b lands is be' coming a flood as the oil-producing nations collect their windfall profits f r o m the most recent doubling, on Jan. 1, of the price they charge for oil. Last year, Middle E a s t oil revenues r a n about $22 billion. M u c h of the profit was invested domestically. This year, w i t h revenues running anywhere between $80 billion and $110 billion, a n estimated $<f0 billion to $90 billidn should spill into the international-money m a r kets. Over the longer t e r m — b y 1980, according to an estimate by Chase M a n h a t t a n B a n k - A r a b I foreign reserves should swell to more than $400 billion f r o m a meager $5 billion, as estimated by the World Bank, in 1970. That compare* with total foreign investments of U.S. corporations of $145 billion at the end of 1972. The big question is how the Arabs will invest all this money. F o r the immediate future, it appears, most)of it w i l l continue to go into bank deposits and in government securities like U.S. Treasury bills. But the potential dem a n d for such funds is limited. And already there a r e solid indications that the Arabs a r e starting to change their traditionally ul.traconfiervative investment policy to take the plunge I into more profitable ventures. A r a b institutions 1 are buying r e a l estate i n the U.S. and elsewhere—hotels, apartments and office build,ings. A r a b institutions and p r i v a t e . investors are buying and attempting to buy interests i n U.S. banks. A n d negotiations are starting for joint ventures, mainly i n oil, petrochemical and other energy-related projects, i n the U.S. An A r a b Landlord on F i f t h Avenue P a r t l y for political reasons, and also because they haven't yet developed a big force of investment professionals and business manage d , the A r a b nations are unlikely to m a k e a run on the U.S. stock m a r k e t or acquire big publicly held companies anytime soon. I r a n , i t is true, has indicated that it plans eventually to invest hdavily i n "blue chip" U.S. securities, -and it already has agreed to a joint venture w i t h Ashland Oil i n the U.S. Individuals i n the Middle East, too, m a y buying U.S. securities. " D o n ' t be surprised if A r a b interests already have a significant participation i n A m e r ican companies," Joseph A . El-Khoury, director general of the Banque de l a Mediterranee of Lebanon, said during a recent visit to N e w fork. M a r c h 5, 1974 [ But these kinds of developments now seem I more typical: —Shah M o h a m m e d Riza Pahlevi of I r a n has bought, through his Pahlevi Foundation, a large office building, which he's remodeling, a t 642 F i f t h Avenue i n N e w Y o r k . —A group of Kuwaitis recently paid about $27 million for property along the Champs Elysees in P a r i s for a luxury office and bank building to be called the House of K u w a i t . —A group of A r a b banks is setting up F i r s t Arabian Bank and F i r s t Arabian Corp. as vehicles for pumping funds—Including money to buy ownership interests in U.S. banks—into the U.S. Sudanese i n California —Adnan M . Khashoggi, a Beirut-based Saudi Arabian who acquired 50% of the stock of Security Capital Corp. last September, and who has purchased two California banks, also has acquired about $1 million i n r a w land* for development in California. H e plans to bring some 40 young business trainees f r o m the Sudan to California to learn how to use vehture capital and develop r e a l estate. —The Saudi Arabian government has talked to Chase M a n h a t t a n bank about the possibility of Chase managing a pool of $200 million i n . Saudi government funds for investment in Saudi business and in joint ventures w i t h foreign partners whom Chase would find. —Libya has established an investment bank in Buenos Aires. Abu D h a b i and £ a u d i A r a b i a are discussing building a large oil refinery, i n partnership with a N e w York-based f i r m , i n Puerto Rico. And the Saudi Arabians a r e investigating the possibility of a refinery and petrochemical complex in the Philippines. —Kuwait, a small" nation with inordinately large oil revenues and relatively solid experience in investment, also is buying U.S. r e a l estate. The Kuwait Investment Co., one of several owned jointly by the K u w a i t government and individual Kuwait investors, this month bought K i a w a h Island off Charleston, S.C., for $17.4 million in cash. The company plans to spend more than $100 million developing it as a residential resort over the next 15 years. The same company put up $10 million, or half the equity funds, for a project in downtown Atlanta that includes the new Atlanta Hilton hotel. Once Stung, Doubly Cautious — A n executive with a m a j o r U.S. bank estimates that in the past few months up to $400 million has been lent directly to U . 6 . borrowers by A r a b investors. Enck, Hollingsworth & > Reveau, a Louisville real estate f i r m , says it has agreed in principle to borrow $150 million f r o m Persian Gulf investors for the purchase of U.S. real estate. Wooten & Associates, a Dallas builder and developer, says it has got about $200 million in Middle p a s t financing for a n apartment development in St. Louis. —Najeeb Halaby, former chairman of P a n American World Airways, has assembled $100 million in real estate he hopes to sell to private Saudi Arabian investors. Arabs like real estate because it's "tangible," M r . H a l a b y says. "They've seen prices of their own r e a l estate rise faster than other investments," he adds. D a v i d Toufic Mizrahi, editor of a N e w York-based newsletter called the M i d E a s t Report, says some land in the H a r a , district of Beirut has doubled in six months. E v e n so, some bankers say, the Arabs appear to have rejected most of the deals offered them by "the flocks of investment men who have been giving them pitches in recent 246 Arab Investors: as Wealth Pours in, Mideast Lands Seek Places to Put I t Continued From Page One months. This may partly reflect some unhappy past experiences. Arab investors were hurt by the collapse of Bernard Cornf eld's I.O.S. Ltd., which sold many mutual-fund shares in the Middle East. Some Arab investors still haven't received full repayment from the collapse of a major Mideast baqk, Intra-Bank, eight years ago. That kind of experience explains the Arab desire to enter joint ventures with experienced, reputable partners, says Benjamin V. Lambert, president of Easdil Realty Inc., an affiliate of Blyth Eastman Dillon & Co. that is planning & nUxed pool of Arab and other investors' funds. The Arabs, he says, have been "stung and double-stung." M r . Lambert thinks the AOddle East oil nations will invest around $1 billion in U.S. real estate in the next two years. Other observers think it might amount to five or 10 times that. Mr. Lambert Is conservative because, he thinks, investment may be limited by the supply ot "good" investment property and by political considerations. The Saudi Arabians, for example, apparently fear that a worsening in relations with the U.S. might persuade the U.S. to freeze Arab funds in U.S. banks. The Arabs are aware that Congress has been making fretful noises over the prospect of massive Arab Investment in the U.S., and they are aware oi the controversy in Hawaii over Japanese investment in the tourist Industry. ! Some bankers, however, see a masSive flow of Arab money into foreign real estate and Industrial development as a near-inevitable development over the long term. Derick Richardson, Chase Manhattan's group executive for the Middle East and Africa, doubts that money markets alone can absorb all the new Arab wealth.'"Looking at the capacity of markets to cope with the accumulating dollars," he says, "unless there are structural changes in the nature of institutional markets there will be severe difficulties two years but." Specifically, he says, the market for Eurodollars, or dollar deposits held outside the U.S., will become "saturated." Alternative Energy Sources Other big U.S. Wanks have discussed alternatives, to money-piarket Investment at considerable length with Arab financial officials. Chase seems more willing to talk about these discussions than its competitors. Chase says for example, that Chairman David Rockefeller and Mr. Richardson have encouraged Saudi Arabian officials to establish a large pool of Arab money for investment in energy respirch and development—partly because Arab oil eventually will run out. • Many international banks and brokerage houses are buying into Arab institutions and forming new ones in the Middle East to influence and exploit the Arab desire for new investment. Most of theoe efforts are thinly veiled attempts to Import surplus Arab dollars' and shore up financial markets here and in Europe, though the financial men usually describe their efforts as "harnessing Arab funds for Arab investment." . i Though internal investment has top priority in most Arab countries, even ambitious projects, given the relatively small populations and capital needs, aren't likely to drain off much of the cash flowing into Arab treasuries. Not even the $3 billion fund for loans to underdeveloped countries proposed by the shah of I r a n amounts to more than a tiny fraction of Arab funds that will become available for, investment over the next six years or so. A Place In Financial Folklore Their vastly increased wealth has earned Arab investors a certain notoriety in some financial markets—and the Arabs are displeased. " 'Arab sheikhs' have now replaced in financial folklore the notorious 'gnomes of Zurich' of the '60s," Abdlatif Y . Al-Hamad, director general of the Kuwait Fund for Arab Economic Development, complained recently at a meeting in Luxembourg. Arabs,, he says, have "played virtually-no role" in recent foreign-exchange and commodities-market gyrations, he says. Some international bankers say that although Arab governments may not be very active in those, markets, private Arab institutions and investors are. The oil-generated profits of Arab contractors, business consultants, private banks and others on the fringes of the oil business are financing foreign-exchange and commodities speculation, they say. At the same time, some Western "ihoney brokers" are trying to exploit awareness of the Arabs' new riches by collecting feeB from U.S. firms for arranging loans from Arab investors, and then disappearing. Offers to arrange such loans have proliferated since last fall. M r . Halaby, proprietor of his -own investment company, says he has checked out many of these brokers and found them to be "phonies." 247 Opening the Arab well I to money-dry nations The oil-producing countries have the money and the oil-consuming countries need i t - m o s t of all the developing lands with only limited access to the world's capital markets. So World Bank President Robert S. McNamara was in Algeria this week, Treasury Secretary George T. Shultz was in Caracas, and Managing Director Hendrikus Johannes Witteveen of the I n t e r n a t i o n a l Monetary Fund leaves Tuesday on a six-week swing through oil-producing nations from Iraq to Venezuela. Each man hopes to open a conduit through which the billions of dollars being paid for oil today will flow to nations that face bankruptcy because of soaring fuel bills. The financing of oil costs through borrowings in international markets has worked well enough for someBritain this week announced a $2.5-biIlion commercial bank standby f a c i l i t y but countries w i t h doubtful credit ratings need more foreign exchange than the market will give them. So far, oil-producing countries talk in generalities about plans for officially recycling funds to the hardship cases the markets turn down. But they are not plunking down much hard money. Says McNamara, whose agency so far has had only $200-million from Iran and $27-million in commitments from Venezuela: "No doubt other funds will come forward. The question is whether they will be soon enough, and in the proper amounts." Eurodollar*. The pinch would be worse if the Eurodollar market were not so fertile in providing financing. Britain, France, and Italy have put their stateowned companies to work borrowing at a great rate. Japan has directed its private banks and corporations to seek out Eurodollar resources. Even Britain and Italy would like to supplement what the market is willing to lend them with official credits, provided they could be had without the strings the IMF attaches to all the ordinary credits it gives. Among the poorer countries, India was able to borrow $62-million from the IMF a few weeks ago, but the increase in its oil bill this year over 1973 is estimated at $900-million-which it cannot pay. Meanwhile, the schemes for using the oil money are focusing on development of the oil regions first. This leaves little for other less developed countries. Already in the Arab world, there are no fewer than five local development BUSINESSWEEK March 30 1974 funds-the Kuwait Fund for Arab Economic Development, the Abu Dhabi Fund for Arab Economic Development, the Islamic Bank, the African Fund for A g r i c u l t u r a l & I n d u s t r i a l Development, and the Arab-African Bank. The latest talk is that the Islamic Bank, set up to help Islamic nations w i t h the important patronage of Saudi Arabia, will see its resources doubled to $2.8billion. Venezuela seems likely to dispense oil money in a similar regional pattern. I t is negotiating with the Inter-American Development Bank to set up a $250-million fiduciary fund. And a national investment fund, which will collect an estimated $5-billion in oil revenues, will be used partly to finance Latin American development projects. One project is for an oil refines^.in Costa Rica to supply Central America. Gaps to fill. With the increase in the world's total oil bill estimated at $50billion and up, this leaves a lot of financing gaps for McNamara and Witteveen to fill. Witteveen's contacts with the oil countries will make or break his proposal to set up a special "oil window" at the IMF where governments can borrow w i t h relative ease. Says a fund official: "Without oil money, the window would have to be so severely scaled down, there is doubt it would be possible." I t does not help that the Arabs are apathetic and the U. S. hostile to the Witteveen proposal. No oil money has been committed since Witteveen first proposed it in January, except for $700million that Iran may place with the fund. Says University of Colorado Professor Ragaei El Mallakh, who does consulting work for the oil govern- ments: "He doesn't really have much of a chance to get Arab countries to subscribe heavily to the IMF. They want to invest unilaterally." As for the U. S. viewpoint, a Treasury official says: " W i t h the embargo off, the oil price must come down. Why institutionalize high money costs and give the oil countries guarantees? I f you go to them on bended knees and ask for money, the terms will not be very generous." For this year, at least, the U. S. feels the market can do the job for developed countries that can afford to borrow at all. By next year, though, financial officialdom may find itself giving guarantees to commercial bank loan officers i f the oil financing problem does not wane. Still, Witteveen in the 127-member IMF has a wider constituency than the industrialized nations. Furthermore, aides say preliminary contacts with the oil countries about putting money into the IMF are not so negative as to keep the managing director from making the trip. And, they add, not only does the IMF chief expect to bring back some commitments, but he also feels there is a "good chance" to get them at interest rates below going market yields. • 248 T H E WASHINGTON POST M a r c h 1, 1974 Iran's Proposals for the World Economy RAN HAS MADE a far-reaching proposal to cope with some of the acute dislocations caused in the world economy by the oil cartel's quadrupling of prices two months ago. To help poor countries hit by the increases to maintain the momentum of development, Iran would have 12 oil exporters and 12 industrialized countries put up $150 million each a year (a total of $3 billion) in a new soft-loan fund, to be run by donors and recipients on "non-political" lines and to be serviced by the World Bank and the International Monetary Fund. To help oil importers absorb the severe balance-of-payments impact of the new prices, Iran will lend perhaps $700 million (at commercial rates) to the IMF, to be recycled to importers. Iran also will buy (at commercial rates) some $200 million in ordinary World Bank bonds. The Shah has committed his country to put, up $1 billion for these three uses this year. He hopes his initiative will be joined and supported by other states. The Shah's proposal is, first, a major political move reflecting an Iranian bid for global political stature. It goes well beyond the bilateral oil arrangements which the Shah is quietly and simultaneously making with countries of his region. It makes Iran the first member (of OPEC, the oil cartel, to offer a comprehensive adjustment plan for the world economy. It puts Iran in the prestigious position of using the great international financial institutions, the World Bank and IMF, as instruments of Iranian policy to a considerable extent. Indeed, these institutions, by accepting the Shah's initiative, have in effect endorsed his grand strategy of reshaping the world economy to pay the new high prices of the oil cartel; it is the American grand strategy, of course, to lower the prices. And no matter what comes of the proposed new soft-loan fund, the Shah will make a good return on funds invested * n the IMF and the World Bank's hard-loan branch. The soft-loan fund idea is especially interesting because of the poor countries' desperation. The oil export- I ers have sound moral and political reason to come to the aid of, their price-stricken third-world brothers. To be candid, however, $150 million a year per donor is not much; for Iran, it's only one per cent of the increment of its oil. revenues. Then, there are differences between Iran's aid proposal and the evident aid proclivities of OPEC's Arab members. Iran and Saudi Arabia are political rivals; whether the Saudis will wish to support an Iranian proposal, one which they were not invited to help shape, remains to be seen. Iran wants aid to be nonpolitical but the Arabs avowedly want to use oil as a political weapon. The Arabs may not be as ready as Iran to use the services of the World Bank and IMF. So far only Venezuela, another non-Arab OPEC member, has indicated support for the Iranian proposal. There is always the prospect, however, that if the Arabs do not choose to join Iran on this fund, they will create their own separate and larger one. The need is there. The $700 million which Iran plans to loan to the IMF will help it serve better the swollen liquidity requirements of the oil-importing nations. There is no particular political reason why the Arabs in OPEC should not follow suit, and there is good economic reason why they should: the IMF is a good safe place to invest some of their surplus funds. Recycling oil revenues to consumers should quiet their nerves, at least in the short run. Just how consumers are to earn the money to pay back the IMF, and their other creditors, is necessarily a longerterm problem running beyond the writ of the IMF. Needless to say, the Shah's initiative is not the last word, or perhaps even his last word. But he has put into circulation serious proposals to deal with some of the basic new conditions of the world economy. Moreover, he is treating the world economy as the integrated interdependent entity which it is. If there is a tight strand of Iranian self-interest in what the Shah of Iran suggests, then the rest of us should not be put off. We should test his ideas to see which of them may work. 249 BUSINESS W E E K M a r c h 2, 1 ( 174 RNANCE How to handle $50-billion in Arab oil money n o r m a l I . S. c e i l i n g s o n d e p o s i t y i e l d s , so loni_r as t h e v w e r e u s i n g onlv Eurodollar monev. But the i m p l e m e n t a t i o n would h a v e t o be d o n e h v t h e F e d . A n d central bank officials are very s k i t t i s h a b o u t t h e i r c a p a c i t y t o police b a n k s here to p r e v e n t t h e m from using their unregulated E u r o d o l l a r f u n d s l o r m a k i n g domestic loans c o n t r a r y to m o n e t a r y policy. ^ ou d need e x c h a n g e controls to insulate t h a t Eurodollar window o n . o t f i . i i l obs< , \ t s S E C problem. I lie > o c u n t i e s iV E x change ( omirussion laces a different d i l e m m a . A year ago. the SECt o h e l p t h e b a l a n c e ot p a y m e n t s b y g e t t i n g I . S. b u s i n e s s t o f i n a n c e overseas i n v e s t m e n t s w i t h overthat securities : h a v e t o be r e g mmission. Surplus A r a b oil m o n e y , the s t r e n g t h e n i n g o f t h e d o l l a r , a n d t h e e n d o f U . S. a n d f o r e i g n capital controls are comb i n i n g to create a vast, i n t e g r a t e d international capital market. But just how the g o v e r n m e n t will permit private i n s t i t u t i o n s to o p e r a t e in the n e w environment has r e g u l a t o r s ' phones r i n g i n g all over W a s h i n g t o n . T h e E u r o d o l l a r m a r k e t is as n o t o r ious!}" u n r e g u l a t e d as d o m e s t i c E . S. f i nancial m a r k e t s are t i g h t l y controlled. Y e t both are expected to share in the e x t r a $oO-billion that oil producing countries will have for i n v e s t m e n t this year. T h e I ' . S. w a n t s i t s m a r k e t s free e n o u g h to recycle c a p i t a l i n f l o w s of oil m o n e y in excess of w h a t it needs t o balance its o w n i n t e r n a t i o n a l Ixioks. A n d it w a n t s a f r e e c a p i t a l m a r k e t t o encourage inflo ; t h a t t h e c; p i t a l < Thi t r o l s t h a t er i d e d o n .Jan. 29 nly one of the m a n y g o v e r n m . regi•egism e n s r u l i n g U . S. m a r k e t s , f t r a t i o n of securities to reserve r e q u i r e m e n t s on b a n k s . O n e of tin- h o t t e s t issues c o n c e r n e d t h e b i g - l o a n business t h a t IJ. S. b a n k s h a d d o n e i n t h e L o n don E u r o d o l l a r m a r k e t d u r i n g the era of the controls. Reserve rule. I n 1969 t h e F e d e r a l Reserve imposed special reserve r e q u i r e m e n t s o n a n y l o a n s by t h e E u r o d o l l a r b r a n c h o f a E . S. b a n k t o c o r p o r a t i o n s r e s i d e n t in this c o u n t r y . T h e idea was t o close a l o o p h o l e i n t h e c r e d i t c r u n c h then p r e v a i l i n g by s t o p p i n g E.S. banks from siphoning Eurodollar market funds. To oblige the capital controls p r o g r a m , however, the Fed had e x e m p t e d loans to A m e r i c a n s by t h e f o r e i g n b r a n c h e s o f E . S. b a n k s i f t h e A m e r i c a n b o r r o w e r s p l e d g e d t o use t h a t money to pay for the factories t h e y b o u g h t or b u i l t overseas. Idle s u d d e n e n d of c a p i t a l controls in J a n u a r y made bankers fear that the e x e m p t i o n f r o m E u r o d o l l a r r e s e r v e req u i r e m e n t s w o u l d be c u t o f f . A n d it w a s , at least on n e w loans, e v e n t h o u g h Fed governor Andrew F. Brimmer heard t h e i r protests t h a t t h i s was unf a i r in the n e w i n t e g r a t e d m a r k e t . Says D a v i d D e v l i n , vice-president of First National City Bank: " T h e probl e m is t h a t f o r e i g n - o w n e d E u r o d o l l a r b a n k s c a n l e n d t o E . S. f i r m s h e r e a n d ( nts t r\ ( Investors look for guidance in the new, vast international market | Th< • B r i m m e r : 'If the p r o b l e m is f o r e i g n banks, the Fed will not s t a n d by helpless. t h e y are not subject to reserve r e q u i r e ments. Subjecting our London branch to reserve r e q u i r e m e n t s for the same l o a n , " he a r g u e s , w o u l d i n c r e a s e t h e n costs a n d m a k e t h e i r l o a n r a t e s to prospective borrowers uncompetitive. So f a r , f o r e i g n b a n k s a r e n o t l e n d i n g t o E . S. c o m p a n i e s o n a n y scale. I n t h e f u t u r e , " says B r i m m e r , " i f the p r o b l e m is f o r e i g n b a n k s , t h e F e d w o u l d n o t s t a n d b y a n d be h e l p l e s s . " A l t h o u g h One Presidential plan would repatriate the Eurodollar operations of U. S. banks t h e F e d has no w a y to put r e s e r v e req u i r e m e n t s on f o r e i g n banks abroad, w i t h a c h a n g e i n l a w , it m i g h t d o w h a t G e r m a n y d i d i n 1972. T o k e e p E u r o d o l lar m a r k e t b o r r o w i n g s f r o m ballooning the d o m e s t i c money supply, G e r m a n a u t h o r i t i e s put reserve requirements d i r e c t l y on G e r m a n c o r p o r a t i o n s w h e n t h e y b o r r o w e d a b r o a d in d e f i a n c e of anti-intlation restraints. Nixon's proposal. T h e F e d a l s o is n o t r e s p o n d i n g too w a r m l y to a N i x o n A d d i t i o n p r o p o s a l t h a t it f e l t h a d 1 implications. The international eport of the P r e s i d e n t u r g e d t h a t E u r o d o l l a r m a r k e t o p e r a t i o n s ot E . S. b a n k s be b r o u g h t h o m e . I f d o n u s t i c b a n k s k e p t a s e p a r a t e set o f b o o k s , t h e y c o u l d be e x e m p t e d f r o m d o m . sti< " SH w is tw iit of th. d tn- * impanv might nomic a p i t a l issues t o f o r m d arrange tor the d i s t r i b u t i o n t o lie r e r o u t e d b a c k t o retail customers inside the I . S . - a v i o l a t i o n ot r e g i s t r a t i o n r e q u i r e m e n t s . H o w t * e r s o l m i g is t h . mt< n ^ . q u i l r i t i o n t i \ »11 I I \ i n « If. < t t h . < \ t r I cost i t i m p o s e d o n A m e r i c a n s p u r c h a s inis s e c u r i t i e s f r o m f o r e i g n e r s g a v e e f fective insurance that this danger w o u l d not m a t e r i a l i z e . N o w t h a t the 1 F:T IS g o n e a n d A m e r i c a n c o r p o r a t i o n s are no l o n g e r r e q u i r e d to e m p l o y foreign m o n e v to finance overseas c a m t a l s p e n d i n g , t h e sEc savs t h a t w e h a v e t o w o r k u p a set of g u i d e l i n e s t h a t w i l l keep the stufi t r u m c o m i n g back. S i m i l a r l y , tne T r e a s u r y D e p t . had been, m effect. w a i v i n g I . withh o l d i n g tax on A m e r i c a n - s o u r c e i n t e r est a n d d i v i d e n d i n c o m e p a i d t o f o r e i g n e r s so l o n t r as t h e s e c u r i t i e s m question came under the IEI. Like the F e d a n d t h e SEC. it d i d so t o g e t I . S. corporations to finance abroad. I he I r e a s u r v n o w s a v s it w o u l d l i k e t o tret r i d o l t h e w i t h h o l d i n g t a x a l t o g e t h e r . T h e a r g u m e n t for a b o l i s h i n g it, h o w e v e r , goes s t r a i g h t back t o t h e dil e m m a ol the new i n t e g r a t e d capital m a r k e t . The people overseas who are p o t e n t i a l b u v e r s of A m e r i c a n securities. i n c l u d i n g the A r a b i a n oil sheiks, are n o t a p t to t o u c h a n y issue w i t h a w i t h h o l d i n g tax. T h e r e are p l e n t y of i n v e s t m e n t s a r o u n d w i t h o u t it. A n d some investors fear thev risk exposure at h o m e f o r t a x e v a s i o n it U . S. t a x collectors get d a t a on t h e i r incomes. • 250 THE NEW YORK TIMES, THURSDAY, APRlf, 25, 1974 Arabs Starting to Invest New Oil Money in West By LEONARD SILK A large amount of Arab oil But the truly massive flows are revenues has begun to flow yet to come. West, including about $l-billion Among the projects that have to the United States—a small come to light so far are these: but significant part of the vastly f A Louisville, Ky., real Increased revenues the Persian estate and finance comGulf states are obtaining for pany, Enck, Hoilingsworth & Reveaux, will invest an initial their oil. Only limited amounts have $50-million of Kuwaiti and surfaced as direct investments Lebanese money in American in the West, so far. Some of it real estate, backed by a $200is going into real estate—raw million line of credit Ultiland, hotels, apartment houses, mately, the company claims, office buildings, including one the investment will reach $250on Fifth Avenue and one on the million. Champs Elysees in Paris. qWooten k Associates, An unknown amount is flow- Dallas builders and developers, ing indirectly to Moscow, in say they have $200-million ofi payment for arms, and may be Middle Eastfinancingfor apartflowing back to the United ment house development in States in payment for wheat. St Louis. fThe Shah of Iran, through his Pahlevi Foundation, has 251 ment, if relations with the Arab is all the Arab oil money going? construction and development For the fact is that most pf it projects in Saudi Arabia, inworld deteriorate. flAdnan M. Khashoggi, a rich seems remarkably invisible. cluding petrochemical plants. bought 642 fifth Avenue in Lehman Brothers, the big New York City. The Pahlevi Saudi Arabian based in Beirut, Rudyard Kipling wrote a poem about hte unseen flow of Foundation purchased the for- has bought raw land in Cali- money as an underground river New York investment banking house, .with former Commerce| fornia for development. He has mer DePinna Building on the also acquired •controlling inter- more powerful than the Ama- Secretary Peter G. Peterson southwest corner of Fifth Ave- est in the Security Capital Cor- zon. But the Arabs and Iranians and former Under Secretary of nue and 52d Street last August poration with assets of $115- are sending forth their money State George Ball leading the for $8.6-million from Sam Min- million, and in the Bank of not in a mighty river but in way, is seeking to interest the skoff & Sons, the building Contra Costa, Calif., with as- hundreds and thousands of Arabs in a broad range of derivulets. velopment projects and to get organization, Lehman Brothers sets of $22.8-million. American bankers and finan- the United States Government Fall-Out Still Evident and the Cust6m Shop Shirtcal advisers are in ardent pur- to support the joint developSix months after the Arabs makers. The foundation is suit of Arab money. David ment of the Middle East in based in Iran and is named deployed their "oil weapon' Rockefeller, chairman of the such areas as food, education, against the West; in the course after the Shah, Mohammed Riza 0 f the October'war against Chase Manhattan Bank, has housing, and desalinization. On their side, the Arabs have Pahlevi. 'Demolition of the Israel, the fall-out from the in- concluded a deal with the buildingn was recently begun duced energy crisis is still strik- Saudis in which Chase will set up their own banks and manage $200-million in Gov- joint ventures, especially with to clear the site for the con- ing the world economy. ernment funds for investment. the French, and are using them The quadrupling of oil prices struction of a 34-story multiThe Philadelphia Fidelity Bank as a vehicle to move part of use tower that will include an by the Organization of Petro- has bought 80 per cent of their funds West. Iranian cultural and commer- leum Exporting Countries has Lebanon's largest bank, the Hundreds of foreign banking, cial center. The tower project hurt a broad range of industries Banque de la Mediterran£e; brokerage and investment inhad been originally planned by from autos to air lines to pub- Irving Trust is taking over an- stitutions in financial centers lic utilities. . . the former owners who had other. all over the world are waiting abandoned it when the office Worldwide inflation has been The First National City Bank for the truly massive flows of intensified. An enormous transspace market in the city be- fer of wealth to the Middle East of Chicago is opening a branch petrodollars to come, but so far came glutted. in Dubai, and the Continental the flows of Arab money have has begun—the equivalent of a ^Several Kuwaitis paid $27- massive tax increase on tihe Bank of Illinois reportedly is been less than expected. million for a large property on rest of the world. Interest rates about to buy a Bahraini instiA Lag In Payments "the' Champs Elysees in Paris, have been forced to record tution. One reason for this is that where they will build a large levels, everywhere, squeezing The First National City Bank luxury office and bank building Stock brokers and investors, of New York — which ranks the payments for oil from the to be called the House of and threatening the solvency of with Chase Manhattan and big international oil companies many busineses dependent on Morgan Guaranty as the big- have not yet been reaching the .Kuwait. gest American holders of Arab Middle Eastern oil-produting f i n early March, 1974, in ready credit. The combination of soaring Government funds — already states in sizable amounts. H one of the moves that has most, ^caught public attention, the oil bills, inflation and huge has branches in Bahrain, Dubai, Major oil companies such as ^Kuwait Investment Company shifts of funds jeopardizes the Abu Dhabi and Quatar. and is EXxon, Mobil and Gulf norbought Kiawah Island, 15 miles balance of payments and cur- the only foreign bank in Saudi mally pay their bills with lags 'South of Charleston, S.C., for rehcy of many countries—in- Arabia. Chase is setting up a of three to sue months. The »$17.4-million in cash and are cluding some of the poorest, branch in Egypt—in Aswan, of Persian Gulf producers have -planning to develop a $100- such as India and Pakistan—of all places—despite the coun- not been pressing for early pay! million residential resort there. many countries and endangers try's nationalized banking sys- ment. For the moment, thereThe same company put up $10- the stability of the entire world tem. Manufacturers Hanover fore, their funds are still piling \!million, half the equity, for a monetary system. Trust of New York has an 18 up in the oil-companies' own acj-downtown Atlanta center that The quest is on for monetary per cent interest in Beirut's counts. Bigger transfers will will include a Hilton Hotel and security—in the oil-producing Arab Finance Company, which come within the next few [•a. shopping mall. states as well as among the oil is 56 per cent Arab owned. months. " f Many other real estate con- consumers. The use of the oil The Bank of America is exA second reason for the • cerns are looking for Arab weapon by the Arabs, far from panding in the Middle East, limited visibility of the Arabs' money. Benjamin V. Lambert, causing a counterattack by the with a 30 per cent share in new wealth so far is that a president of Easdil Realty, an Western powers, has set off a the Bank of Credit and Com- great deal of Arab money has affiliate of Wall Street's Blyth, race in business, financial and merce International, set up in been flowing to the Soviet Eastman Dillon, says he thinks government circles for access Luxembourg in 1972 with Arab Union, in payment for armaMiddle East oil states will put to the billions of "petrodollars" ment furnished to Egypt and about $l-billion into American flowing to the Middle East. That partners. Syria for the war against IsThe American Express properties in the next two flow has been estimated as rael. The Arabs — especially years. But he disputes claims likely to exceed $80-billion in die East Development Company the Saudis — bankrolled the that the Arabs may invest five 1974 alone and to reach a cu- which helped a large British Egyptians and Syrians,-and are to ten times as much, asserting mulative total by 1980 of half insurance brokerage company still paying off their arms bills. that they are nervous about a trillion dollars in investible buy into a Saudi Arahian in- The Russians have been eager surance company, is joining exposing themselves too much funds. with Japanese and other Amer- to get dollars to meet their own . and having their assets frozen Yet one of the critical mys- ican institutions to set up a' external obligations—especially by the United States Governteries of the moment is where merchant bank to invest in to the Americans for the huge 252 Meanwhile, they are eagerly ernments 1973 wheat deal. in the Eurodollar a timely adjustment will take Thus, Soviet supplies of trying to screen the vast num- market this year will reach place. weapons to Egypt and Syria ber or projects, at home as well about $30-billion. Britain has economists as Prof. Richard announced that it intends to Cooper of Yale and Prof. Sidwere essentially paid for by as abroad, open to them. higher oil prices charged in the The greatest single share of borrow $2.5-billion to help ney Rolfe of Long Island UniWest by the Arabs. The Saudis, Arab money seems to be going cover its oil deficits. Italy will versity feel, the world needs Kuwaitis, and Libyans have into the Eurodollar market — be after $2.2-billion—if lenders an international central bank been shipping money to the dollar deposits in banks abroad are willing to give the shaky to serve as a lender of last Soviet, who transhipped some —and into foreign exchange, Italy Government that much. resort, should some major naof it back to the United States. especially West German marks, France is expected to borrow tional financial institution European sources estimate that which helps to account for the $2.3-billion. The Philippines, the Arab payments to the Rus- superstrength of the mark. Spain, and Denmark are ex- crack. The danger is that, if sians have amounted to nearly For the time being, the Arabs pected to borrow nearly half a there is no prompt bail-out, $5*billion. are staying' liquid. Such long- billion dollars each, and a siz- there could be an extinguishment of money and credit that Middle Eastern money is term investing as they have able group of other countries ptfrkf^bring depression in its also being used in growing done in Europe has gone into will seek smaller amounts. amounts to increase imports gilt-edged securities in London Including both prmrte I from Western Europe and and into West German bonds mblic borrewfegSjiJEaHtiSollar Others believe that such Japan. In Europe, West Ger- and they have reportedly been oans thi^yeir-are forecast to fears are exaggerated, and that many appears to be reaping buyers tjf gold. They have also total $40-bilHon—about double the highly developed internathe biggest gains in trade with panted millions in longer-term last year. tional money markets will au- ' the Araos. time deposits, rangingfromthyae ''" The resource-poor developing tomatically take care of the Much oil money is likely to to 10 years. New Yorfcjttdfces countries, such as India, Bang- recycling of excess funds flowgo for increasing imports of say they have stayed out of ladesh and Pakistan, have been ing to the Middle Eastern states armament. United Stater "Treasiiry bills. thrown into desperate straits back into the normal channels Iran has spent about $4- Howeveft Venezuela—a benefi- by the increased oil price, and billion in the last half dozen ciaiy of the quadrupled oil price regard increased loans or aid of the world monetary system. years, especially on American —has been a heavy buyer of from abroad as a life-and-death If these moves are not enough to bring the extraordiaircraft and British tanks. Brit- United States Treasuries. matter. ish tanks have also been going The Arabs, American observ- Economists of the World nary new situation down to to Saudi Arabia, Iraq and the ers agree, are nervous about Bank have estimated that, on manageable proportions, there Gulf States. The French have jutting too much of their hold- the basis of an $8.65 price per are also the possibilities that been selling aircraft and sur- ngs into dollars. They have barrel of oil, the poor develop- the Arabs will make matters face-to-air missiles to Libya >een asking Washington for ing countries will require an easier themselves — by lowerand Kuwait, and have re- guarantees against further de- additional $9.4-billion in capi- ing prices, or increasing their portedly just agreed to sell valuations, but the Treasury h tal to cover their external pay- imports and their foreign aid $150-million worth of missiles, refused to give such guarantees. ments gap. The Arabs and — or the countries that conmortars, ammunition and other Some critics feel that the Unite Iranians have indicated that sume oil will move to buy less, from producing equipment to seven Arab coun- States should be prepared to they will cover some fraction especially countries that will not use the tries. The Soviet Union has of this but are ambiguous on money productively. been the big supplier of mili- sell bonds to the Arabs, de- how much. Or the West might seek actary goods to Egypt and Syria, nominated in riyals or othe but the Egyptians are in Middle Eastern currencies, And, overwhelmingly, it is commodation with the Arab oil process of switching to United which would assure repayment Arab money that these borrow- producers on thefr own politiStates and other Western without loss of value. This has ers will be taking. As one New cal terms. Says Professor been done in the past, but only York banker puts it, "all the Oweiss: "The United States sources. longer-term money in the Euro- should take another look at its with major currencies. Thus far, the Arabs are takdollar market is from the Mid- foreign policy and at the right Dollars Still Dominant ing their time in making longdle East." of Arabs in the area. It should Even without guarantees, range investment commitments. Immediately, given the rela- also take another look at its Prof. Ibrahim M. Oweiss of much of the Arab money going tively moderate flow of Arab true economic interests. If the Georgetown University says into the Eurodollar market is oil into capital markets, United States and the Arabs that they "are studying all likely to find its way to the themoney heavy demands of govern- can build up cooperation and prospects, and seeking to find United States anyway — direct- ments, caught in a balance-of- mutual respect, then Arab on their own what investment ly from the Middle East or in- payments and of private money will flow into the United demands are open, to them." directly via Europe — given the borrowers, bind, hit by inflation and States for investment." Somee outsiders criticize them still dominant international role urgent cash interest Some- observers feel this is for having no "system" for of the dollar and the size of rates are beingneeds, forced up to a more subtle and dangerous evaluating investment projects; the American capital market. 10 per cent and higher, here form of blackmail than the oil All countries that purchase and they are short of expert anin Europe, although big- embargo, one that poses serious alysts, economists and plan- oil are strapped for funds to ger flow of Arab moneya into pay the bill this year. The oil the capital markets in coming danger for the survival of Isners. Professor Oweis£ a native of squeeze is intensifying the de- months is expected to ease in- rael Others think, however, Egypt, feels that the Arabs are mand for Eurodollars on the terest rates next summer and that in the long run improved in no hurry because of the lag part of nations threatened with prvent the situation from be- relations between the Arab world and the United States in collecting the oH funds due unpayable balance-of-payments coming critically tight. are a precondition both of them; he suggests that the lajg deficits. will last another »ix or seven Financial experts estimate However, not all money-mar- world political and economic ' months, stretching into 1975. that total borrowings by gov- ket experts are confident that stability. wake* i 253 EUROMONEY A p r i l 1974 Oil money and tlie markets W as» month the markets started to ice the l i m early of what the new oil surpluses might mean. We don't know whether it was a switch of oil funds out of the dollar that triggered off the currency's weakness towards the end of the mortth; but we can be pretty M R tint it was a flow of oil funds into sterling that brought the rate from S2-I6 to $2-36 between midJanuary and late March. Certainly it was not confidence in the economy that did this. There is some debate whether the flow of funds into sterling was mainly oil companies buying the currency in Older to pay their royalties (much Middle East oil is still invoiced in sterling), with these funds not being switched out of sterling by the new holders; or whether the flow was more a straightforward placement of royalties previously earned. It must be a bit of both; the question is one of degree. But we do know that there has been steady buying of gilts since mid-January by Middle Eastern interests, sometimes on a very big scale. On two days towards the end of last month £80 million was bought, while total purchases of U K Government securities by oil producers this year may already have reached £500 million. The gilt purchases are the main example seen in London of the producers investing medium-term—in this instance mainly in five- to seven-year maturities. Elsewhere shorter maturities seem to have been favoured, with some funds (apparently from private Middle Eastern investors) being placed in CDs. Evidently, too, substantial funds have been placed in US Treasury bills by the New York Fed, acting for Middle Eastern government agencies like the Saudi Arabian Monetary Agency. Aside from some publicized properly purchases— for example, by Kuwait on rhc Champs-£lysees—that is about all that is known. There has not been much longterm placement of funds, there has been virtually no investment in equities, hardly any direct investment. The Arab funds coming into the Euromarket have been largely from Arab banks (in the medium-term market) and private individuals (in the Eurobond market), not from official sources. So it means the pressure is still on the producers to do something other than pile up short-term paper, which offers them no real return at current inflation rates. What docs it mean? This is pretty thin evidence to start drawing conclusions about the implications for the financial world of the oil revenues, hut it does seem worth making a few points, if only because of the scale of the funds in question and the fact that these will be a major (if not the major) influence on exchange and interest rates for several years. Besides, no better guideline of what will happen exists. First the parochial part. As far as Britain is con- cerned there are, m fact, very dear lessons. The breadth of the London market gives the country a real advantage in attracting Arab funds to tide her over until she becomes a major oil producer herself. London, New York and perhaps Paris ire the only markets where funds on the scale accruing to the oil producers can be placed without sending the market through the roof. Secondly, the guarantees now given to official holders of sterling make sterling, in effect, a secure currency. The fact that this country may see a steady (and perhaps embarrassing) rise in>the currency coinciding with a continued awful current account deficit has been pointed out already. It may even be that Britain will be able to cover the nor.* oil—as well as the oil—deficit from capital inflows without needing the official $2-5 billion borrowings now negotiated and the others in the pipeline. For the world as a whole the lessons are less bbvious. Certainly the influence on exchange rates will be massive if the impact on sterling is anything to go by. There is no evidence that the oil producers will use their currency holdings as a potential weapon; nor even is there any evidence that they will pursue an active foreign exchange policy, switching between currencies to try to maximize their return. Not only do they not need to play this game; they probably could not, as there would be no one playing against them on the other side. Since'central banks can sit out the dance by floating their currencies the days of the one-way bet on the exchanges are now over. But even the oil producers'straightforward investment policies are bound to distort currencies. It would be extraordinary if their investments tallied precisely— currency by currency—with their earnings. For this to happen, countries which were more successful at exporting to the oil producers would have to take a smaller share of the producers' investment funds. This, seems most unlikely. If anything, the reverse will happen, with countries with close political ties with the producers, or which are particularly successful at exporting, getting more than their share of investment funds. We have just seen how one currency—sterling—can move i r quite the opposite direction to what might be expected on economic and political grounds. Such movements are bound to be repeated by other currencies, with the French franc as an obvious candidate. If this is correct, the idea of centrally planned distribution of the oil revenues, via the IMF. lakes on further attractions. The cynical view of the Fund's plan is that it puts the Fund back in business alter floating rates had reduced the need for its services. This is true enough, if unkind. But the Fund's plan docs provide the muchneeded mechanism through which the distortions of the market's redistribution of oil revenues can be counterbalanced. This job hus to he done; and no one has yet come up with a better way of doing it. Euromoocy April 1974 3 7 - 2 1 1 O - 74 - 17 TK: American KCOIKMUIC PAPERS A N D Rev1CW PROCEEDINGS OF TT1 F F.i rh: >-(/x: i Annua! OF AMERICAN THF I ( ( ) \ ( >\1 K MAY Meeting VFl ASSOCIATION 255 Politics, Economics, and World Oil By M . A . A D E L M A N * Zen Buddhist monks used to torment novices by asking: "What is the sound of one hand dapping?" That sound has become deafening in recent years: the official predictions that because world oil consumption will increase, oil must grow more scarce and the price must increase. But scarcity is the pressure of demand upon supply. To omit either element is nonsense. They are united in the true measure of scarcity, long-run marginal cost. The only relevant question is whether, as consumption grows, society must keep putting more or less into the ground to get out another barrel. Long-run marginal cost is mostly the return on the investment needed to develop additional capacity. Failure to discover new flush reservoirs means ever more intensive development of old fields, hence rising development investment and cost per unit, and rising prices. Anticipated price-cost increases delay development of some deposits, forcing more intensive work on the remaining ones, hence higher costs. Thereby a development cost increase serves as a distant early warning signal of future scarcity, bringing it into the present. Conversely, a stable (or declining) marginal cost means no greater scarcity, and this is the actual case. For the Persian Gulf, or even for the whole world outside North America, real costs have been sharply declining, and even if they were now to reverse course and climb, as is always possible, they would be a negligible fraction of price. The current flood of projections from here to eternity is a pitiful and futile attempt to replace the price-cost thermometer-thermostat, but they are official truth. One projects "needs" and "amounts available" to And a "surplus" or "deficit" regardless of elasticities ol demand or supply.1 A Royal Dutch Shell executive sums up the world oil market: "The underlying situation of supply and demand remains one of potential surplus. Yet the producing countries manage to reap the rewards of a sellers' market by creating a producer's monopoly" (Geoffrey Chandler). * Massachusetts Institute of Technology. I wish to thank Harry J. Colish, Richard L. Gordon, Richard B. Mancke, and Joseph L. Yager for comments on an earlier draft; errors are my own. 1 Elementary economics is ignored in grain as in oil: the Department of Agriculture's Economic Research Service was never consulted on the notorious 1972 wheat sale to Soviet Russia (A7 I T , Oct. 7,1973). I. Monopoly The multinational oil companies are not junior partners but rather agents of that monopoly, the members of the Organization of Petroleum Exporting Countries (OPEC) (but not OPEC itself). Aside from short-termflights,the price is now around $8 and (probably) close to the long-run profit-maximizing level set by the competition of substitute energy sources, as the Shah of Iran has stated (New York Times [Arrr], Dec. 24, 1973). The official truth stated by Secretary of State Henry Kissinger, that prices haverisenbecause of a surge of demand against inelastic supply (NYT, Dec. 12, 1973), is in utter conflict with the fact of enormous supply elasticity at cost of at most one-fortieth of the current price. The popular slogan "avoid overbidding" suggests that oil prices have been bid up by demand exceeding supply, which is untrue, and also betrays a misunderstanding 256 INTERNATiONAL ENERGY SUPPLY pitulation—and ceased upon his request; of what has been happening in 1972-73. see M. A. Adelman (1973). He later exCurrent supply-demand fluctuated, with plained that the threats had been made occasional excess capacity. But the demand for crude for later delivery was in- privately (James Akins). This evades the issue; threats are made in private so that satiable because buyers knew prices were going to be raised. Buyers had littk down- they may be denied, reinterpreted, or repudiated. And to say that the threats side risk. If the producing countries delivered at the contract price, buyers would ceased is completely false in die light of the numerous public statements which culmimake a speculative gain; if they delivered nated in a formal OPEC resolution, issued at the expected higher prices little would just before the Tehran agreements, threatbe lost. Whereupon the OPEC countries ening "total embargo"—and equally nuturned around and cited the rising conmerous threats since. tract prices as a reason for raising their taxes~-thereby putting a firm tax floor The first triumph of blackmail anunder the higher prices and validating the nounced more to come—as some were then expectations. "Reasons" are as plentiful as denounced for saying. Our government blackberries; what matters is the power to "expected the previously turbulent world raise the price of oil dose to the cost of oil situation to calm down following the (expensive) substitutes. new agreement." In fact, the five-year Tehran agreement lasted four months, and Monopoly means control of supply, after several "revisions" was pronounced hence power to stop It, hence dependence and insecurity. Food is more essential than "dead" vst fall when the Persian Gulf nations unilaterally raised prices. Perhaps fuel, yet nobody is "dependent" on any farmer or on all farmers together, because they were bored with what an oilman farmers cannot act together to control and called "the charade of negotiations." (NYTt Oct. 19, 1973.) But the American if need be withhold their production. Our policy maker may be right in claiming that "dependence" on imports exists only bethe Tehran agreements "worked well" cause of the cartel and (in the short run) (Akins)—from his point of view. So also the Arab majority bloc. Its history is exwith the proposal for preferential entry tremely important: "those who ignore the past are condemned to repeat it," and we into the United States for Saudi Arabian oil—the most insecure source conceivable. have already repeated it once. The key words in that history are threats by the The State Department was "enthusiastic" producers, and collaboration by the con- (Oil and Gas Journal [OGS], Oct. 9,1972), for reasons not explained. Nobody can suming nations, especially the United States. The threat of an embargo gave the doubt that its "exaggerated talk of an energy crisis greatly strengthened the barcartel its first triumph: the Tehran gaining power of the Arab states" (Petro"agreements" of February 1971, whose leum Press Service [PPSJ Nov. 1973). expected and actual effect was to raise prices at a time of slack demand. The II. Shooting War and Economic War documented record of the 1970-71 events Middle East politics, specifically the shows that only after American-sponsored Arab-Israel tension, have had no effect on capitulation to producing country dethe price, and a Middle East settlement mands in January did anyone dare voice public threats. The American policy maker will do nothing at all'to keep the price did not blush to tell a Senate committee from increasing to the monopoly level. that threats had been made be/ore the ca- The producing nations will take what they 257 AMERICAN ECONOMIC ASSOCIATION "much" too high for Saudi Arabia's good, can get. The monopoly revenues make twenty MBD is catastrophically too high, peace unlikely. (See below.) and we will owe them three times as much The shooting war and economic war or more in 1980 than we do now. To keep waged by a subgroup of the cartel—the the oil lowing, we will impose a just peace Arab oil producers—were invited by rein the Middle East this year. Next year it peated American statements, of which the will have to be even more just, and the public record is probably only the tip of year after t h a t . . . and so on. the iceberg, and whose complete exploration would richly repay a Congressional This official truth about needing to do inquiry. The Saudis were told they were something for Saudi Arabia, because it is the last best hope of civilization, we had not worth their while to expand output, is to have their oil, and would they not all implicit, never set down for analysis. please produce it, even though it was not But it appears to rest on two assungytkMss. (we said) in their economic interest to do (a) "Oil in the ground appreciates faster so? No revenues were high enough to inthan money in the hank/' abbreviated duce the Saudi government to agree to big OGMB. It is often embellished by saying production increases; something extra that the dollar has depreciated, and prices must be done for them. (Wall Street on the New York Stock Exchange have Journal [WSJ], Aug. 15, 1973; OGJ, gone to pot, ergo, there is no place to Sept. 10, 1973.) This was a self-fulfilling invest. In fact the dollar may be an underprophecy. For if we believe it and are valued currency, or payment may be in willing to do something extra for the another, and in any case the annual volSaudis, they are glad to demand it. ume of capital formation in the developed world (not to mention the total stock of The buyer is asking to be had who tells a seller, " I know you don't want any more existing purchasable assets) is many times business but please just to do me a favor "the future revenues of even Saudi Arabia. But let that go: OGMB is at best meaningwon't you sell me something?" There are less without specific numbers. The current few such buyers because they don't stay price of Persian Gulf oil is about $8. If 8 in business very long. Not so in governpercent is a safe interest rate, then a barment. Sheik Yamani, the Saudi Arabian petro- rel is worth holding) instead of a corporate bond, for four years for an expected price leum minister, recently asserted that berise to $11, and for nine years for an exfore the recent cutbacks, when Saudi Arabia was producing eight million barrels pected price of $16. The price is not going to appreciate indefinitely at 8 percent per per day (MBD), "we were producing at a much higher rate than what we should for year: it is not going to $32 in eighteen our economy (Meet the Press [MP], Dec. years, nor to $64 in twenty-seven years. But Saudi Arabian crude reserves are fifty 9, 1973). And that was a sacrifice on our times current output, and can be greatly part" It amounted to "losing money." increased at negligible cost. They are held Sheik Yamani says, without a smile, that back in order not to wreck prices. OGMB his government has been producing not is an irrelevance in a noncompetitive marfor its benefit but for sweet charity. He ket. speaks as a man who expects to be be(b) Saudi Arabia (and others) will limit lieved. But that's no wonder, for the United States Government was saying this their oil revenues to what they "need." This means—if it means anything—that publicly before he was. they will hold back output short of the But if eight MBD is a production rate 258 INTEXNATiONAl ENERGY SUPPLY monopoly optimum, Le., the point where it maximizes the present worth of their assets. I t is an odd assumption, to say the least, and quite unsupported. If King Faisal acts like a true dynast to serve his successors, family, retainers, friends, etc., the best way to insure this is to maximize present worth. We are better off with less talk of "need" and a little thought about economics. Saudi Arabia, like the U.S. Steel Corporation or the Texas Railroad Commission in other days, has the usual problem of Mr. Big in a cartel: find the combination of price and quantity which will maximize group profits—or more generally, best serve the economic interests of the producers. They can fix the price and let the price determine quantity ; or fix the quantity and let it determine price, but these are only two routes to the same goal. No blandishments will make them expand output; anyone who thinks he can persuade them is merely stroking his ego and reminding us howrightwas a Scottish professor of moral philosophy who Warned against the "overweening conceit" of men "in their own abilities." Repeated assurances of how badly we need them are simply taken as evidence of inelastic demand and signal the monopolist that there is greater profit in even greater restriction. The drift of American policy was visible in these statements that we owed Saudi Arabia, to whom we sent as ambassador the principal architect and defender of the Tehran "agreements." His earlier statement that "a seller's market arrived in June 1967" disregards three years' price decline but reveals his belief that the Six-Day War was a calamity to be reversed. He "think(s) the OPEC countries should be granted substantial increases," in order to induce alternative energy sources needed "to avoid an energy crisis in the 1980's, or 1990's," a "crisis" again assumed, never explained. Also, "price in- creases will hurt America's commercial competitors Europe and Japan," and Saudi Arabian revenues would mostly be invested in the United States (Economist [Ec. J, Nov. 26, 1973). Saudi Arabia "planned the Arab strategy for the [tm] Middle East War/' both shooting war and economic war (LeMonde \LMJ, Oct. 9, 1973; NYT News of the Week in Review [NWR], Oct. 14,1973; OGJt Oct. IS, 1973; NYT, Nov. 10, 1973; see also NYT Mag., Nov. 18, 1973). King Faisal and Prince Saud al-Faisal had stated they needed to put pressure on the United States. But "the US. can get along without Arab oil until the end of the decade" (OGJ, Sept. 12, 1973). Therefore it was necessary to reduce total production deeply and deprive others of more oil in order to deprive the United States of less. A selective embargo was taken seriously by our principal policy maker but by nobody else (Akins 1973). III. Surrender Without a Fight The cutbacks have been a great political success. We are right back to the 1930% when European nations looked for a deal with the aggressor in the hope he would go jump on somebody else, and when German generals opposed to aggression were discredited by the willingness of the Western powers to give away other people's lands and lives; so too the moderates among the Arabs. For, confronted with the cutbacks, the Europeans and Japanese stood clear of the Americans, however dangerous that was for them. More important, in my opinion, was their inaction at home: oil stocks were not spread over time by rationing, i.e., not used as a defensive weapon to gain time wherein to carry out a plan, but as a means of putting off the unpopular decisions to curtail demand. Most important was European eagerness to collaborate with the Arabs rather than each other. "Arabs don't have to police their 259 AMEMKAN ECONOMIC ASBOCtATfON own boycotts. Sycophant nations are doing it for them" (WSJ, Nov. 6, 1973). The Common Market countries refused to ship or pool oil resources, as requested by the Dutch who had been picked out as a special victim. Apparently the Dutch are getting some covert help—but only after they threatened to cut off natural gas deliveries to France and other nearby countries. Japan had been more pro-Arab than any large country but France, and had stood aloof from other consuming nations, lest they offend (Petroleum Intelligence Week!y [PIW\, May 14,1971), only to find itself accused of "odious neutrality" (NYT, Oct. 18, 1973). Saudi Arabia was ready to make new demands "because of their success in recent yean in enforcing a boycott . . ( W S J , Nov. 7,1973; NYT, Nov. 9, 1973). A cut in British deliveries " . . . is dearly causing embarrassment to the government, which . . . had received assurances [sk] from Arab countries.. . " (Piatt's Oilgram [POPS], Nov. 20, 1973). The French government is embarrassed ova* reduced supplies (NYT, Nov. 20, 1973). Such governments are especially reluctant to begin rationing because it would be an "admission of failure," i.e., groveling did not insure oil supply (PIW, Nov. 19, 1973; LM, Nov. 23, 1973). The servility of consuming governments, playing the Abbe Alberoni to the Arabs' Due de Venddme (see Luigi Barztni), has made the original Arab demands of no importance. A weapon which makes consumer nations shake like jelly cannot be contained by a scrap of paper enumerating Israeli security or Palestinians' rights, etc.—there are far bigger objectives now to be considered. Moreover, Saudi money, to be multiplied many fold, can procure more arms from many sources, freeing the Arabs from whatever control the Soviet Union might exercise. This makes fresh wars likely if not inevitable, especially when the Saudis begin shopping for the nuclear weapons they can weH afford. Already there is a semiofficial Egyptian call for nuclear weapons, which would cost only an estimated t l billion, stimulated by "a high-level Washington visitor" to Cairo (NYT, Nov. 24,1973). IV. Economic Failure, Political Success Yet the cutback failed badly to reduce American supply. At its maximum (as of December) it amounted to 4.7 MBD, about 14 percent of aU oil moving in international trade. Hence had there been just enough leakage and diversion to put us as well off as oil importers generally, our import loss would have been about 14 percent. Now, for the four week* ending November 16, our combined imports of crude and products averaged 6J5 MBD. Since the boycott date was October 17, and Persian Gulf—U. S. transit time is about a month, this amount measures the pieboycott level of shipments. For the next four weeks, through December 14, the average was 6.10 MBD, indicating a loss of about 450 thousand barrels daily, 7 percent of imports, about 2.4 percent of total supply. The truly vulnerable place was the East Coast's heavy reliance on residual fuel oil, much from Caribbean and Canadian refineries which also ran some Arab crude oil and might therefore be forced to stop all shipments to this country in order not to lose some supply. An Arab resolution of November 26 to cut off the Caribbean and other transshipment centers (OGJ, Dec. 10, 1973) shows that by midNovember the Arabs realised their failure and their resolve to damage this country where they could. Yet on November 8 our ambassador to Saudi Arabia had warned that the plight of the East Coast would be "critical" if Arab oil supplies were not increased "in a matter of days" (sic) (NYT, Nov. 10,1973). This was wildly untrue. 260 tNTMMNATtQNAL MNUtQT SOFTLY The Arabs' 25 percent cu^ack in their production was scheduled originally to keep increasing 5 percent per month until Israel withdrew to her 1967 boundaries and "the legal righto ol the Palestinian people" were restored. But the Arab ofl exporters1 meeting of December 26 reduced the cutback to IS percent, ignored the two conditions, and let it be understood that the cutback would be cancelled upon Israeli withdrawal from the west bank of the Suez Canal (NYT, Nov. 26, 1973). Furthermore, the "friendly" nations (Britain, France) were guaranteed Arab oil even in excess of the base amount (September 1973), which means that their previous imports of non-Arab oil are completely freed for the not-so-friendly (Japan) or the unfriendly nations (United States, Netherlands). To what extent this failure of the production cutback to reduce US. supply is due to cheating by the Arab producers and to diversion of non-Arab oil is as yet impossible to say. V. Monopoly Harmful to Consuming Nations Relief at this failure should not obscure the fact that the oil cartel is very harmful to American interests, (a) In 1974 customers, including us, will be paying out well over |100 billion, and over 1972-30 cumulative the transfer to the producing countries wiU be several times that. The richer these nations are, the better they can maintain an embargo to make supply yet more insecure—as the Arab production cutbacks remind us, (b) The world monetary system will be harmed by huge amounts of liquid funds ready to move at a moment's notice, not to serve the holders' malice (the usual straw man) but for self-protection. Controls on capital movements to prevent this danger will in themselves be harmful (c) Restrictions on American imports, because of the expected oil deficit, have already embroiled us with our main trading partners in Europe and Asia, not only because of John Connally's bluster and bullying but also over the substance of our demand to get more than we give (NYT, May 1G, 1973). (d) The risk of mineral exploitation in less-developed countries is much greater ; concessions and contracts are now worthless. (e) The hope of a rule of law for the world's oceans has gone by the board because of the hugely inflated artificial value of any possibility of oil. (f) A vast arms buildup is just beginning in the Persian Gulf. Producers have billions available and every little patch of barren ground or barren seawater is actually or potentially worthfightingover. The arms buildup reminds us that although the oil monopoly will cost us dear, there will be gains for exporters and for contractors for construction, investment management, public relations, etc. There will be plums for many in the industrialised nations and crumbs for less-developed countries. Those "working for the petrodollar,11 paid or enriched by the monopoly, are highly influential. Moreover, each industrialized nation can hope that the burden will be borne by them in proportion to their oil consumption, but that they will get a disproportionate shaie of export and investment business. M. Pompidou appears to have talked to King Faisal of little else but French exports during their May 1973 meeting (LMt May 15, 1973); he is now "shocked" that anyone thinks exports have much to do with his Middle East policy (LAf, Nov. 19,1973). VI. Implicsrions for Policy Only in the long run can we get the cartel off our backs, and it will not be easy, quick, or cheap. I t is necessary but no longer sufficient to stop the oil producing companies from being the vehicle for the price-fixing agreement of the producing 261 AMS*KAN ECONOMIC ASSOCIATION governments. (1) Expelling the companies and losing their know-how would be a huge waste of resources, harmful to all. But if they simply produced (and developed and explored) and were paid in money or a modest share of the oil, the producing countries would have to do their own selling and monitor thousands of transactions all over the world. The companies have managed the difficult task of determining output shares because they have sold the bulk of the final product; the producer nations would inherit the task without the means. Nothing in the history of the trade suggests they would succeed; even the tight cartel of the 1930's was eroded, and it never faced an independent refining industry. A managing director of Royal Dutch Shell has well said that in buying from producing countries the multinational oil companies "have formidable advantages." (See G. A. Wagner and A. Glimmerveen.) Once they become "formidable" buyers of crude oil rather than tax collecting agents, the market will look considerably different from what it does today. The oil companies are a big gun pointing toward the consuming countries, which ought to be pointed the other way. Hence real nationalization is greatly to the advantage of the consuming countries. The producing countries may yet oblige us, as did Algeria and Iraq, byfirstexpelling the companies and then inviting them back as contractors or by doing their own selling of most of their oil as "participation." This is good for the individual country in the short run and bad for the group in the longer run—the classic cartel dilemma. It is imprudent to assume they will be so helpful, but the chances of this happening look better in late 1973 than I expected a year earlier; see Adelman (1973). Perhaps such prophecies will be realized as those of Thomas R. Stauffer in 1970: "We conclude . . . that prices will probably sink below the $1.15 level and t h a t . . . non-concessionary oil will drive out concerniontry oil/' The price-undermining effect of direct sale by the producing countries'natkmalcompanies("nonconcessionary oil") remains a l i y variable if the consuming countries wanttomake it one* The American government ought not to force American companies into being contractors, since they would merely be displaced by European or Asian companies. It must be done in unison or not at all. By the time moat consuming nations see their inteiests a bit more dearer, some will have taken another step: put oil imports under quota, to sell the tickets on sealed competitive bids. Any country which wished to expand or even retain its market in the United States would have to share its gains with the Treasury. This would not reduce the price of oil to the consumer. There would be in effect a tax on imported oil which would keep the domestic price level high also. (In my opinion a high energy price is desirable to reduce pollution and congestion. Those who disagree with this policy judgment may yet prefer to have the money go to the American not the Saudi government.) If the producing countries succeeded in coHusively fixing quota ticket prices, we would be no worse off, but chances of success are small because it would not take much cheating to fill the quota. Detection of cheating would be difficult and might be made impossible by Theodore Moran's suggestion that prices in any given bid be kept permanently secret. There would be no way of knowing whether any country's higher exports were due to its cheating. The current price level is so much higher than the cost of producing oil, even in highcost deposits—see Adelman (1972)—that trickles, then streams of new supply in the 1970's are a foregone conclusion, and they have been the bane of all cartels. Given supertankers and superports, a barrel of 262 MTBMMATIONM. MNSMGY SUPPLY oil anywhere in the world is a barrel everywhere, at a transport cost ol a dollar, which is little compared to the producing nation's profit. Only the shortage ol men and materials keeps this potential from becoming actual. But even now the producing countries are not deceived about the "world oil shortage.'1 Saudi Arabia, as mentioned earlier, tried lor preferential entry into the United States, which only makes sense when more people are trying to enter than there are places to set them. Venezuela keeps proposing worldwide prorationing. Iraq expelled the Iraq Petroleum Corporation from the largest oilfield because they refused to expand output, which under the new regime will have doubled or tripled from 1972 to 1975. When the consuming countries want to get rid of the burden they can; but at present there is no will, hence no way. This brings us back to the dismal present and decisions to be made soon. The Arabs have failed to cripple us; the Administration is trying to snatch defeat from the jaws of victory to serve some grand design not yet revealed to us. Our greatest immediate danger lies in a super-Tehran agreement for "cooperation" of producing and consuming states, announced by a flourish of trumpets on a TV spectacular, with the same promise made by the same people who brought us the first Tehran that this lime "the previously turbulent world oil situation" will really "quiet down." The ambassador to Saudi Arabia, who in 1972 told the Arabs that it was in their interest to curtail output, told us that for lack of oil our condition would be "desperate" by 1976, (Adelman 1973) and thought the Tehran agreement had worked well, etc., has suggested a world commodity agreement to set oil prices and ensure availability (NYT, Apr. 16, 1973). It would be a one-way street, preventing independent action by consumer states to promote price reductions. But if the mo- nopoly holds and the price can be rigged higher, up it will go. A lew weeks ago, in proclaiming the Tehran agreements dead, Sheik Yamani supplied a classic formula: "We in Saudi Arabia would have liked to honor and abide by the Tehran agreements, b u t . . . " circumstances had changed (Middle East Economic Survey (UEES) Sept. 7, 1973). Sheik Yamani may one day say that he and his colleagues would have dearly Umd to honor and abide by the Kissinger agreements, but. . . circumstances, etc. The supersubtle diplomat is no match for the fellow who grabs what is in his reach, then asks if you want to fight to get it back. But it may not even be necessary. For in waving proudly an "understanding" with Saudi Arabia to let output increase to 20 MBD or whatever, our government will not realize that there is no meaning whatever to an agreement which does not specify both quantity and price. For i! Saudi Arabia's interests are better served by producing less, it raises price to where there is less demanded. As regards supply outside this country, a sound world oil policy lor the short run is to do and say nothing. There are some virtues in necessity. Without a world agreement, each producing nation will seek to maximize its own profit. If Saudi Arabia will for years play the statesman and hold back on output expansion, we are no worse off; if they retaliate against anyrivals,we have gained enormously. Similarly with the consuming countries: some of them will recover from their panic and will begin inviting producers to make some special deals for disguised low prices, to put the cartel on the slippery slope. This country needs not ordnung but disarray in the cartel. But we cannot by statesmanlike action cure the nonexistent world oil shortage. However, there are some matters where action may help. Sheik Yamani warned in 263 AMKJUCAN ECONOMIC ASSOCUTfON early 1973 that any attempt at consumers' sell-defense meant "war," and "their [Le., our] industries and civilization would collapse" (Piatt's OOgrarn News Service [PONS], Feb. 22,1973). By November 9, he and his colleagues "are letting the word out that the present cutbacks in oil output are the limit." The reasons mentioned are possible Western responses: food, manufactures (including armaments), ami military action (ATF7\ Nov. 10, 1973). They who had talked ol "war" and suited the action to the word understand the language. We had better learn it quickly. There is as yet no weakening in our infatuation with Saudi Arabia, to whom we seem resolved to return bounty for evil done to us. In late November "a very high official in the Nixon Administration who is a policy maker in this area" told a reporter "he feels King Faisal... at the last minute would prevent any serious economic harm from being done to this country because he is at heart a friend oI the % United States" (MP, Nov. 25, 1973). Meanwhile, King Faisal is "angry with Mr. Sadat" of Egypt for being too cooperative with the Americans (Ec., Nov. 24, 1973). Without doubt the Saudis feel they have every right to be hostile to the United States, and it is not for an American to say they are wrong. But our safety demands that we recognize winch way is down. The Saudi connection, which our government values so highly, is no asset but a heavy liability. The profits of Aramco, whose protection is a perfectly legitimate national objective, will be kept at a level needed to secure incremental investment, and can scarcely amount to a billion dol-' iars annually even if Aramco reaches 20 MBD. If the Saudi investment portfolio reaches $100 billion, a 0.1 percent per year management fee is the most the management company can reasonably expect. This is less than the extraordinary expenditures already forced upon us this year by King Faisal's shooting war, and it is insignificant compared with the losses of national product here and throughout the world, due to the oil embargo: 1 percent of GNP lost is $13 billion per year. In war one seeks not to be strong everywhere, but only at the stiatqgk points. For the non-Communist world the decisive point is the United States. This country should immediately take steps to separate itself completely from Arab oil •aarces.Once we are beyond the reach of oil cutoffs, they can no longer pressure us. Then there is no profit in tormenting Europe and Asia, and risking retaMation, as an indirect means of pressuring the United States. Our overseas imports before the cutback were about six MBD. Future imports wffl for a time be larger, but will come nowhere near the ten or more MBD freely predicted a short time ago, because of the drive for greater self-sufficiency. The four largest non-Arab oil exporters—Iran, Venezuela, Nigeria, and Indonesia—already produce thirteen MBD, and their production will grow substantially, Iran alone being a good bet for 10 million MBD in a few years, especially if we act. (Our current ambassador to Saudi Arabia insisted in September 1972 that Iran had been interested in production increases, but no longer (OGJ, Sept. 25, 1973), which was contradicted by previous public evidence (OGJ, Aug. 14, 1973, Sept 4, 1973, Sept 13, 1973), and also the expansion program decided early in 1973.) Two routes ought to be examined. One is to bar or penalize imports from countries declaring embargoes against us or pressuring third parties to embargo us (see above). Or the United States could make contracts with any countries desiring preferential entry, in return for which they would guarantee certain minimum amounts. We would of course have to promise—and keep our promise—to pay the very high 264 OmUUiAT/ONU MNMMOY supply address, Institute of Petroleum, 27, Jan. 1973. G. F. Keanan, "And Thank You Very Much/' New York Times, Op. Ed., Dec. 2, 1973. T. R. Scantier, "Price Formation in the Eastera Hemisphere: Concessionary versus Non-Concessionary OB," in Zuhayr Ifikdashi, et aln Continuity and Change m the World OH Industry, Beirut 1970. G. A. Wagner and A. Gtimmcrreen, Presentation to a meeting offinancialanalysts in The Hague on Oct. 4,1973. American Petroleum Institute, Weekly Statist. Butt. (API). British Petroleum Statistical Review of tke World Oil Industry (BP). Bureau oj Mines, monthly releases (BP). Economist, London (Be.) LeMonde (IM). REFERENCES Meet tke Press, NBC Television (MP). ML A. Adelman, The World Petroleum Mar-Middle Bast Economic Survey (MEES). New York Times (NYT). ket, Baltimore 1972. "Is the Oil Shortage Red? DO Com- New York Times, News of tke Week in Repanies as OPEC Tax Collectors," Foreign view (NYT NWR). Policy, 9, Jan. 1973. OH and Gas J. (OGJ). J. E. Akios, "THs Time the Wolf is Here," Petroleum Intelligence Weekly (PIW). Foreign Afairs, 51, Apr. 1973. Petroleum Press Service (PPS). L. BanM, The Italians, 1964. Piatt's OOgram News Service (PONS). G. Chandler, "Some Current Thoughts on the Piatt's OQgrsm Prict Service (POPS). Oil Industry," Petroleum Rev^ Presidential Watt Street Journal (WSJ). world prices. But as shown earlier, this price frill likely be in the neighborhood of what it would cost us anyway to produce at home from substitute sources. Richard Gardner has embarrassed our government by pointing out that Saudi Arabia has violated their treaty with us providing for mutual most-favored-nation treatment (NYT, Dec. 19, 1973). We need only tell the Saudis their embargo on shipments to us is henceforth permanent, their status having been cancelled by their own act. As George F. Kenaan, a respected scholar and ex-diplomat, has *e& shown, in saving ourselves, we save our friends abroad, by making boycotts against them unrewarding and therefore unlikely. 265 IMF Survey March 18,1974 Aid from Oil Producers Asked for Poor Nations Fund Managing Director H. Johannes Witteveen and W o r l d Bank President Robert S. McNamara met on March 12 with Inter-American Development Bank (IDB) President Antonio Ortiz African Development Bank Mena, President Abdelwahab Labidi, and Asian Development Bank President Shiro Inoue. The meeting was held at IDB head- quarters in Washington to assess the impact of the current international energy situation on the economies of developing countries and to encourage a flow of funds from the oil producing countries to the developing world. The participants recognized that sharply higher oil costs represent not only a heavy drain on the external payments of the developing countries, but also a threat to the orderly execution of their development programs and to their economic growth. The developing countries urgently require additional external aid, both short-term assistance to avoid harmful adjustment measures and long-term financing to sustain their development efforts, and a considerable part of this assistance should be made available on concessional agreed. terms, the participants They re-emphasized that the advanced countries have a continuing responsibility for providing aid re- sources. At the same time they pointed out that the oil exporting countries now have a greater capability to share the burden of the additional aid effort, both through their o w n channels and through cooperation with existing international institutions. The participants indicated that the expertise and experience of their institutions in channeling resources to the developing world give them the capacity to play an important role in the international aid effort. However, to additional perform this function, funds are required, and a special effort is needed to mobilize such resources from the increased financial assets of the oil exporting countries. The heads of the five organizations agreed to continue to coordinate their actions in light of the new financial requirements. 266 I f r f f c ^ A p r i l 8,1974 A financial agency to supervise the flow of Arab funds among the various Arab countries has been suggested by El Sayed Hassan Abbas Zaky, Economic Advisor to the United Arab Emirates. The agency could help Arab countries cover the deficit in their balance of payments and could also give long-term facilities to Arab banks so that they might give medium-term loans to finance local Arab schemes* In addition, the agency would reinforce the potentialities of existing development funds in Abu Dhabi and Kuwait as well as the Arab Development Fund by granting loans to these funds. The Egyptian official said that in spite of the current large increase in oil revenues, Arab countries suffered unique problems, foremost among them being the absence of machinery for channeling Arab funds to Arab countries in need of them. He advocated the establishment of a market for Arab capital and the early institution of the Arab Payments Union to serve as a nucleus for an Arab monetary market. He added that the idea of issuing an Arab dinar should be revived, and suggested the dinar be issued initially in Arab countries on the Persian Gulf, and then introduced gradually in other Arab markets. Egyptian Gazette, C a i r o , M a r c h 22 267 T H E OECD OBSERVER February 1974 CONSEQUENCES OF THE OIL PRICE RISE: The Need for International Aetion Highlights from the speech of OECD's Secretary Generals Entile van Lennep} to the Consultative Assembly of the Council of Europe 23rd January 1974. F or the OECD countries three main types of problem result from the very sharp increase in oil prices. One problem is that a new twist is given to the price-wage spiral. There is the likelihood that, in the immediate future, the price increase will rise beyond last year's 10 per cent rate into the 'teens. The longer that anything like a double-figure price rise is continued, the greater the danger that inflationary expectations will become engrained in our thinking and in our economic behaviour. This means that a renewed attack on the problem of inflation, using all the available weapons, must be made by OECD countries acting simultaneously, for when inflation is so widespread a phenomenon as today, the efforts of individual countries are bound to be frustrated unless they are matched by equal efforts on the part of all. Another problem is the danger of an unwanted contractionary effect on the general level of economic activity and of employment. Income which would have been spent by OECD residents is being transferred to oil-producing countries. If they spent the whole of their increased income on purchases of goods and services, there could be no threat of recession. But for a number of them it is certain that, in the short-run, they will not be able to step up their expenditure in line with their incomes. Moreover, sharply rising oil prices may cause a general climate of uncertainty in OECD business circles. These potential contractionary effects on activity and employment may, at least in part, be offset by other expansionary elements. The appropriate inter-governmental bodies in OECD keep the prospects for demand and employment under continuous review, and discussions in the early weeks of 1974 suggest that governments are alert to the possible depressive effects of the energy price rise and to the importance of taking action to support demand if and when appropriate. A third problem area concerns the balance-of-payments. Higher oil prices will raise the import bill of OECD countries: a figure of around $50 billion—which already allows for some economies in the use of oil—is an approximation of the higher bill for the first year. In normal cases, a rise in the bill which an OECD country has to pay for its imports could be expected, rather quickly, to be followed by an equivalent rise in export possibilities. But because the oil-producing countries cannot in the short run be expected to use more than a small fraction of their additional earnings for stepping-up their own purchases, OECD countries will be unable, as a group, to raise their exports in step with their import bills. For this reason, OECD countries, taken as a whole, are going to have to see their balances of payments swing from a normal sizeable surplus on current account to large deficit. For illustrative purposes only, instead of earning a current account surplus of around $10 billion in 1974, OECD countries taken as a whole could go into deficit to the tune of $30 billion. If individual countries seek to escape this swing, it will only mean that the balances of other OECD countries have to swing further into deficit. This swing does not, of course, mean that the area will have an overall deficit on the balance of payments and a net loss of reserves. The oil-producing countries will certainly in one form or another, invest their unspent earnings in the money and capital markets of the OECD area. Nonetheless, a change of this order of magnitude in the structure of the OECD's balance of payments can only be digested if governments take a highly rational and sophisticated view of the position, and convince markets that this is going to be so. If countries struggle to offset the impact which higher oil bills have on their current 268 balances, we could witness a spiral of competitive—and mutuallyfrustrating—devaluation, deflation and trade restrictions—the disastrous spiral which we witnessed between the two World Wars. Governments could take this path through a simple failure to accept that, for some time to come, current account deficits will have to be the order of the day. More likely, perhaps, will be a fear by individual governments that they may be unable to attract, to their own shores, a sufficient part of the return flow of capital from oil-producing countries to offset their current account deficits. A further danger may be that O E C D countries, in the attempt to ensure that they attract a sufficient share of the return flow of capital, will engage in a competitive escalation of interest rates that would raise the cost of credit to levels inappropriate from the point of view of the general expansion of activity. To avoid these dangers emanating from the changed balance of payments situation witt require an important measure of agreement, inside the OECD, as to the aims which each country should now set itself on current account. Only thus shall we escape the danger of seeing OECD countries scrambling, individually, to preserve or create for themselves current account surpluses which the area as a whole cannot, over the next few years, achieve. The task of seeking agreement on individual balance of payments aims is not new to OECD. We went through a very similar experience in 1971, and without the understanding reached between countries on that occasion, largely through OECD's Working Party No. 3, I do not think that the Smithsonian exchange rate agreement, and the further devaluation of the US dollar in 1973, would have been possible. But the adjustments that now have to be accepted, are far bigger than the ones we had to negotiate at the time of the Smithsonian realignment. And in the present case, questions of aims on current account cannot be discussed without, at the same time, discussing what is going to happen to the capital which will be flowing back from the oil-producing countries. For we cannot expect an individual OECD country to resign itself to a rather sizeable current account deficit unless it is reasonably confident that it can obtain a sufficient capital inflow to finance it. An urgent task is, therefore, to consider what steps need to be taken to enable the very large amounts of capital that will henceforth be flowing out of oil-producing countries to be made available in the geographical locations—and in the forms—that will most facilitate the continued expansion of world trade and employment. Stable conditions in the international monetary system—which are in the essential interest of all countries—are unlikely to prevail unless the vast capital sums flowing from oil to non-oil countries are invested in a reasonably stable form and unless they are channelled directly or indirectly—through the markets or by other means—to recipient countries in rough proportion to their external financing needs. It is encouraging that discussions on this problem have already begun. Immediate Problems for the Developing Countries One obviously important group of countries to whom part of these funds should be channelled are the less-developed countries who are not, themselves, producers of oil. The facts speak for themselves—and in an alarming fashion. These poorer countries are likely, in 1974, to find their oil bills put up by something near $10 billion as a result of the recent price rises. This would just about wipe out the whole of the official development assistance that the OECD area makes available each year to these countries. For some developing countries, the higher oil bill will amount to about half their existing earnings from exports. The new conditions faced by developing countries call for three major policy imperatives: • First, existing official development assistance programmes must not be slowed down or reduced. This would worsen the difficulties of developing countries and would only add to our own problems. • Secondly, the developing countries that are worst hit will need special help, largely in the form of cheap loans, to enable them to adjust their economies and balance of payments to the additional burden. • Thirdly, the new problems also present new opportunities. There is going to be a substantial rise in world savings since the oil producers will not be able to spend all their extra revenue. It should be possible to find ways by which part of these savings can be mobilised to accelerate economic progress throughout the developing world. Thus in the present situation, there are clear dangers of uncoordinated policies which would lead to over-reaction both to the inflationary and to the recession threats; of isolated moves to compensate the impact on foreign trade of higher oil prices; of cutting on development assistance thus aggravating the situation of non-oil producing developing countries; of going to a sterile confrontation between oil-consuming and oil-producing countries. Such policies would be both inadequate and self defeating. What is required, on the contrary, is. increased cooperation at all levels to solve problems common not only to the industrialised countries but to the international community as a whole, including in particular the oil producing nations. 269 Longer-Term Problems of World Energy Supply The suddenness of the price change over the last few months should not obscure the fact that both oil producers and oil consumers have a common interest in a price for oil which correctly reflects the longer-run supply and demand for oil and alternative sources of energy. Looking first at this question from the point of view of the oil-producing countries, we should recognise that they themselves face difficult problems in the pricing of their oil. In particular, it would be wrong to describe recent decisions by the oil producers as simply the actions of strong monopoly producers who can fix the level of output or prices of their product without concern for the future. • First, the oil producers are having to exploit a depletable asset. How fast, at any given rate of consumption, their oil reserves will be depleted varies from country to country—and this, in itself, may be a source of difficulty for the producers when they seek a common approach to their problems. The task of government in any traditional oil-producing country is to ensure that its oil is traded on optimal terms. On the price at which they sell their oil will depend their ability to raise the living standards of their own populations, and diversify their economies against the day when their oil runs out or is in less demand. If the price is set too low, their incomes may prove insufficient for their future needs—and some of them will see their oil resources disappearing at an alarming rate. If the price is set too high, they will enjoy great prosperity for a short while —but the higher the price the shorter the period, because the faster will be the action which their customers take to economise on traditional oil sources and to develop alternative energy supplies. • A second very real problem for the oil-producing countries is to find suitable forms in which to hold their earnings until such time as they wish to use them. It is both in their interest and that of the rest of the world that these investments should as far as possible go to increase the productive potential of the world economy. But at the rate at which these assets seem now likely to accumulate, this may not be easy to achieve. Now let us look at these same problems from the point of view of the industrialised countries. It should first be noted that O E C D countries are important producers of energy. Indeed, in 1971 about two-thirds of the energy consumed in the O E C D area was produced from indigenous sources. Moreover, there is much potential for future development. Although O E C D countries account for only some 10-20 per cent of estimated world 3 7 - 2 1 1 O - 74 - 18 reserves of crude oil, their reserves of all fossil fuels, including coal, shale oil and tar-sands, probably account for the major part of the world total, sufficient—at a cost—to meet foreseeable needs. The main question now before these countries is how fast they should, in fact, develop alternative sources of energy. This is where any rational person shou'.d see that the interests of the O P E C countries and the O E C D countries really coincide. First, because investment in alternative forms of energy is extremely costly, and can have extremely damaging effects on the environment. Therefore, it is in the interest of O E C D countries not to move faster in this direction than they have to. Second, because it is not in the interests of the OPEC countries if the industrialised countries were to embark on costly programmes for energy diversification which might, in time, seriously reduce the earning power of the O P E C countries before they have had time sufficiently to diversify their own economies. The speed with which O E C D countries build up alternative energy supplies will depend, essentially, on the cost of imported oil in relation to the cost of the alternatives. If the cost, in O E C D countries, of imported oil is well above the cost of comparable alternative sources of energy (in economic parlance, if the substitution price is exceeded), a wild and wasteful scramble for national independence through the exploitation of indigenous energy resources will be set in motion with all the attendant disadvantages to O E C D countries and oil-producing countries alike. If, on the other hand, the price of oil is too low, there will be a wasteful use of the oil producers' valuable but exhaustible asset, while in O E C D countries the incentive to invest in alternative energy sources will be insufficient to prevent at some stage, an energy crisis of far more serious proportions than today. This is why I think that the price of oil in the next few years is going to be a matter of common interest to all countries, an area in which international consultation can yield important longerterm benefits for all. The issues concerned cannot be limited simply to the question of oil prices. They cover a wide range of associated economic questions concerning supply, the development problems of the O P E C countries, investment outlets for OPEC countries' savings, and (urgently I trust) those developing countries which are not producers of oil. All these are questions which can now profitably begin to be discussed in appropriate broad intergovernmental forums. And, when they get under way, the discussions will benefit from the work which, in many of the important areas, has recently been done inside the O E C D , including, in particular, the Organisation's comprehensive assessment of long-term energy trends. I hope we can now carry these discussions forward into the wider intergovernmental arena. 270 THE MONEY MANAGER MARCH 4. 1974 Money Surges Out To Meet Oil Costs, But Only a Trickle Finds Its Way Back By ROGER LOVE A surge of oil payments money from western countries is flooding into the Middle East—and apparently staying, there. Reports indicate that thus far this tidal wave of money, which may reach $50 billion this year because of the sharp increases in oil prices decreed by Middle East producers last year, is not reflowing significantly into western markets or western corporations, with the. possible exception of the Swiss franc. Observers note* the following recent development: • Apparently less than $21 million of a recent $1.5 billion French Treasury international bond issue was taken up by Arab banks, despite France's efforts to cultivate a special relationship with Arab states. This cultivation included a refusal to join with other industrial countries at this month's Washington energy conference in forming some kind of "united front" of consumers to deal with producers' claim. In fact, the bulk of tl>e French bond issue appeared to be subscribed to by banks in the industrial countries which France had refused to support. Barring $500 million taken up by Government-influenced French banks, the other big subscribers were U.S. banks, with some $370 million, Canadian banks with some $117 million and British banks with so^e $98 million, according to reports from Paris. .. • Iran, which triggered the recent oil crisis through unilateral price increases, has now agreed to make $1 billion available through international organizations and special development funds to help ease -.the - balance-of-payments impact of higher oil prices on industrial and underdeveloped countries. This is about of the anticipated rise in all revenues this year and would be split three ways, between the ' World Bank, the International Monetary Fund (IMF), and a special development fund which would be operated in some fashion jointly by the two Washington-based institutions. • Islamic countries, meeting in Lahore, Pakistan, rejected proposals that Arab oil money should be used to help all developing countries. Instead, the meeting called for restrictions on aid from Arab countries to Moslem countries and also refused to set aside a specific amount of money for aid. • Arab oil- countries earlier turned down a request from African countries for preferential oil prices. The Arabs argued inter alia that any attempt to run a two-tier international oil market would be unworkable. This caused bitterness in Africa where many countries had gone out of their way to break diplomatic relations with Israel Arab interest ki Switzerland may have been fanned by last month's decision of the Swiss Authorities to remove many of the restrictions on non-resident use of the Swiss franc in making deposits. ahead of and in the aftermath of the Middle East war in October last year, in sympathy with the Arab cause. • Iran- refused to roll back oil prices, while pledging some unspecified help to developing countries.-The Shah did proclaim ' that the United States was getting "more oil than any time in the past" in spite of the Arab embargo, a remark which drew furious denials from U.S. energy officials. Iran, in turn, issued a harsh attack against the United States and other oil consumers for using the energy crisis as a "scapegoat" for reducing aid to developing countries. • The United States indicated that it would like to see Arab and other oil producers pick up the tab for the estimated increase of some $10 billion in oil import bills of developing countries. The Arabs and others showed little inclination even to pick up the tab for the higher import bills of developed and industrialized countries which in their eyes are much better credit risks. 271 • Various national Governments, including that of Germany, indicated that the impact of the «il crisis, on top of other imponderables like higher domestic wage, rates, already raging inflation and a clouded export outlook, made economic policy decisions increasingly difficult. Reports that Arab cash to the extent of perhaps billion had gone into the Swiss franc in the last few days were particularly interesting. The Swiss currency is a traditional refuge in times of international capital and currency upheavals, even though the interest rate structure of the Swiss money market offers little incentive to investors as compared with other European countries or New York. Arab interest in Switzerland may have been fanned by last month's decision of the Swiss authorities to remove many of the restrictions on nonresident use of the Swiss franc in making deposits, investments or purchasing for instance real estate. The presence of such restrictions over the last year or so did succeed in turning away some inflationary money inflows, while the lifting of the restrictions has now returned the Swiss franc to its traditional role, that of a currency one oan get into or out of without too many questions being asked. However, the apparent Arab opting for low Swiss returns and a high degree of guarantee of exchange rate risks raises some disturbing questions on the willingness of oil producers to play the part sketched in for them by western nations in saving what is left of the world's monetary system and economy from total collapse. The Lahore iconference decision is perhaps the most disappointing blow to efforts to get oil producers to accept a ' role in helping developing countries, most of whom are excluded from western capital markets by the shaky conditions of their economies ar.d by their low credit ratings. The number of poor Moslem countr'es which would benefit from the largesse of oil producers under the Lahore decision is sizable enough. I t would include Egypt, Syria, Jordan, Tunisia, Morocco, Sudan, Mauritania, Mali, Niger, Somalia, both Yemen rep.blks, Pakistan .and Afghanistan. I t would, however, exclude India, Ceylon, Burma, Thailand, Kenya, Tanzania, most of southern Black Africa and all of iLatm America, barring a mass Conversion of these countries to Islam. I f the Lahore conference decision is sustained, it would leave a large numher of non-Moslem countries directing their aid attempts even more clamorously to the fton^Moslem world, at a time when the industrial and developed countries are beginning Seriously to feel the pinch of Arab and Iranian oil price hikes arid supply cutbacks. « Two African countries are a particularly poignant example. The most heavily ipopulated are not overwhelm- If friends of the Arabs can expect such treatment why should 'enemies' expect to do any better? ingly or even in majority Moslem, and these countries supported the Arab cause without stint in last year's confrontation with Israel, losing in the process considerable Israeli development aid and technical assistance. The African countries as a group paid about <$350 million on oil im-r ports last year at $8.60 a barrel, according to estimates of the Organization of African Unity, headquartered in Addis Ababa, Ethiopia, but this bill is likely to rise to at least $1 billion this year. This compares with total African reserves of some $2.9 billion held by Libya and some $600 million held by Nigeria—.both oil producers. ^ The Arab countries told African states recently that no concessionary prices could be granted to Africa or indeed to other developing countries. The Arabs did make proposals for the establishment of an Arab development bank for Africa, with a capital of some $500 million and on the establishment of a separate $200 million fund which African countries could draw from to help defray the costs of increased oil. But African countries were cautious in the face of these (proposals. Some of them, Kenya for instance, estimated that the rise in oil prices had a»de its entire current development plan unrealistic and estimated that annual economic growth, currently running at about 7.5f, could f a l l to zero within the next 12 to 1ft months. The African nations, as noted above, had generally wholeheartedly supported the Arab cause last October and since. But if friends of the Arabs can expect such treatment, why would "enemies" expect to do any better? The "enemies" are the industrial countries iwho seem to be relying on massive injections of Arab cash into western money markets, to permit industrial countries to borrow to cover their balance of (payments deficits, in effect paying western cash to Arab and other producers for oil, then borrowing the cash back to cover the gap caused by the oil payments, then paying more cash for oil, then borrowing more back to close the gap. The great .problem with this scenario is that none of the oil .producing countries has as yet indicated any eagierness whatsoever to play its part, whether through normal channels of the International Monetary Fund (mainly for industrial countries) er through the World Bank (for undesdeveloped countries). Meanwhile, th*e lines in front of ticket windows in the international money markets are. getting longer and longer. France which ihas already borrowed i$l.S billion in the medium-area of the Eurodollar market,.is seeking at least another $1J5 billion to $2 billion through state-owned and statecontrqlled corporations. I t a l y seems bent on raising as much as possible, perhaps $4 billion, before its credit resources run dry. Britain has indicated that it may be seeking as much as $7 billion internationally this year. And Japan is seen as a likely candidate either for direct official borrowing, or for government-sponsored corporate borrowing. . The total of demand in the first half this year could easily reach $15 billion with little end in sight if other industrial countries start to join the scramble. Where the funds to finance this demand are coming from is unclear, but at the moment it appears unlikely that it will be from the Arabs and others. • 272 London Letter BY JOE ROEBER Arab Oil Money and the City of London A yeat-ago the only people you would expect to find in the offices of a London merchant bank at 7 AM in the morning would be the char-ladies. These days it is not uncommon to find a banker at his desk. In Bahrain it is 10 AM and the working day, which starts at 7 AM, is half over. London's bankers are only too aware that a few sacrifices have to be made if they are going to profit from the Arab's new found wealth. Britain has always had close ties with the Arab world. Kuwait, Oman, Qatar and the United Arab Emirates are all in the Overseas Sterling Area. London, along with other continental centres such as Paris, Zurich and Geneva, have been havens for Arab funds for many years. But only recently these funds were modest. Total 011 revenues of the major Arab oil-producers and Iran in 1972, amounted to a mere $10 billion. The recent sharp rise in oil prices has changed all that. At the end of this year oil revenues could be running at an annual rate of close to $70 billion. Saudi Arabia's oil revenues this year will probably be 8 times as high as in 1972. In a 7-month period it can earn enough, at present oil prices, to cover the entire cost of its 1970-75 development plan. A similar situation faces Libya, Kuwait, Abu Dhabi, and Qatar. All are wondering what to do with their new funds. Petrodollar Tidal Wave M. Jean Parrey, president of Arab Bank International, estimated recently that around 60% of these surplus funds would find its way into international money markets. If true this would amount to more than $30 billion this year alone. How large this inflow is, can be gauged from the fact that publicized medium-term credits on the euromarkets amounted to only $21.6 billion in 1973. Even before the latest surge in oil revenues London was attracting a large amount of Arab money both in sterling and foreign currency. The latest Bank of England statistics, which refer to December 1973, show that non-sterling liabilities of UK banks to Middle Eastern countries, not members of the sterling area (such as Saudi Arabia, Libya and Iran), had risen from $1.7 billion in 1972 to $4.2 billion. The sterling holdings of Kuwait, Bahrain, Qatar, the UAE and Oman had risen rather more slowly from $1.3 billion to $1.8 billion. Until the Bank of England releases fresh statistics in June it is impossible to gauge the inflow of Arab money this year. Nevertheless there are signs that it has been substantial. In the first three months of 1974 sterling rose 20% against the dollar, a large part of which City experts ascribe to the inflow of Arab funds. The inflow has been patchy. Little interest has been FINANCE MAGAZINE • JUNE 1974 JUNE 1974 shown in the equity market and, even more suprisingly, in the gold market. Considerable sums, however, have been invested in UK Government bonds. According to C. P. Lunn, a general manager of Barclays Bank International, up to £500 million has gone into gilts this year (on two days alone £80 million is thought to have been so invested). The bulk of it has gone into 5 to 7 year maturities. Others pitch their estimates somewhat lower — but it is generally agreed that the reason why the 1980 Tap stock ran out so quickly was due primarily to Saudi Arabian demand. Diversification A certain amount of money (primarily Kuwaiti) has been channelled into the UK property market, which is currently in desperate need of funds, following the collapse of its primary deposit reservoir, the beleaguered secondary-banking sector. One merchant bank, which has been busily arranging loans in Kuwaiti dinars for UK property companies, estimated that up to £70 million might have been invested in this sector. But despite their shortage of funds many UK companies still shy away from the exchange risks involved in taking foreign-currency loans. The bulk of the surplus oil funds, however, are being deposited in the eurocurrency market — a large chunk of which is based in London. Once again estimates of the Middle East involvement vary considerably. The Bank for International Settlements estimated almost 12 month ago that $8 billion of Arab money was deposited in the euromarkets. Since then the market has grown substantially — Morgan Guaranty estimate that its size in April 1974 was $16 billion. Arab and Iranian deposits may now amount to $25 billion. As in the past, much of the money is placed very short-term and handled by the big American banks, such as Chase Manhattan, Morgan Guaranty and First National City Bank, all of which have close links with the Middle East. Whereas in New York considerable sums of Saudi Arabian money have been channelled into Treasury bills, most of the funds moving into London and the euromarkets are from Arab banks and private individuals. Just how these funds are managed varies considerably, depending on the expertise of the Arab countries concerned. Kuwait is probably the most sophisticated. In London, apart from the United Bank of Kuwait, the state-run Kuwaiti Investment Office places substantial official funds in the overnight-market. Another stateowned vehicle, the Kuwait Foreign Trading and Contracting Company, has also been aggressively developing its business. In February it surprised the London 273 London Letter financial community by appearing as co-manager of a $34 million loan to the City of Bristol—a novel and welcome departure for an Arab institution. More recently still it has notched up another first, acting as co-manager of an Arab-currency-related eurobond issue, in partnership with First Chicago Ltd, European Banking Company, and Kredietbank Luxembourgeoise. Short-Term Preferred KFTC's aggressive approach is exceptional. So far Arab banks have been noted for their absence in medium-term lending syndicates — contenting themselves with placing money short-term on the euromarkets, much to the consternation of loan managers fearful of a liquidity squeeze. Their absence probably reflects lack of expertise rather than unwillingness to join in. This is being partially solved by Arab participation in a growing number of consortium banks being established both here and in the Middle East. (UBAF, based in London, is a prime example). Another drawback is that a substantial proportion of Arab funds is controlled by Arab central banks, which are unable to participate in syndicated loans. The government-owned Libyan Arab Foreign Bank was formed to get round this obstacle. Iranian banks have been more visible — there are 4 in London in addition to a new consortium bank, the Iran Overseas Investment Bank. Bank Melli Iran, which has been in London since 1967, and Bank Saderat Iran, have underwritten a $200 million loan to the City of Glasgow and a $500 million loan to the Electricity Council. With the exception of the Kuwaiti banks, Arab banks have tended to deal in London at arm's length. Preferential Prejudices A considerable amount of business is being put through a few London merchant banks; most notably Morgan Grenfell, Kleinwort Benson, Hambros, and to a lesser extent Robert Fleming. Morgan Grenfell, one of the most traditional of the Acceptance houses, and a breeding ground for future governors of the Bank of England, is typical. Lord Catto, its chairman, stresses that the bank is particularly strong in the Gulf states because "we are effectively a non-Jewish bank" and has emphasized this aspect. At the time of the Yom Kippur War the bank aroused widespread criticism by going ahead with a $180 million loan to Abu Dhabi. Political—or rather religious—considerations rule out a large number of London's merchant banking elite. Much of their work is straightforward — dealing in the foreign exchange market, buying and selling gilts and equities, and generally advising their Arab customers. Even if the funds are not deposited in London, the merchant banks often earn commissions for their advice. With an eye on the day when the Middle East may control two-thirds of the world's monetary reserves (one source predicted this will happen by 1980) the banks are consolidating their Middle Eastern ties. Morgan Grenfell recently took a 50% stake in the Arab and Morgan Grenfell Finance Company and Hambros has taken a 20% stake in UBAF Financial Services Ltd. New York may still attract the bulk of the Arabs' funds but London is certainly in the running. The Eurobond Situation If the one place the Arabs have not been putting their money is into eurobonds, then who has? In contrast to New York, where, despite rising interest rates, new issues have been sold in bigger volume than ever before, this year, issuing activity in the eurobond market has run to a virtual standstill. In the first four months of this year less than $700 million has been raised, compared to $1.64 billion in the same period of last year. With even tiny issues of $10-$15 million being slow to get away, issuing houses have had to plumb the depths of inventiveness to interest investors, and one or two novel issues have been appearing — for instance, one denominated in Canadian instead of US dollars and another offering an Arab currency option. Mostly, however, underwriting has become such a hazardous affair that issuing houses are simply telling their clients to stay away or to turn to the rapidly expanding medium-term eurodollar bank lending market. 274 I " F L O A T I N G ON OIL - A W O R L D M O N E Y THE ECONOMIST M a r c h 2 3 , 1974 SURVEY" Without precedent There will be no agreement between centres in the competition for the most governments on a grand new monetary sought-after funds of all times. system by this summer as had been Every banker naturally thinks he has scheduled. Instead, the formal debate the edge over the next one, and stands, on it is about to be wound up. It would therefore, to be disappointed. But it is probably have never really made the encouraging that the oil problem is now winning post, anyway. But the decisive widely recognised as one of recycling point has been that the very framework funds through either private or instiof the debate has been torn apart: every tutional channels and not one to be taken variant of the system which finance by exchange rates or by domestic deflaministers have been considering—and tions designed to make room for exports. squabbling over—assumed that the The flexibility provided by floating major industrial countries would strive exchange rates can help industrialised to keep their overseas accounts roughly countries adjust among themselves in balance over a reasonable length of to the differential impact of higher oil time. That is now neither practical nor prices, but not eliminate it. However desirable. cheap industrial goods became, there is The sudden, sharp rise in the cost a physical limit to how much of them of imported oil has made it impossible the Arab countries could absorb in the for the world to maintain a balanced short run. Indeed, the upshot of compattern of payments. Even if oil prices petitive depreciations would probably fall a little, as seems likely, the sums be to shift the bulk of the aggregate involved are huge. Whether it turns deficit on to the United States, since out to be $30 billion or $50 billion, the payments for imported oil are largely increase in trade payments to a handful made in dollars and therefore countries of countries this year will be without trying to depreciate their currencies precedent Only America and Germany would appear in the exchange markets among the big industrialised countries as buyers of dollars and sellers of their have any hope of seeing their current own currencies. That sort of beggaroverseas account anywhere near the my-neighbour policy could all too easily black this year. At a stroke, the oil prob- precipitate a world slump in a year when lem has altered the whole international the American economy promises at best industrial and trading scene. It follows to stand still and only France, Italy that it has also altered the monetary and Canada, among the industrialised nations, hold out any prospect of decent system needed behind it. But in what way? Tke Economist economic growth of 4 or 5 per cent. has long been on the side of the floaters The problem has been put elegantly and is more than ever convinced that a by Mr Robert Solomon, a vice-chairman system offloatingcurrencies is the only of the deputies of the Committee of one for today's uncharted waters and Twenty; he points out that it is useful beyond them. But dofinanceministers to visualise the oil price increase as a and bankers agree with us? At the same large sales tax on the use of petroleum time, we feel there are parts of the reform products. Internally, that tax has a under consideration before the oil crisis deflationary effect on demand which is that should still be brought in piece- likely to require offsetting action to meal, while others should be adaptoi avoid unemployment. But the proceeds to the new energy situation. But, again, of the tax are transferred unilaterally what do the politicians and practitioners to the oil-producing countries who, think? unable to increase their imports in the We have interviewed some of the key short run, cannot avoid lending their politicians and advisers who have been receipts back to the rest of the world. leading the official debate in the Com- So the effect of the higher oil prices in mittee of Twenty and some private terms of absorption of real resources bankers too, questioning them on the will only be felt in the long run when solutions they would like or expect, and oil producers are in a position to receive are grateful for their co-operation. Their repayment, with interest, of their loans replies arc on pages 12-53, preceded to the industrialised world. by our summary, of the main points If only the oil producers were to lend they make. The rest of this survey re- back to each country exactly what they ports on the various plans being hatched have levied in the oil tax, there would in national treasuries and banking par- be no effect on a country's total balance lours to capture the new Arab oil money of payments in the short run. But, of and, more specifically, how bankers course, they will not. This survey emrate the chances of individual financial phasises that the United States can expect to get more than its fair share; the International Monetary Fund could counter the effect in part simply by making more liquidity available all round, through special issues of SDRs. (For definition of those unsexy bits of paper, see glossary, page 16.) However, clearly some redistribution or recycling of funds among oil consumers will be essential The money may come back from the oil producers in all sorts of ways: direct investment in industry or in property, bank deposits, purchases of equity, fixed-interest securities or Treasury bills, gold or commodity purchases, development loans (such as World Bank bonds) or loans to a central international clearing-house. All that can really be argued about as yet is whether most of the recycling will, or should, be done through the Eurocurrency market or through the IMF. But since the IMF was not set up to deal with something like the oil crisis, it can only play a central role if a special oil facility is set up, as its managing director. Mr Johannes Witteveen. is urging (again, see glossary, page 16). Countries would be able to draw on this facility in amounts related to their oilinduced deficits, to the size of their 275 St.'RYl.Y reserves, nnd lo ihcir quotas in the IMF; it would be supplementary to their other access to Fund resources. But. of course, the schcmc depends on the oil-producing countries supplying the funds, preferably dircctly. Iran lias indicated it would play—;at market-related rates. But some exchange rate guarantee will have to be given. r.nd will the Arabs like the idea of that being related to the "basket of currencies", in which SDRs are to be defined, as seems to be the idea? Bankers are dubious: the Arabs have shown no interest in such abstract concepts in the past. Only Mr Witteveen. who will tour the Middle East next month, can hope to discover the answer. Unfortunately it looks as if he will not go with the full blessing of Washington. The Nixon Administration has reservations about the plan, both tactical and technical. But at least some constructive proposals are being made and in the face of a huge upheaval the monetary system THE ECONOMIST MARCH 2}. l')74 INTERNATIONAL BANKING look mini. If a chaotic slip into worldrecession is to be avoided, an unprecedented degree of international cooperation will be needed. The deputies of the Committee of Twenty will at least have something to get their teeth into when they meet in Washington next week. Not only will If the committee does spin out its job. its efforts there be the new oil facility to discuss, will be in danger of being overtaken by one of but a paper from the I M F which puts two events. There may be another currency the emphasis on getting an "interim" crisis which will reintroduce floating generally agreement on managed floating—and . . But even if there is no such crisis, the Com- you can interpret "interim"' as you like. mittee of Twenty could neverthelessfindthat its The proposals are basically two: a hefty reform, if not introduced for another three or guidebook of rules which, funnily four years, is out of date. The distribution of enough, would in some ways give the power will go on changing: significantly, Japan I M F more powers than it ever had under and the Middle East now have 16 per cent of the old Bretton Woods system; and, by the free world's reserves, compared with per implication, the notion of target values cent only two years ago. But it is now essential to set up a top- for exchange rates. Also, a definition of level decision-making forum for dealing SDRs in terms of a standard basket of with international money problems. major currencies is spelt out. The quesThe movements of funds round the world tion is whether in the end the politicians this year will be of a size that will make will be able to swallow it whole. the operations of the multinationals is holding up well. No one should mourn the demise of the Committee of Twenty; if truth were told, the finance ministers were glad of an excuse to wind it up. The writing was on the wall when The Economist wTOte in September, 1972, more than a year before the oil crisis broke: Figuring out the oil crisis bined deficit for the industrial countries importing countries will be less than On top of all the usual uncertainties as a group will be at the higher, rather it would have been in the days of plaguing payments forecasts, especially than the lower, end of the range in our cheap energy, but only to the extent in a floating world, there are the new table is quite simply the unhappy likelithat higher prices themselves induce questionmarks about consumers' ability hood that the less-developed countries economies. to economise on oil. producers' readiness will not be able to finance a current to supply it and whether, or for how long, (3) Oil producers will step tip their imaccount deficit of much over $15 billion present oil price levels will be held. ports from oil consuming countries, (see page 73). If they are enabled to do Nevertheless, the debate about appromore particularly the industrial counso, by increased aid flows or by special priate policy responses cannot get far in tries, this year—but not by very oil-financing schemes, that will help a vacuum. The world's policymakers much. The usual range of guessticountries like America, Britain and Japan have been getting most of the key statismates here varies from a cautious $5 to improve their own current account tical work—as well as early warnings billion to an optimistic $10 billion. performances. If they are not, the burden about the dangerous implications of the The best compromise guess is, perof oilfinancing,superimposed on existarithmetic for world growth and trade haps, that the OECD countries wffl ing payments imbalances, looks frightenif countries react without regard to the enjoy a $7 billion boost to their exingly large and lop-sided. Just three consequences for others—from the ports. However, against that must countries—Japan (especially vulnerable Organisation for Economic Co-operation be set what they will have to pay out to the oil crisis itself), Britain and Italy and Development in Paris. Normally very in interest on increased Arab invest(both of which have had the bad luck to little of the OECD's work is made public ment funds placed in their markets— be hit by the oil crisis just when their pay—although the Bundesbank's Dr Otmar a sum that will probably amount to ments were anyway weak)—could be left Emminger last month admitted that the about $2 billion this year (andriseto carrying well over half of the total current latest estimates put the likely current closer to $5 billion next year). account deficit of the industrialised world. account deficit of the industrial countries One reason for thinking that the comin 1974 closer to $40 billion than the $32 billion that was being bandied about The current account arithmetic in January, and more details have since Reserve 1974 guesstimates become available. holdings Post-oil Additional The Economist has attempted its own end'73 crisis oil bills exercise. The key assumptions underforecast* (inc. = - ) lying the data in our table are: — ^ to — 3 United States +1 (1) Oil prices will remain at the levels -u>i Canada implied by today's posted prices Japan throughout 1974. If you disagree, -3.7 — 7-Jto — 9 Britain make your own corrections; a rough + 0.4 France +3.8 rule of thumb is that every change of Germany $1 a barrel in the price adds (or subItaly Other industrial tracts) $10 billion from the total oil countries bill of the OECD countries. -33 to-40 139.8 Industrialised world (2) Actual oil supplies will not fall short Less developed of "normal" demand at current prices; oil importers that is, straight political rationing will Opec countries cease, as now looks on the cards. s: America's deficit is put at S4 billion. Column 3 of our table does imply »l St billion mxacihf. that the volume of oil consumed by f? =a +H 276 THE ECONOMIST MARCH 23. 1974 INTERNATIONAL BANKING The forgotten poor Tha less-developed countries are the real victims of oil The combined oil bills of the lessdev eloued countries will rise by no more th in S3 billion—SlO billion in 1974. This is less than a fifth of the expected rise in the oil bills of industrial countries and amounts to no more than a quarter of the accumulated reserves of a country like Germany. But those are not the comparisons that count. Paying up on oil will mean, in effect, handing over virtually the whole of the gains of the poorer countries from the commodity boom—or, alternatively, the whole of their normal receipts of aid The picture is even less pretty when it is realised how cruelly uneven the impact will be from one country to the next It is not only such obvious weak brethren like India who will need rescuing. So will some high performers like Korea who have been particularly successful in building up industry, yet whose income a head remains vulnerably low. They have not been the main gainers from the commodity boom. Far that matter, it is easy to forget to what extent the gainers have been the industrial countries themselves: members of die Organisation for Economic Co-operation and Development are 80 per cent self-sufficient in raw materials. On food and fertilisers alone the terms of trade have swung against the developing countries to the tune of $5 billion over the past year. The World Bank divides the developing countries into three broad groups— leaving aside those oil-lucky devils like Nigeria and Indonesia in a league all of their own. There are those, Eke Ghana, which have built up their reserves on the back of the commodity boom (or, like Turkey, on the backs of their emigrant workers). Second, there are those, like Brazil and Mexico, which have high enough credit ratings to hope to keep their toeholds in die Eurocurrency markets—though the going here will be much tougher this year than last (when publicly-announced mediumterm Eurobank lending to less developed countries soared to $8 billion) and relative newcomers to the market, like Chile, may find themselves pushed to the very end of the queue, liiird, there arc those unfortunates with virtually no reserves, insufficient credit ratings to tap the private international markets for funds and yet not much capacity to reduce imports. India, of course, is the prime example in the last group. Its oil bill will rise this vear by at least $550m-600m, or maybe, some say. by nearer $1 billion. At most India can cover about $300m from its own slim resources—but not much more and not for long. A modest $62m drawing from the International Monetary Fund has pushed the deadline back a shade but before that came, it looked as if India would be out of funds entirely by end-May. Other countries particularly hard-hit by the oil crisis include the rest of the subcontinent—Bangladesh, Pakistan and Syr Lanka—and some of the Latin and central American countries, particularly Uruguay. Mo&t of these are such obvious hard-luck cases that, at the crunch, their very weakness might prove their strength —the rich are resigned to bailing out India regularly. But other countries normally regarded as at least the partial successes of past aid programmes will also be in serious trouble, above all Korea, as we have already said, but also Taiwan and Thailand. The need for special outside help to pay increased oil bills may be held down this year to perhaps no more than S3 biliion-$4 billion. Current earnings of key commodity producers are still very healthy; there is perhaps $3 billion in developing countries' reserves that can be used in payments. Another S2 billion might still be winkled out of the Euromarkets by the creditworthy countries. But what of next year? The commodity price boom, already past its peak, will then have been finally punctured by the lagged impact of the slowdown in world growth, and the fat now in countries' reserves will have been eaten up. Also, mounting debt burdens and curtailed export earnings will make the Eurobankers most unreceptive to calls from the third world. (Obviously the more you have borrowed the lower your credit rating goes.) The financing gap for the less developed countries in 1975 is more likely to be on the order of $7 billion-$9 billion than this year's $3 billion—$4 billion. Who will fill the gap, and how? The popular answer—certainly from the industrial countries facing oil deficits of their own—is that the money ought to come from the oil producers themselves. This is fair enough, but nevertheless it will be disastrous if the rich think they need not play a part. The oil producers are extremely unlikely to be willing to lend enough either direcdy to the less-developed countries or, at one remove, to the established intermediaries like the World Bank. Though some promising noises are being made from various quarters, notably Iran, the actual aid effort of oil-producing countries to date has not been impressive. Middle East countries (and particularly Kuwait) have been lending about $700m-$750m a year to the World Bank, but such sums amount to no more than a recycling of the net aid ($770m in 1972) garnered by the 12 major oil producing countries from OECD sources in the first place. To the extent that the oil producers do not themselves give back to the developing countries as much as they take from them on oil, the industrial countries (which, obviously, will be the net gainers) will have to bridge the gap instead. Which route? Unfortunately, the industrial countries, facing payments problems of their own, will be tempted to reduce, rather than increase, their own aid programmes. Indeed, even the relatively well-placed Americans have been making ominous noises. Not only has the House of Representatives baulked at contributing towards the replenishment of the exhausted resources of the World Bank's soft-loan agency, the International Development Association (IDA); the normally responsible Senator Fulbright has gone so far as to argue that the United States should scrap all of its aid save some modest "compassionate" programmes. This may be silly as well as mean—after all, a dollar given to the less-developed countries *is likely to come back almost immediately in the form of an export order and so help both to sustain growth and to diminish the current payments imbalance of the OECD countries as a whole. It is nonetheless a political fact of life. This danger makes it all the more important that the major international T h o oil burden Estimated increase in 1974 oil b:!ls as % of 1973 exports Ethiopia C Brazil £ Bangladesh £ Pakistan £ 277 INTERNATIONAL BANKING organisations, which can act as intermediaries for Arab money, do their jobs efficiently. Two points follow. First, the International Monetary Fund will have to become more of a source of medium- to long-term general support aid for the poor—a point already noted implicitly in the plans of the new managing director. Mr Johannes Witteveen. for a special oil-financing facility. Second, the rules of World Bank lending. and the demarcation lines between the Bank and its affiliate organisation. I D A , will need a radical rejigging. Much has been made of the ability of the World Bank to tap the oil producers' new wealth indirectly, through the Euromarkets or New York, as well as directly, through, for example, Kuwaiti dollar issues. The bank's own credit rating is excellent, but it does not have the flexibility to direct its funds where they are most needed, or as quickly as they are needed. Because its loan terms are relatively hard, the World Bank tends tofinancethe relatively strong, just those countries which do, or should, go directly to the commercial Euromarkets. This February alone the bank not only lent as much as S2l4m to Mexico but also S75m to Iran, while Venezuela obtained S22m the month before. Also the World Bank, like most of its regional counterparts, is geared to financing specific projects; the inevitable time spent finding these, then vetting and launching them explains why the bank's disbursements have lagged so embarrassingly behind its commitments. There is no quick-footing here. Nor is that all: although the bank has made some effort to discriminate between various categories of borrowers in the past few years, all too often all comers, relatively strong and weak alike, have wound up being subsidised, getting their money at less than it cost the bank to acquire the funds. Probably it would be wrong to argue that the Work) Bank should drop its project approach to lending altogether; the job offindinggeneral balance of payments support (as well as specific financing for oil) for the poor might be better left to the I M F . However, it would clearly be useful if the World Bank could use its financial muscle more directly to help beef up the resources of IDA. Indeed, perhaps the demarcation lines here should be broken down com- THE ECONOMIST MARCH 25. 1974 pletely, not only on the fund-raising but also on the lending side of the equation, and a single schedule of rules drawn up to govern which less-developed country would be allowed to borrow how much on what terms. Such a schedule should make the relatively strong eligible for loans only if alternative finance is not forthcoming from private market sources and then make it available only on commercial terms. The very poor, on the other hand, should be given particularly concessionary terms—and the scale of charges in between judged much more flexibly, on a case by case basis, than it is now. Finally, there should be much closer co-ordination between the I M F on the one hand and the World Bank group on the other. It is reassuring that the staff of the two organisations are already swapping data and guesstimates on the impact of oil on their members. It is less reassuring that their respective chiefs, Mr Witteveen and Mr Robert MacNamara, are touring the Middle East on separate fund-raising missions. This is a time for a policy of togetherness in all fields of international finance but, above all. on development aid. The gold conundrum Will gold be mobilised to finance aid? For nearly two years now, ever since the free market price of the metal really took off, no central bank has willingly parted with gold. The 1.2 billion oz hoard locked into official vaults does not bulk large; it could all be jammed into a short freight train. Yet at today's rates of output it would take the world's mines more than three decades to produce. Even at the nominal official price, of $42.22 an oz, it is worth almost $50 billion—an amount uncannily close to the windfall oil producers hope to exact this year through higher oil prices. Valued at free market prices—say, in mid-February when gold first burst through the $ 1 SO an oz barrier in London —it would be worth roughly $180 billion, an increase that would boost total world reserves (including the 154m oz of gold held by the International Monetary Fund) by two-thirds. brink of recession. Unlocking gold, of course, is not the only answer; emergency issues of SDRs, enlarged swap lines among central banks and special I M F facilities are more sophisticated solutions. But gold is familiar and already at hand, and the advocates of using it are growing. Three different approaches suggest themselves: a straight rise in the official gold price; the abolition of any official price; or the funding of national gold holdings into. say. the I M F (which could either use the metal as a secondary asset in effect, as a backing for its own paper money. SDRs, or could gradually sell it off on the free market or, perhaps, directly to Arab oil producers). In The Economist's view the third choice would be by far the best. Unfortunately, it is probably also the least likely, just because it is the least straightforward The effective freezing of gold was and time (or, rather, patience) is running occasionally inconvenient even in the out. By May at the latest the common days of world boom, dollar glut and market's monetary committee is supcheap energy. It now looks totally, posed to come up with its own proposals even dangerously, absurd. Resistance for a joint EEC approach. So it is imto using reserves as one option for portant that governments get their financing oil deficits has obvious dangers thinking clear on the alternatives while in a world already teetering on the there is still time. Raise or abolish the official price? The EEC opts for an increase in the official price. After all, its members hold nearly half of the official gold of all industrial countries combined. From Brussels's point of view there would be something to be gained even if such a step were taken unilaterally—that is, if the gold price were raised for transactions among EEC central banks alone—if only because the move would make it easier for the present defectors (particularly France) to rejoin the European snake. But that would be relatively small beer. Obviously Brussels would prefer it if a higher price could be applied in dealings with other central banks as well— especially Arab ones. But the problem of getting everyone, gold-rich or gold-poor, to agree may prove difficult enough even within the common market, let alone on the international plane. Moreover, even if finance ministers can come to terms, there remains the time-consuming hurdle of parliamentary (more especially. American Congressional) assent to clear. Then there is the question of what price. The fashionable answer these days is a "market-related" one. But no one 278 THE ECONOMIST MARCH 13. 1974 has defined precisely what that means: today's price, an average of the past six months* prices, the price on settlement day, the market price less, say, 10 per cent or what? Finance ministers may not simply pull a figure out of a hat (however market-related at the time) and then attempt to stick to it come what may. But even a floating gold price could prove tricky. It is easy to forget how thin and volatile the free markets in gold are. A heavy day's turnover in the London and Zurich markets combined is only 25 tons or, even at S150 an oz, only $120m, a ludicrously tiny sum compared with turnover on the world's bourses or foreign exchanges, t h e price has been known tofluctuateby 12 per cent in a day. Moreover, although U is difficult to put a precise figure to the proportion of total market demand coming from "investors" and speculators (because no one knows how to break down the data for jewellery), it is obviously very large. Certainly in recent months the market has been dominated by wheeler-dealers rather than firm holders of gold. Betting on the free market price of gold is likely to prove as wild a ride as betting on the price of any other commodity. Although the rules now allow the big central banks to sell on the free market, not one has tested the water yet—partly because the bankers are not sure that present I M F rules would allow them to change their minds and repurchase but also because they are all too well aware of the depressant factor on the [Mice of any significant unloading. In the long ran, no doubt, gold will continue to appreciate, however dramatic its gyrations along the route. But that probability is of limited help. Indeed, if anything, it throws further doubt on the efficacy of the whole exercise of linking the official price of the metal to the market price. For it suggests that central banks might continue to regard their gold hoards primarily as an investment not to be used except as a very last resort. Finally, there is the old problem of equity. A rise in the official price of gold to market-related levels would not, of itself, reward private speculators in the metal—they nave managed to do quite nicely on their own. It would award the official hoarders—that is, precisely those rich countries which were most bloody-minded about international co-operation in the days of dollar glut— while doing nothing to help the poorer countries. Where gains did match oil deficits, that happy outturn would be pure accident. I f the object of the exercise is to increase world liquidity, there arc better ways of gong about i t SURVEY INTERNATIONAL BANKING The abolitionists propose a backdoor route to a market-related price for official stocks. Its advantage over the front-door approach is that it ducks the problem of coming up with one definitive price formula. Each central bank would be left free to strike whatever deal it could with whatever partner it liked—the Arabs, presumably, standing to get prime terms. The solution would amount to formally treating central bank gold holdings as second-line reserves, rather like Britain's old dollar portfolio. That might be more realistic. It would still require international agreement and still ran foul of the equity argument. Then there are the awkward implications for the future of SDRs. That a higher official price would make a nonsense of the current debate about defining SDRs in terms of a basket of currencies (or in terms of currencies in general) would not be too serious if an official gold price remained: the simple solution then would be to leave the valuation provision of SDRs alone. As matters are now the unit is effectively defined in terms of gold. Coping with an abolition of the official gold price would be much stickier. But the more serious objection is the likelihood that a rehabilitation of national gold reserves would unleash Gresham's law. Though they may differ in their recipes for mixing exchange rate flexibility and stability, virtually all finance ministers now pay lip service to the idea that any permanent system of world money should be based on SDRs and must not risk a return to a sloppy compromise between a gold and a dollar standard. Whether these sentiments would be translated into practice once official gold stocks were revalued, however, is another matter altogether. T H * official hoarders Funding in the I M F For all these reasons, The Economist would favour funding national stocks into the I M F . In exchange for their gold, central banks could be offered special profit-linked SDRs; if the I M F subsequently sold gold at a higher price than it had paid to buy it in, some part of the profit, say half, would be distributed proportionately among the original owners, the balance to be applied to beefing up the IMF's resources for concessionary lending to less-develcoed countries (a link in another guise) or, during an interim period, to Mr Witteveen's proposed oil-financing scheme. Actual sales, if any, would be left to the discretion of the I M F . Normally they would be made through the free markets —and all central banks would be free to buy (and seD) gold on those markets after the initial funding of their existing holdings. Alternatively, for an interim period, the I M F could be authorised to sell gold directly to die central banks of oilproducing countries. Even this scheme would not be wholly "fair". Today's official gold hoarders would still get something of a windfall, both because the initial conversion price of gold would have to be pitched higher than the present official gold price ami because they would share in the profits of any subsequent I M F sales. But it would be fairer than the other alternatives. Moreover, while giving a needed initial boost to the resources both of the I M F and of individual countries, it would not prejudice the long-term position of the SDR but, rather, directly or indirecdy, enhance it. Agreement would not be easy—and our sketchy outline is full of technical gaps. But such an approach should at least be discussed before the issue is prejudged by the actions of one small club. (at $ 4 2 . 2 2 an oz) Industrial countries: United States Germany France Switzerland Italy Holland Belgium Canada Japan Britain Austria Other developed countries: Portugal S. Africa Spain Less developed (excl. oil producecs) IMF Official gold <$ billion) total reserves 11.7 5.0 4.3 3.5 3.5 2.3 1.8 0.9 0.9 0.9 0.9 81 15 50 43} 54 35 35} 16 7 14 30} 16 9 11} 29 12 9 8 4 2 2 11* 128} 86} 85 426 84} 139 108 112 10 21} 267 1.2 0.8 0.6 4U 65$ 9 34 13} 6 n/a n,'a 61 2.6 6.5 9 — 3 — >973 (rg. baton tha first nsn in t»i pneast Additional o» Mis an i As a % of: normal imports additional oil bills 2} 279 DECEMBER 27, 1973 Hobart Rowen The Impact of Arab Oil Demands , The Western W6rld, which should have known better, can now see that , appeasement of • the Arab nations didn't pay: Europe and Japan, which had gracelessly bowed to Arab blackmail, are confronted with a new doubling of tile price of crude oil, which is likely to plunge them into an economic tailspin. • » International oil experts calculate 'that the world's imported oil bill has suddenly jumped about $40 billion, on top of a $17 billion increase created by higher prices announced October 16. Oil price inflation of this magnitude —which'bears no real relation to costs a - can have a disastrous effect on the less developed nations, and poses extraordinary problems — possibly unmanageable — Iter tome of the indtutrial countries. The "Christmas present" of reduced cutbacks means very little when the more important factor of prices is considered* This sober thought is begining to be reflected in reaction from, consuming countries all over the worid. Japanese authorities, for example, estimate that if oil imports are maintained at this year** volume, their entire currency reserves of $13 billion will be wiped out by the higher costs. And the ball game isn^ over yet: the new prices, according to the Kuwaiti oil minister, cover just the first quarter, of 1674. Another boost i^i in the off- - greed should convince sriy fair-piinded person that the oil weapon is being wielded primarily, to enhance the wealth and the economic leverage of the m a l l group oi nations clustered around the Persian G u l l pects that once the Arab-Israeli dispute is settled, the Persian Gulf nations will lower the price of oil in grateful acknowledgement that their political goals have been metT. Their embargo 'against a handful of nations, and the onagain, off-again series of production cutbacks are merely devices by a well-run cartel to maxim ize already swollen profits. If the price of oil ever moves down, it will be becsyae_the Arab Oil weapon.—the boycott combined with the unbelievable price jumps—propels others into a crash program to develop alternate sources of energy. What will be the Western response if the Arab nations, inundated by paper money, take it into their heads Western response if the The new market priee few Persian Gulf oil is about $8.80 a barrel, which works out to a delivwvd price here of about $10a barrel, aibiir-itold increase in * year. But accondlng to energy czar WilUam E. Simon, the United State* could boost domestic prodmtfiop 4 blUiori to 0 tthumhamw «t ' t t ' E barret v Arab nations demand payment for their oil in gold?9' Nonetheless Slkofc mates clear that the administration, i f "toot actually as sured of an -end to the.-Arab embargo,T is indeed quite hopeful that its mends, the Saudis; Kill soon turn toe spigot on. " What will be the to demand partial or total payment for their oil in gold? So far, the1 Western World, the United States included, has betrayed a shameful impotence in the face, of the Arabs' economic aggression,, 1 ' Prof. Rfchird Gaxdnpr of Columbia v h a s pointed out—violates existing to- There may be some naive observers left who still believe that the Arab oil weapon is merely a diplomatic tool yielded to force Israel back to her old borders. The world has been willing to delude itself into thinking that if the Inraett "liability" Couldbe brushed aside, all would be well. ,But t h r ' latest examples of Arab But is there anyone around who ex- non's, decision against coupon rntig d gaaollhe at thte tiaie is & compound not otriy of a fear the bureauoatte mfess Involved but an total tion thititfeally wont be necessary. Wfcat is needed at this point, ill ti«Jt te a long-run prpgntmlor n f r trials, along the lines of prppoealsjar ~ d y initiated by Sen. Me** dale(MBnn.) , The Arab nylons, as Gardner mA^ should he p u t S n not** t h a t t b e y « § k taUSe"'e0(>l,0lniC * * * * * * * 280 THE MONEY MANAGER Gnomes' of Moscow Recycling Oil Money to West By ROGER LOVE A portion at least Of Arab oil revenues are.being recycled through the. Eurodollar market to frantic oilhungry borrowexa-rbut perhaps not in th» way that Western monetary draftsmen had intended. Demand for money is certainly there; first quarter medium-term. Eurodollar l o a n s by international banks are estimated to have reached a record $10.5 bttlkm, nearly four tittles the $2.9 bUHon total of the 1973 first quarter and more than doubl* the $4*9 billion of the 1973 fourth quarter. The iat*et berretwing? -compare with the previous quarterly record' of$728 billion in the 1978 third quarter. France, Italy and the United Kingdom drew an estimated $8.2 billion in official borrowings from the Euromarket in the first quarter, and may be seeking more than$«-billion additional in the ncirt few months. Sources say that a portion of the money borrowed did originate with oil-producing countries, but some of it 'bypassed th# traditional financial pipelines through Zurich, London or Frankfurt, and came instead through Moscow. The recycling: .mechanjenr of the Moscow "gnomes" worfcd.afe foHo^s: • hard currencies from Western and other consumers to oil producers to pay for oil; hard currencies from oil producers to Bgypt and Syria for. Mideast war and re-armament ex- ' penses; hard currencies from Egypt and Syria to the Soviet Union for military hardware; and hard currencies from the Soviet Union to Euromarkets for foreign borrowers. The amounts v involved are difficult to determine, but some sources indicate that activity of Soviet banks as Eurocurrency offerers, mainly dollars, increased substantially in the first quarter this year, to the extent of several billion dollars. Besides the oil-currency-arms circuit to Moscow, the Soviet Union has also been profiting on foreign sales of raw material^ at high world prices, including the prices paid for Soviet oil deliveries to .many European countries—at Middle-East prices. Soaring prices for gold, in Western markets, in small part reflecting Arab demand for the metal rather than currencies, has attracted some Soviet bullion sales, helping to feed the Moscow^ dollar pool and expand Soviet Euro-* dollar lending, sources say. Some of this Moscow money, at interest rates of 100 or better, has been going to beth oil-strapped industrial countries and chronieally-cash-, short developing countries through the Eurodollar market, with hardnosed Soviet bankers* apparently no readier than-anybody else—including the oil producer*—to make cash available to the poorest countries at anything less than the highest going, rate. The demand for medium-term Euromoney to meet oil and other payments deficits, appears insatiable. France raised $?.3 billion in this area in the first quarter this year', contrasted with no borrowing last year, and may be seeking a further $8 billion in the ne*t few months. Italy raised $2.2 billi+n in the first quarter alone, against about $4.4 billion through all of last year, and some 281 "projections are that it may seek a further $2.5 billion in the near future. British Eurodollar borrowing totaled $3.7 billion in the first quarter, against $2.3 billion in all of last year, and London may seek another $1 billion. Some Euromarket sources see a further $20 billion in demand for Ipurocredit in the coming period: France, $3 billion; Britain, $1 billion; Italy, $2.5 billion; Japan, $2 billion.; Brazil, $2. billion; Spain, $1 billion, and the rest split among other countries. A t the same time, demand and inflationary pressures have caused a sharp shift f r o m the long end of the Euromarket' iftto the medium-term area, at seven-ta-ten years maturity. This - largely. neftecis; accelerating inflation in all industrial countries, which is making investors increasingly, reluctant to put money into long-term securities. I n fact, the total of long-term Euro issues in the first quarter was down over 40$ from the final quarter of 1973, with continuing inflation making it unlikely that the trend will be reversed. The secondary1 Eurobond market has also been adversely affected, by a general malaise, sharp price declines and reports that major Swiss investment funds were unloading large portions of the Eurobond portfolios and shying away from new issues in the face of demands from fund holders for repayment. The unprecedented demand for Euromoney from industrial countries > has of course boosted interest rates Activity of Soviet banks as Eurocurrency offerers, mainly dollars* Jntreased substantially in the first quarter this year, to the extent of several billion dollars. and caused governments to- resort to considerable "arm twisting" pressures on underwriting and issuing syndicates over terms of their issues and in some cases the reluctance of syndicates to proceed with planned offerings. Some observers say that the British Government was lucky to get the terms it did for its recent $2.5 billion ten-year borrowing, even with 3 7 - 2 1 1 O - 74 - 19 Into Proposes A New 'World Bank' U N I T E D NATIONS—-Iran has pledged $1 billion for a series of wideranging measures to increase world money flows and provide development funds for the less advanced countries, Iranian Finance Minister Jamshid Amouzeghar told the three-week special General Assembly session on economic problems. " A t the core of these proposed measures is the establishment of a new special development fund with an initial.capital of $2 billion to $3 billion, to be financed jointly by the oil-exporting as well as industrialized countries," he said. Iran will open its plan to any oil-ex-porting and industrialized countries willing to put up capital, M r . AmMuegit&r said. v \ His country wants to establish a special development fund, he said, because "10 industrial countries have 51% of the vote in. the World Bank and, as a result; vexy imps>riantprojects h»ve been pr«p«sed by developing countries and been rejected on political grounds." His government wants a "one man, one vote" board of governors for the new institution, representing developing, oil-exporting and developed countries equally, he added. . major British commercial banks handling the issue. The spread London obtained over thxee, s i * or twelve month Eurodeposit rates (at the borrower's option) is staggered from a respectable 0.375# for the first two years of the issue to 0.75$ for the final three years, the latter a rate generally imposed on lesser-quality borrowers. The "base" Eurodollar deposit rates have recently been running at a shade above or below 10 though in recent weeks they shot to 10% % and higher. There is little indication of any decline in these rates, given both the enormous projected demand and the iack of evidence of any intergovernmental consensus on staggering borrowing to avoid driving interest rates through the roof.. Japan was switched from a lender to a borrower of Eurodollars under the lash of the oil crisis. Optimists hope that Arab oil revenues will more than make up the gap of supply and the increased demand. But Arab oil producers have thus far shown re-: luctance to lend money at even market rates to international institutions, which are "politically safe" and which would also safeguard against currency depreciations and devaluations. The Arabs appear to wish to keep veto power over the end-use of their funds, even in development and balance of payments aid to the poorest countries, which generally supported the Arab cause in the Mideast war. Borrowers from the industrial world, There is little indication of any decline in Eurodollar rates, given both the enormous projected demand and the lack of staggering of borrowings. who were generally lukewarm if not opposed to the Arab cause, may well find similar policies affecting their attempts to tap Arab cash, via the Eurodollar market. Denmark, for instance, is a traditionally heavy Eurodollar borrower and is also in Arab badbooks for its alleged pro-Israel attitude. • 282 WORLD FINANCIAL MARKETS m a j o r p o r t i o n of O P E C i n v e s t m e n t s . Morgan Guaranty T r u s t C o m p a n y of N e w Y o r k Energy self-sufficiency* percentage derived from domestic sources, in 1971 W h i l e t h e r e is a n e l e m e n t of t r u t h in all t h e s e J a n u a r y 1974 oil prices payments Japan Italy Belgium France United Kingdom Germany Netherlands Canada United States 0 6 1 5 2 7 7 98 74 presumptions, the ad- v e r s e i m p a c t of t h e c u r r e n t l e v e l of 11 15 18 22 53 51 64 110 89 should on the U.S. for the next not be balance few of years underestimated. As s h o w n in T a b l e 2, n e t i m p o r t s of oil and gas a m o u n t e d to 1 0 % U.S. imports 1973. This in of t o t a l January-October ratio is considerably h i g h e r o n l y in J a p a n , b u t it is l o w e r i n all E u r o p e a n c o u n t r i e s . S i n c e it requires s o m e time to d e v e l o p sub"Source: OECD, Economic Outlook stitutes for oil, these ratios give s o m e i n d i c a t i o n of t h e r e l a t i v e ad- v e r s e i m p a c t of h i g h e r oil p r i c e s o n various countries' imports. Further- more, as the table shows, the share of oil a n d g a s in t o t a l U . S . The impact of oil rose sharply imports in r e c e n t y e a r s . This reflects the fact that i n c r e a s e d on the dollar do- mestic d e m a n d for s o m e y e a r s now has had to be c o v e r e d entirely In r e c e n t m o n t h s t h e e x c h a n g e m a r k e t s ' a s s e s s m e n t of t h e d o l l a r and other currencies has b e e n influenced h e a v i l y by t h e d e v e l o p m e n t s in t h e s u p p l y a n d p r i c e of oil. S o o n after t h e c h a n g e s b e g a n t o o c c u r in O c tober, the market view that participants the adopted United States' by i m p o r t s . Irv f a c t , b e f o r e O c t o b e r , i.e. before the creases embargo were and price announced, lowing for the Alaska pipeline, that the volume it w a s in- and al- of the completion anticipated a n d v a l u e of U.S. oil i m p o r t s w o u l d i n c r e a s e a t a v e r a g e a n n u a l r a t e s of a b o u t 1 3 % payments 20%, would adversely a n d 1 9 8 0 a n d t h a t t h e s h a r e of o i l than be affected those of less Japan and Europe. T h i s v i e w is b a s e d o n s e v e r a l pre- respectively, between and e c o n o m y a n d b a l a n c e of 1973 in t o t a l U . S . i m p o r t s w o u l d c o n t i n u e to mount. This underscores the be- Table 2 s u p p o s i t i o n s . First, t h e U n i t e d S t a t e s lief t h a t it w i l l r e q u i r e a m a j o r e f f o r t Net oil and gas imports as percentage ot total imports is less d e p e n d e n t o n f o r e i g n e n e r g y o n t h e p a r t of t h e U n i t e d S t a t e s t o sources than reverse the trend toward 1970 1972 1973' 6.3 15.1 8.5 7.1 8.6 8.2 4.8 4.0 1.2 (2.5) 7.6 19.6 8.6 7.8 9.9 9.6 5.2 5.6 3.4 (3.2) 10.0 17.3 8.5 8.5 7.7 7.6 6.0 3.5 2.2 (4.4) most other industrial c o u n t r i e s ( s e e T a b l e 1). S e c o n d , its industrial activity w o u l d b e United States Japan United Kingdom Germany France Italy Switzerland Belgium Netherlands Canada" "based on data for i mports prior to the effects of oil price increases in October "net exports World Financial Markets / January f o r e i g n oil directly increasing imports. Estimates of increased net a f f e c t e d r e l a t i v e l y little a s t h e U n i t e d a n d g a s i m p o r t s , a n d of t r a d e States has a large capacity to save current-account b a l a n c e s for oil a n d e n e r g y in g e n e r a l , particu- larly in t h e h o u s e h o l d s e c t o r . T h i r d , this country has a very g r e a t p o t e n tial f o r i n c r e a s i n g its d o m e s t i c en- e r g y supplies be- come and could self-sufficient again in e n e r g y m a t t e r of y e a r s . F o u r t h , t h e States' nancial 1974 large and markets in United sophisticated would a attract fia industrial Table 3. countries U.S. are oil a n d given gas billion on the a s s u m p t i o n will not of imports exceed that of t h a t t h e r e will b e s o m e of oil prices. This will in imports a r e p r o j e c t e d t o rise b y a b o u t p h y s i c a l volume oil and major that in 1973 $11 the 1974 and weakening push the t r a d e a n d c u r r e n t a c c o u n t s into d e f i - 283 cit a g a i n in 1 9 7 4 a f t e r 1 9 7 3 ' s brief earnings respite. T h e trade b a l a n c e could be well in growth deficit by following an $3 billion $1 b i l l i o n (customs this estimated year, surplus basis) in of 1973. of U.S. decline in and response companies line with profitability to e a s e d rect-investment may reduced abroad, U.S. in foreign-di- controls, and due In v i e w of t h e c o n t i n u e d h i g h g r a i n to t h e a p p r e c i a t i o n of t h e d o l l a r in prices, agricultural exports will again recent months. do well, and may even exceed In contrast, net tourist expendi- the already high $181/2-billion level tures as well as direct military of non- penditures last y e a r . T h e balance on a g r i c u l t u r a l t r a d e ( e x c l u d i n g oil a n d gas) should favorable, current is be considerably at assuming level of maintained, approximate dollar and more least the devaluation may balance rise in from 1973 it s e e m s moderately, sales the flect rather trade and of the expected t o a d e f i c i t of p e r h a p s $2 b i l l i o n or c l u d i n g oil, will b e o f f s e t s i g n i f i c a n t improvement closely that t h e a d v e r s e s w i n g in t o t a l t r a d e , in- an to Thus, w e a k e n i n g of t h e t r a d e b a l a n c e , a n d in by military partly countries. t h e o v e r a l l c u r r e n t a c c o u n t m a y re- shift a d v e r s e l y unlikely increase, ex- decline overseas well oil-producing more ly and may could to a b o u t $6 b i l l i o n this y e a r . However, abroad net in- 1974. by a b o u t $4 Beyond current deteriorate accounts further on account of appreciation of the the m a j o r items, U.S. interest t h e d o l l a r o v e r t h e p a s t six m o n t h s pay- very much different. be Outstanding and average low are those could be of likely last event that agricultural Along with the United States, countries on n e a r l y all o t h e r i n d u s t r i a l be will e x p e r i e n c e c o n s i d e r a b l e to year, an offsetting interest-bearing producing in t h e e x p o r t s s h o u l d fall. U . S . l i a b i l i t i e s t o f o r e i g n o f f i c i a l ins t i t u t i o n s of industrial effective the could v i s i b l e t r a n s a c t i o n s in 1 9 7 4 . A m o n g m e n t s to nonresidents m a y not 10% billion 1974, but bethere increase liabilities countries. well to Since in oil- it is countries deter- i o r a t i o n in t h e i r t r a d e a n d current- account will balances. There be w i d e v a r i a t i o n in t h e e x t e n t of t h i s weakening, however. Germany still s o m e w h a t doubtful that U.S. interest is likely to h a v e a s i z a b l e t r a d e sur- r a t e s in 1 9 7 4 o n t h e a v e r a g e will b e plus. T h e c u r r e n t p a y m e n t s b a l a n c e s below those ments on in 1 9 7 3 , i n t e r e s t these foreign m a y not c h a n g e m u c h . pay- liabilities Repatriated of Britain will and probably Italy, already bad, worsen further. Can- a d a and Holland are hardly affected a t all by t h e oil d e v e l o p m e n t s , o n a Table 3 net Trade and current-account in billions of dollars change in net oil/gas balance in 1974 guesstimates payments -11 + 1/2 -11 -4 -6 -6 -51/2 -21/2 - 1/2 -11/2 because of gas resources. The trade balance 1973 1974 current account 1973 1974 +1 + 11/2 +3% -51/2 + 12 + 1V2 -5 + 1/2 + 1/2 -21/4 -3 +1% -31/2 -81/2 + 51/2 -31/2 -8 -2 0 -3 +2 -1/2 0 -31/2 +31/2 + 1/2 -3 +3/4 +11/2 +1/4 -2 -1/2 -7 -6 -31/2 -41/2 -51/2 -2 + 1/2 0 guesstimates presented in T a b l e 3 imply that the m a j o r industrial c o u n t r i e s stantial United States Canada Japan United Kingdom Germany France Italy Belgium-Lux. Netherlands Switzerland basis, t h e i r o w n c o n s i d e r a b l e oil a n d will collective achieve a sub- improvement in their non-oil and gas trade performa n c e . M o s t of this g a i n c a n b e a n t i c i p a t e d to a r i s e t h r o u g h i n c r e a s e d OPEC-country spending on trial products, together with net improvement developing indus- vis-d-vis countries — some non-oil, perhaps t h r o u g h s o m e d e c l i n e in c o m m o d i t y Morgan Guaranty Trust Company j 284 p r i c e s — or t h r o u g h e n l a r g e m e n t of the Socialist countries' net deficit S o m e of t h e c o n j e c t u r e t h a t been as to t h e circulating has amount of O P E C i n v e s t m e n t s l i k e l y t o f l o w t o t h e U n i t e d S t a t e s in 1 9 7 4 is a l most certainly account balance. Indeed, progress is b e i n g m a d e o n f a c i l i t a t i n g c a p i t a l o u t f l o w s . A t t h e t u r n of t h e y e a r , position with the West. exaggerated. Deci- s i o n s c o n c e r n i n g t h e i n v e s t m e n t of a s i g n i f i c a n t r e l a x a t i o n of U . S . c a p i t a l controls w a s announced: the est equalization tax was inter- reduced; the regulations covering U.S. direct investment abroad were eased to the extent that they no longer c o m - based p e l t h e f i n a n c i n g a b r o a d of n e w in- factors, including v e s t m e n t , a n d in f a c t p e r m i t n e t r e - r a t e s of r e t u r n , s a f e t y of principal, s u r p l u s oil r e v e n u e s w i l l b e on a variety of p a y m e n t s of p a r t of U . S . c o m p a n i e s ' a n d l i q u i d i t y . F r o m t h e v i e w p o i n t of outstanding foreign debts; and such criteria, U.S. financial ceilings covering foreign claims markets offer s o m e attractive investment o p - banks and portunities. H o w e v e r , as will be dis- tutions c u s s e d in a s u b s e q u e n t s e c t i o n , in- amount. vestment just in one the of a United number States of c h a n n e l s for c a p i t a l f l o w s f r o m oil-exporting to the c o u n t r i e s will doubtedly to investments in the oil-importing countries. O P E C want is possible diversify terms of As nonbank financial were raised regards by capital a the of insti- modest inflows, the c o n t i n u e d a p p l i c a t i o n of F e d e r a l R e serve Regulation M — w h i c h imposes reserve requirements on banks' un- Euro-dollar repatriation to the U n i t e d their S t a t e s — a p p e a r s to i n d i c a t e t h a t t h e currency Federal Reserve is interested in a n d p o l i t i c a l risks. E v e n a s r e g a r d s moderating dollar-denominated investments, the f l o w s . It a l s o s h o u l d b e recognized Euro-dollar and Euro-bond that large-scale m a y offer relatively m o r e r a t e s of r e t u r n t h a n a r e markets attractive obtainable in t h e U . S . d o m e s t i c m a r k e t . invested course, in the do not Euro Funds markets, result in of capital the equity short-term possibility capital of investments in U . S . in- compa- n i e s a n d in U . S . r e a l e s t a t e by f o r eign parties already has stirred concerns the in some quarters, including Congress. flows to the United S t a t e s unless the funds are If t h e relent to U.S. United c e i v e l a r g e net viously very the to re- c a p i t a l inflows, ob- dollar strong. residents. States w e r e Too would strong become a dollar oil r e v e n u e s of t h e O P E C na- t i o n s c a n b e p r o j e c t e d t o rise f r o m c u r r e n t - a c c o u n t b a l a n c e s . In e f f e c t , about a l a r g e s h a r e of t h e c o m b i n e d p r o x i m a t e l y $ 1 0 5 b i l l i o n in 1 9 7 4 . T h i s cur- $22 r e n t - a c c o u n t d e f i c i t of i n d u s t r i a l n a - projection tions with the O P E C countries would crude be oil billion in 1973 assumes to that production ap- OPEC averages ap- United States — p r o x i m a t e l y 3 4 m i l l i o n b p d in probably an unacceptable develop- c o m p a r e d with nearly 3 0 million bpd shifted to the in 1 9 7 3 — p o s s i b l e o n l y if t h e 1974 Arab T h u s , if t h e U n i t e d S t a t e s r e c e i v e s producers end their cutbacks — and a d i s p r o p o r t i o n a t e s h a r e of t h e oil- t h a t oil p r i c e s r e m a i n a t r o u g h l y t o - exporters' day's investible funds, these levels. This projection also large inflows will n e e d to be offset m a k e s a l l o w a n c e for t h e i m p a c t o n by U . S . c a p i t a l o u t f l o w s to a v o i d t o o average strong a g r e e m e n t s n o w in e f f e c t in a n u m - a dollar and excessive de- t e r i o r a t i o n of t h e c o u n t r y ' s c u r r e n t - The would adversely affect our trade and ment. World Financial Markets / January The use of OPEC revenues 1974 oil prices b e r of o i l - p r o d u c i n g of participation countries. 285 T h e p o s s i b i l i t y of s u c h a n i n c r e a s e w o r l d ' s l a r g e s t oil e x p o r t e r , h a s p u b - in oil r e v e n u e s h a s r a i s e d q u e s t i o n s licly concerning the world's financial m a r k e t s to ab- that s o m e price reduction should be disposition, s o r b s u c h l a r g e s u m s not o n l y this considered. A relatively small reduc- y e a r but in t h e y e a r s a h e a d . S e v e r a l tion, of these revenues and their a n d to t h e m e d i u m - t e r m e q u i l i b r i u m nations ac- p r i c e level f o r oil, b u t it w o u l d b e a s t e p in t h e d i r e c t i o n of m a k i n g p a y ment oil i m p o r t bills, a n d t h e e m p l o y m e n t In of the past, OPEC countries w i t h t h e p r i c e s of ex- their the consuming more countries' countries' revenues, manageable. It s e e m s , f u r t h e r m o r e , not u n l i k e ly that the combination of higher oil p r i c e s , n e w c o n s e r v a t i o n meas- ever, the most recent ures, and slower e c o n o m i c growth r o u n d of oil price increases has much more than in t h e i n d u s t r i a l c o u n t r i e s m a y c u r b r e d r e s s e d t h e p a s t i m b a l a n c e in rel- s o m e w h a t t h e d e m a n d for oil. It is ative price m o v e m e n t s . T o be sure, p o s s i b l e t h a t t h e v o l u m e of oil c o n - the many years during which crude s u m e d in t h e i m p o r t i n g c o u n t r i e s a s oil p r i c e s l a g g e d w e l l b e h i n d t h e in- a g r o u p in 1 9 7 4 m a y b e little c h a n g e d c r e a s e s in p r i c e s of from the 1973 represent manufactured substantial OPEC Nonethe- level. If oil p r i c e s w e r e to b e say, by 10% from reduced, today's levels, less, t h e oil p r i c e a d j u s t m e n t s m a d e a n d if O P E C oil p r o d u c t i o n w e r e to last O c t o b e r w e r e m o r e t h a n suffi- remain cient 1 9 7 4 oil r e v e n u e s of t h e O P E C c o u n - to restore the purchasing p o w e r of t h e o i l - e x p o r t i n g c o u n t r i e s . at its tries w o u l d 1973 level, then be a b o u t $85 the billion — T h e f u r t h e r d o u b l i n g of oil p r i c e s at perhaps a m o r e realistic expectation t h e t u r n of t h e y e a r h a s put t h e p r i c e than the previously mentioned $105 of c r u d e oil s u b s t a n t i a l l y o u t of line billion. relative to t h e prices of manufac- t u r e d g o o d s , a s w e l l a s of a g r i c u l tural commodities and non-ferrous metals. It The new oil prices represent a b o v e all a v e r y s i g n i f i c a n t i n c r e a s e in t h e ability of t h e O P E C c o u n t r i e s to p u r c h a s e g o o d s a n d s e r v i c e s in Table 4 of producing i m p o r t s . A s s h o w n in T a b l e 4, h o w - country income foregone. appears also that prices may be above 150 209 Manufactured 111 203 goods 126 Food 94 215 269 Non-ferrous base metals 124 105 681 Saudi Arabian light crude 108 "Third quarter 1973 for manufactured goods, food, and non-ferrous base metals; January 1, 1974 for Saudi Arabian light crude still relative p r i c e s f o r oil a r e o n t h e h i g h s i d e . goods 1960 would tually will r e a c h $ 1 0 5 billion. C u r r e n t in t a n d e m latest > 10% tude of t h e i r m a j o r e x p o r t h a d n o t r i s e n 1970 about l e a v e c r u d e oil p r i c e s h i g h to t h e p r i c e s of m a n u f a c t u r e d g o o d s pressed concern because the price index numbers, base 1950 = 100 e.g., observations concerning the magni- r e v e n u e s of t h e O P E C prices about price increases, and has suggested their It is q u e s t i o n a b l e w h e t h e r t h e oil export terms reservations p a r t i c u l a r l y w h e t h e r it is f e a s i b l e for absorption can be made. Comparative in U.S. dollar expressed and t h e m a g n i t u d e of t h e m o s t r e c e n t oil crude oil medium-term the world market. The capacity of the oil-exporting countries to m a k e e q u i l i b r i u m l e v e l s . W i t h t h e m o s t re- productive u s e of s u c h g o o d s and c e n t r o u n d of p r i c e i n c r e a s e s , t h e r e s e r v i c e s t e n d s to b e u n d e r e s t i m a t e d , w a s a d r a m a t i c c h a n g e in t h e e c o - h o w e v e r . T o b e s u r e , s e v e r a l of t h e n o m i c s of t h e e n e r g y i n d u s t r y . T h e OPEC countries, will future be able n e w oil a n d g a s r e s o u r c e s , a s w e l l to as m a j o r e f f o r t s to d e v e l o p a l t e r n a - their tive e n e r g y s o u r c e s — w h i c h in t h e e v e r , will b e a b l e t o s p e n d l o n g run c o u l d t u r n o u t t o b e c h e a p e r tively m o s t or all of t h e i r oil t h a n oil at t o d a y ' s p r i c e s . I n d e e d , a ings. spokesman for Saudi Arabia, in- the make the Saudi producer, for the f o r e s e e a b l e p r e s e n t oil p r i c e level will s p u r Arabia, including largest t e n s i v e d e v e l o p m e n t of e x i s t i n g a n d u s e of o n l y a f r a c t i o n revenues. Many others, of how- producearn- T h e major oil-exporting countries' Morgan Guaranty Trust Company / 286 g o o d s i m p o r t s f r o m t h e r e s t of t h e world totaled about $17 billion 1 9 7 2 . In 1 9 7 3 , t h a t f i g u r e m a y well h a v a b e e n close to $25 billion. As coun- result of t h e i n f l a t i o n a r y f o r c e s $ 1 5 b i l l i o n a n d $ 2 2 b i l l i o n in in 1973 respectively, it 1972 is clear motion by increases. recent This would bring about on r e c e n t s w i n g in t h e t e r m s of imports oil between the oil-producing and con- received in suming In f a c t , six of t h e O P E C c o u n t r i e s — Algeria, Iran, Iraq, Indonesia, Ni- partial set price exporting countries spent more they a oil at than least the t h a t in b o t h y e a r s s o m e of t h e o i l - revenues. countries. reversal Since of the trade exchange r a t e s c a n p l a y o n l y a m i n o r r o l e in the adjustment process b e t w e e n the g e r i a , a n d V e n e z u e l a — h a v e in t h e oil-producing and consuming past im- t r i e s , t h e a d j u s t m e n t is l i k e l y t o o c - de- cur been porters, substantial both velopment rowers debt as of capital recipients assistance, in t h e markets. of and as international bor- directly through coun- relative price changes. capital In s u m , The combined external combined these countries probably it s e e m s likely that expenditures on the imports of g o o d s b y t h e o i l - e x p o r t i n g coun- e x c e e d e d $ 1 7 b i l l i o n a t t h e e n d of tries could easily r e a c h $35 billion 1 9 7 3 , i n c l u d i n g m o r e t h a n $5 b i l l i o n or m o r e b o r r o w e d in t h e E u r o - c u r r e n c y m a r - oil ket since 1970. billion. Furthermore, per capita incomes in 1 9 7 4 , i m p l y i n g revenues on Since the many unspent order of the of $50 oil ex- porters will b e a b l e to s p e n d most, in t h e six O P E C c o u n t r i e s j u s t m e n - if not all, of t h e i r r e v e n u e s , t h e b u l k t i o n e d r e m a i n v e r y l o w by t h e s t a n d - of t h i s $ 5 0 b i l l i o n will a c c r u e t o ards of the developed countries, also represents the i n c r e a s e s . In t h e a t t e m p t to i m p r o v e current-account importing countries with the economies, nations, w h i c h o n e w a y or oil-exportare in t h e p r o c e s s of m a p p i n g o u t , v e r y deficit approximate living s t a n d a r d s a n d t r a n s f o r m t h e i r m o s t of t h e a h a n d f u l of c o u n t r i e s . T h i s $ 5 0 b i l l i o n e v e n c o n s i d e r i n g t h e r e c e n t oil p r i c e ing c o u n t r i e s a l r e a d y have, or of the oil- OPEC another h a s t o b e f i n a n c e d in 1 9 7 4 . There are a number of possible a m b i t i o u s d e v e l o p m e n t p r o g r a m s in- approaches v o l v i n g s i g n i f i c a n t e x p a n s i o n of t h e i r from the oil-exporting to the oil-im- e c o n o m i c and social infrastructures, porting countries. and transfer major industrialization pro- grams. T h e y also are b e c o m i n g rectly the involved in m a n y petroleum sectors of the primary former. channeling The reserve Some funds latter could assets observers to have suggested, for e x a m p l e , that oil-im- ranging p o r t i n g c o u n t r i e s c o u l d sell g o l d t o the producers at market prices. Non- opment O P E C countries have gold of industry, di- to from the exploration for and devel- production crude and supplies, to the distribution of end amounting to reserves approximately one p r o d u c t s . M a n y of t h e p r o j e c t s a n d billion o u n c e s . p r o g r a m s e n v i s a g e d by t h e p r o d u c - tries also could transfer S D R s , ing c o u n t r i e s a r e h i g h l y c a p i t a l s u p p l y of w h i c h c o u l d b e i n c r e a s e d tensive, tures and and dollars. M o r e o v e r , t h e p r i c e s of t h e g o o d s p u r c h a s e d by the p r o d u c i n g tries will increase c o n s i d e r a b l y as a t o t a l O P E C oil r e v e n u e s w e r e a b o u t and World Financial Markets / January likely t o r e m a i n v e r y l a r g e . in will require imports In a d d i t i o n , of in- expendi- billions military Oil-importing counthe by n e w a l l o c a t i o n s . of S o m e of t h e e x c e s s O P E C reve- equip- n u e s c o u l d b e p l a c e d in t h e EuroEuro m e n t p u r c h a s e s by s o m e O P E C n a - c u r r e n c y m a r k e t , l e a v i n g it t o tions, f r o m both the W e s t and from b a n k s to c h a n n e l the funds to the Soviet bloc, have been and are oil-consuming nations, partly to help 1974 the 287 finance current-account defi- cits. W i t h t h e n e t s i z e of t h e their Euro- oil-exporting countries. A n o t h e r a p p r o a c h to r e c y c l i n g t h e currency market having a p p r o a c h e d surplus a n e s t i m a t e d $ 1 5 0 b i l l i o n at t h e e n d channel them through a multilateral of 1 9 7 3 , up f r o m a p p o x i m a t e l y organization, such as the IMF. $105 oil revenues would be to One b i l l i o n a t t h e e n d of 1 9 7 2 , this m a r - proposal being given k e t h a s d e m o n s t r a t e d t h e a b i l i t y to w o u l d involve a n e n l a r g e m e n t of t h e a b s o r b a l a r g e influx of n e w f u n d s . T h i s is not to s a y t h a t t h e r e no l i m i t a t i o n s o n t h e Euro-currency m a r k e t ' s c a p a c i t y to a b s o r b funds. l i m i t s to t h e a m o u n t There are credit risk t h a t Euro b e w i l l i n g to t a k e f u n d s to are countries banks of would in r e l e n d i n g the with w e a k cur- General consideration Arrangements whereby the Fund to Borrow, would borrow from the oil-exporting countries, and relend to tries. the The oil-importing value of the coun- exporting countries' claims on the I M F be guaranteed in terms could of SDRs. T h e t e r m s of t h e o i l - e x p o r t e r s ' l o a n s , r e n t - a c c o u n t b a l a n c e s of p a y m e n t s , including the value guarantee, would and h a v e to b e s u f f i c i e n t l y a t t r a c t i v e to mounting ness. T h e r e external indebted- is, in s h o r t , no assur- induce them to participate. More- a n c e t h a t t h e d i r e c t i o n of s u c h l o a n s o v e r , I M F c r e d i t s w o u l d h a v e to b e — which for m u c h l o n g e r t e r m s t h a n c u r r e n t would be determined l a r g e p a r t by f a c t o r s s u c h a s t i v e i n t e r e s t rates, c r e d i t in rela- demands, short-term such a facilities. scheme by out to the creditor flow it c o u l d p e r m i t a n o r d e r l y as d e t e r m i n e d policies — would be the in t e r m s of i n t e r n a t i o n a l best payments of oil mutual be the Euro banks, and national capital creditworthiness the However, could and revenues satisfaction debtor to if worked of countries, the recycling consuming c o u n t r i e s , a n d m a k e it p o s s i b l e for equilibrium. S o m e of t h e s u r p l u s oil r e v e n u e s t h e latter to a v o i d a b r e a k d o w n into m a y b e i n v e s t e d d i r e c t l y in t h e n a - c o m p e t i t i v e t r a d e a n d p a y m e n t s bi- tional money and bond markets of lateralism. the or developed without countries, special with bilateral arrange- ments involving e x c h a n g e - r a t e guarantees, or special security issues. Still a n o t h e r p o s s i b i l i t y c o u l d volve long-term capital flows countries. In this The oil-producing countries already fall d e v e l o p m e n t h o l d p a r t of t h e i r r e s e r v e a s s e t s , for less-developed e x a m p l e , in s t e r l i n g a n d d o l l a r category assistance countries Part of this a s s i s t a n c e a n c e s ( b a n k d e p o s i t s , T r e a s u r y bills, the form a n d g o v e r n m e n t b o n d s ) in t h e U n i t e d credits. T h e oil-exporting bal- in- from t h e o i l - e x p o r t i n g to t h e o i l - i m p o r t i n g bilateral could take grants and countries have in t h e p e r s p e c t i v e of t h e of e s t a b l i s h i n g v a r i o u s d e v e l o p m e n t size of tries' the major money and whether value industrial bond measured coun- markets — in t e r m s of of o u t s t a n d i n g the securities, or indicated the (LDCs). Kingdom and the United States. But combined also of would to their intention institutions through w h i c h assistance would be c h a n n e l e d . M o r e o v e r , isting development finance izations, including the World t h e v o l u m e of a n n u a l n e w i s s u e s — the African Development Bank, and the of oil revenues that c o u l d b e a b s o r b e d by t h e s e m a r k e t s is s u b s t a n t i a l . ments more might than In f a c t , s u c h initially a shift invest- involve in a s s e t little owner- s h i p f r o m t h e c e n t r a l b a n k s of oili m p o r t i n g c o u n t r i e s to t h o s e of t h e Development Bank, the amount Asian ex- organ- Inter-American Bank, Development the Bank c o u l d s e e k f u n d i n g for a p o r t i o n of t h e i r l e n d i n g p r o g r a m s f r o m t h e oilexporting countries. S o m e of t h e s u r p l u s oil r e v e n u e s also probably will Morgan Guaranty Trust be utilized Company for 288 various long-term investments, in e q u i t i e s , in r e a l e s t a t e , a n d e v e n in direct investments. However, in approximately 1973 $27 billion represented at about 4 end- months' cover, based on the import outlook 1 9 7 4 it is likely t h a t t h e b u l k of t h e for t h e c o m i n g y e a r . A d r o p b a c k to revenues 3 months' cover would allow a ways in will be described the employed earlier: Euro-currency in deposited market; v e s t e d in n a t i o n a l m o n e y a n d markets; channeled the inbond through the I M F ; a n d d i s b u r s e d a s a i d to d e v e l oping countries. modest Only a s e r v e r u n d o w n of $3 b i l l i o n , would cover 1 3 % current-account 2Va into stock markets and other equity in- v e s t m e n t s in t h e n e a r f u t u r e . The estimated deficit. cover billion, or 3 1 % relatively p o r t i o n is l i k e l y to g o months' of t h e re- which A drop to would yield $7 of t h e d e f i c i t . remainder of the increased c u r r e n t - a c c o u n t deficit will have to be met Many through capital uncertainties inflows. obviously exist in t h i s a r e a . In t h e p a s t , n e a r l y t w o t h i r d s (or a b o u t $11 b i l l i o n in 1 9 7 2 ) Impact of the oil of t h e t o t a l n e t c a p i t a l f l o w f r o m t h e O E C D countries (about $18 billion) situation on the LDCs F o r t h e l a r g e g r o u p of t h e to t h e L D C s h a s b e e n f r o m less-de- veloped countries (LDCs) which are impact of not m a j o r p e t r o l e u m producers, the current account c o s t of p e t r o l e u m payments may m a k e private lenders imports will rise f r o m a n e s t i m a t e d $5 b i l l i o n in 1 9 7 3 oil situation of t h e on the balance of As regards official capital flows, assuming currently prevailing prices it is w o r t h n o t i n g t h a t o f f i c i a l d e v e l - a n d 1 9 7 3 v o l u m e s . T h e 1 9 7 3 oil i m - opment port a c o u n t r i e s in 1 9 7 2 a m o u n t e d to a b o u t 1972 $ 7 b i l l i o n . T h i s a i d e f f o r t b y t h e in- level represented substantial increase already over the assistance from the OECD l e v e l of $ 3 . 7 billion. A l s o , s o m e s l o w - dustrialized nations would be ing t h a n o f f s e t by t h e e s t i m a t e d in L.DC export growth is ex- more $9-bil- p e c t e d . A s a result, a t r a d e deficit lion i n c r e a s e in L D C p e t r o l e u m of basis) p o r t c o s t s . M o r e o v e r , in v i e w of t h e about for all $22 billion (c.i.f. non-oil-exporting LDCs for current-account t e n a n c e of t h e a i d f l o w a t net deficit on in services deficits, the l e v e l s m a y n o w b e in q u e s t i o n . P r e vious The f l o w s a t s o m e t h i n g c l o s e to non-oil-exporting facing a LDCs are current-account mainpresent w o u l d a d d p e r h a p s a billion dollars. therefore im- industrialized nations' o w n projected 1 9 7 4 s e e m s likely, v e r s u s a b o u t $11 b i l l i o n last y e a r a n d $9.5 b i l l i o n 1972. Their commitments may hold the recent l e v e l s in t h e n e a r t e r m , b u t c e r t a i n l y d e f i c i t of a b o u t $ 2 3 b i l l i o n t h i s y e a r , no i n c r e a s e a p p e a r s f e a s i b l e . T h u s , which a s e a r c h f o r w a y s to s h i f t m o r e compares with an annual a v e r a g e of $ 1 0 billion in t h e 1970- 73 period. will be these the aid effort to the O P E C is P a r t of t h i s d e t e r i o r a t i o n n o d o u b t covered countries' by drawdowns international serves. Indeed, recent record of re- rates likely. This programs; and oil-exporting non-oil-exporting L D C s a c u s h i o n to a b s o r b a portion the increment t e r m s of 1974 in oil import cover, (b) mechanisms to directly increase the aid flows from the O P E C the essentially d i r e c t i o n of f l o w s w i t h i n e x i s t i n g a i d have given search of nations b r e a k s d o w n into t w o p a r t s : ( a ) r e - of e x p o r t g r o w t h a n d c a p i t a l i n f l o w s of the and investors more cautious. to a r a n g e of $ 1 3 - $ 1 5 b i l l i o n in 1 9 7 4 , World Financial Markets / January private s o u r c e s . In s o m e L D C s , t h e a d v e r s e nations toward the non- LDCs. As regards the former, the poten- costs. In tial reserves of 1973 figures on d e v e l o p m e n t credits seems limited. Based on mid- 289 from the World Bank, Inter-American IDA and Development the Bank, these possibilities b e c o m e s an portant question. In t h e s h o r t imrun, 12 major oil-exporting countries ac- the c o u n t e d for a b o u t 1 2 % , or m o r e t h a n short-term $ 3 billion, of t o t a l o u t s t a n d i n g l o a n s p u r c h a s e of oil, w h i c h c o u l d later a p p r o a c h i n g $ 2 7 billion. A c t u a l f l o w s of aid funds from sources to amounted these to $ 7 7 0 all 12 net OECD countries credits could to finance r o l l e d o v e r or r e - f i n a n c e d er-term debt. grant the intojofig- Another possibility w o u l d be the creation o f a new I M F 1972, l o n g - t e r m f a c i l i t y s i m i l a r to t h a t n o w a v a i l a b l e to L D C s for c o m p e n s a t i n g d r a w i n g s d u e to e x p o r t s h o r t f a l l s . all LDCs. accomplished Some by partial current back redirection in t h e prepayment disbursed loans aid in countries or 9 . 8 % of t h e t o t a l of s u c h f l o w s to be million OPEC and flows could short of run already relending of by oil exporters to t h e s o u r c e . T h e short-run p o t e n t i a l f o r r e d i r e c t i o n of this sort, However, no d o u b t regional m a k e project making funds di- r e c t e d t o w a r d t h e L D C s — is c l e a r l y LDCs. — rechanneling through the ly f r o m O P E C to t h e L D C s , greater f u n d i n g of e x i s t i n g i n t e r n a t i o n a l d e velopment OPEC organizations nations — have already mentioned However, in t h e p r e v i o u s the n e e d s of s o m e ciently from urgent near-term that the been financial L D C s will b e an suffi- timing of (or greater on general sup- funding would new Further, funds the time from the have much available to organization of OPEC-financed development b a n k , a l r e a d y m e n t i o n e d by t h e S e c r e t a r y - G e n e r a l of O P E C , will r e q u i r e considerable the section. unless it m i g h t b e s o m e countries m u c h greater. T h e various possibili- IMF, development assistance direct- ex- similar essentially loans, so t h a t program before OPEC impact ties will For t h e W o r l d B a n k w e r e w i l l i n g to start port) loans, OPEC time. organizations h o w e v e r , p r o b a b l y d o e s not e x c e e d gory — increasing possibilities more ample, the World Bank and $2 b i l l i o n to $3 billion. T h e p o t e n t i a l in t h e s e c o n d c a t e - other take Among LDCs, the impacts time. the petroleum non-oil primary of the exporting and new situation secondary international will of course v a r y w i d e l y , d u e to t h e s k e w e d distribution of gold and foreign-ex- c h a n g e r e s e r v e s , d i f f e r e n c e s in relative d e p e n d e n c e Table 5 Selected less-developed on imported t r o l e u m a n d l e v e l s of countries A l t h o u g h v e r y a p p r o x i m a t e in millions of dollars, c.i.f. 1974 total $ 295 800 600 1,200 820 225 2,200 450 110 225 increment vs increment % of 1974 over 1973 gross reserves $ 175 500 350 550 500 145 1,300 200 75 145 (a) Based on U.N. data (or 1971, except for Brazil and Chile. (b) Excludes Panama. some c a s e s , t h e d a t a in T a b l e 5 a t t e m p t estimated 1974 oil imports Chile Korea Philippines India Taiwan Central America (t>) Brazil Mexico Peru Argentina pe- development. 59% 48 41 40 33 31 20 17 13 12 % of energy consumption not covered by domestic production (a) 60% 54 97 17 52 93 45 9 39 10 some evaluation of t h e primary ef- f e c t s in a s e l e c t i o n of c o u n t r i e s for w h i c h dar-i a r e r e a d i l y a v a i l a b l e . Of this g r o u p , C h i l e a p p e a r s to b e t h e most vulnerable due to relatively h i g h d e p e n d e n c e o n oil a n d low international reserves, although the oil c r i s i s c o m e s at a t i m e w h e n t h e international financial community has b e c o m e m o r e disposed toward Chilean credits. Brazil, w h i c h heads the bottom half of t h e ranking, a n i n t e r e s t i n g c a s e of h i g h dependence on petroleum is overall imports but s u f f i c i e n t f i n a n c i a l r e s o u r c e s to Morgan Guaranty Trust Company 290 g e t t h r o u g h t h e s h o r t run. Secondary impacts of the c r i s i s w i l l a f f e c t all L D C s degree regardless of in oil some relative de- p e n d e n c e o n oil i m p o r t s . F o r e x a m ple, the slowdown in economic g r o w t h in t h e U n i t e d S t a t e s , J a p a n , a n d W e s t e r n E u r o p e , b r o u g h t o n in p a r t b y t h e w o r l d w i d e oil s h o r t a g e , will reduce d e m a n d for m a n y exports — probably LDC affecting com- modity prices as well as the growth of m a n u f a c t u r e d e x p o r t s . A l s o , s h a r p p r i c e i n c r e a s e s for i n d u s t r i a l g o o d s i m p o r t e d by m a n y L D C s for u s e in manufacturing — as increases to in fuel inflationary well pressures. petrochemical scarcities versely both affect as direct costs — w i l l add Finally, will ad- industry and agriculture, t h e latter d u e to fertilizer shortages. Thus, the secondary p a c t of t h e oil s i t u a t i o n , w h i l e quantifiable mainly to at present, aggravate balance-of-payments cussed World Financial Markets / January 1974 above. the will imnot tend primary effects dis- 291 T H E WASHINGTON POST A p r i l 20, 1974 Big Powers to Tap Euro-dollar Mart1 For Arab Oil Debt From News Dispatcher TOKYO—A meeting of some of the world's major industrial countries on the oil problem ended yesterday with forecasts they would have to pay billions of dollars to Arab and other petroleum producers and then borrow much of the money back. The conclusion emerged from a two-day meeting of a working party from the Organization for Economic Cooperation and Development, a club of 24 of the world's advanced countries. Eleven countries were represented at the meeting, the United States by outgoing Treasury Under Secretary Paul A. Volcker. The group's spokesman, . Dr. Otmar Emminger, vice president of West Germany's. Central Bank, p r e d i c t e d ; , the huge sums of dollars be- ing accumulated by oil pro>. ducing countries, would b«r; partly channeled back to ' western nations and Japan,, through the European cur- ' rency market. Although Emminger re- ^ fused to discuss figure*, conference sources said OECD ; countries would suffer bal- '« ance of payments deficits of' |25 to $40 billion this year ; trying to pay for oil. They forecast also that ' Middle East countries and ; other producers would eon- * trol a hoard of $200 to $250 ; billion in "oil dollars" by * 1980, "In any case the figure* : are enormously large," Emminger told a news conference. "The problems they : raise for the advanced countries and international fi- * nancial markets are great." The West German official said that as oil countries ac- ; cumulate dollars the problem of investing them is . bound to arise. , ; "TO begin with, a rela- « tively large part will be in- * vested in liquid form in in- ; ternational money markets," Emminger said. "Up to now international ^ money markets, particularly the European dollar market, have performed reasonably : well as a medium between oil producing countries and medium term borrowers." Emminger said medium term loans totaling around $12 billion have been channeled through the European currency market so far this year. He added that "under the present circumstances" the , Eurodollar mechanism appeared able to handle the task. But the Dow Jones Now Service reported from London that there has been concern expressed in the Eurobond market over the drop m the dollar exchange rate, notably against the German mark. The service observed that Emminger, at the Tokyd meeting hinted that the mark could appreciate further. Emminger said that West Germany is willing to assume some deterioration in its balance of payments to make it possible for deficit countries to improve their payments positions. He went on to say that exchange rates must play some role even if they couldn't be used exclusively to even out surpluses and deficits. With both the interest rate and currency outlook unfavorable to the Eurodollar bond market, underwriters have been looking for special situations that will appeal to investors. 292 _ _ _ MARCH 4, 1974 IMF Survey Shah Offers Proposal Fund Advances Work on New Oil Facility As Iran Pledges to Lend Its Financial Aid Intensive international efforts are c o n t i n u i n g in the search for solutions to the balance of petroleum payments problems arising from the recent sharp increases in prices. I n W a s h i n g t o n , t h e F u n d ' s E x e c u t i v e B o a r d is c u r r e n t l y d i s c u s s i n g a n outline p r e p a r e d b y t h e staff f o r t h e e s t a b l i s h m e n t o f a n e w f a c i l i t y , o f t e n r e f e r r e d as t h e o i l f a c i l i t y , t o assist c o u n t r i e s i n f i n a n c i n g c u r r e n t a c c o u n t d e f i c i t s to from h i g h e r oil bills. S u c h a facility w a s p r o p o s e d b y M a n a g i n g D i r e c t o r H . J o h a n n e s W i t t e v e e n to the C o m m i t t e e of 20 ( C o m m i t t e e o n R e f o r m of the Monetary System and Related Issues) at its Rome International meeting (IMF Survey, January 2 1 , 1 9 7 4 , page 17), a n d the C o m m i t t e e of 20 asked the Executive Board to explore the idea urgently. In T e h e r a n , m e a n w h i l e , the c o n c e p t that the n e w oil facility w o u l d receive s u p p l e m e n t a r y financing f r o m t h e h i g h e r earnings of t h e oil p r o d u c i n g tries w a s a d v a n c e d as t h e Iranian authorities $1 b i l l i o n this year, t h e b u l k o f w h i c h pledged to is t o b e d i r e c t e d set a s i d e to the new coun- at least facility. T h e b a l a n c e is t o b e u s e d t o p u r c h a s e W o r l d B a n k b o n d s , a n d t o p r o v i d e of the financing of a n e w institution proposed by the Shah of Iran to part make loans o n concessionary terms to d e v e l o p i n g countries that d o not p r o d u c e a n d are thus especially hard hit by h i g h e r oil Iran's p l e d g e of $1 billion for t h e t h r e e purposes f o l l o w e d Teheran a m o n g Iranian authorities, M r . W i t t e v e e n , and President of the World Hoveida, announced was attended by Bank Group. Iran's Prime Amuzegar, Mr. M c N a m a r a and Mr. Witteveen. the discussions R o b e r t S. Minister, t h e d e c i s i o n at a press c o n f e r e n c e jahangir oil, prices. Minister on of in McNamara, Amir Abbas February 21 Finance, that and by Staff m e m b e r s o f b o t h t h e B a n k a n d the Fund have b e e n h o l d i n g discussions w i t h authorities of oil p r o d u c i n g c o u n t r i e s on the problems stemming from higher prices, M r . W i t t e v e e n p l a n s t o visit o t h e r o i l p r o d u c i n g and in the months ahead, nations. Role of Oil Facility F o l l o w i n g t h e d e c i s i o n o f t h e C o m m i t t e e o f 2 0 in f a v o r o f u r g e n t exploration o f t h e n e w oil facility, the 13 industrial c o u n t r i e s r e p r e s e n t e d at t h e W a s h i n g t o n Energy C o n f e r e n c e a g r e e d o n February 13 to lend i m p e t u s to this a n d other efforts to deal w i t h oil-related b a l a n c e of p a y m e n t s disequilibria u n d e r w a y the Fund, the W o r l d Bank, a n d t h e O r g a n i z a t i o n for E c o n o m i c C o o p e r a t i o n Development ( I M F Survey, T h e o i l f a c i l i t y w o u l d assist F u n d m e m b e r countries in m e e t i n g t h e i m p a c t o f t h e i n c r e a s e i n o i l i m p o r t costs b y p e r m i t t i n g d r a w i n g s i n Access to the n e w facility w o u l d their b e s u b j e c t t o a n assess- m e n t o f m e m b e r s ' b a l a n c e o f p a y m e n t s p o s i t i o n , a n d it w o u l d b e tary t o t h e i r o t h e r access t o F u n d initial amounts related to their o i l - i n d u c e d deficits, to t h e size of their reserves, a n d to q u o t a s in t h e F u n d . in and February 18, 1974, page 49). supplemen- resources. F r o m t h e o u t s e t it has b e e n e n v i s i o n e d t h a t t h e F u n d w o u l d u s e its e x i s t i n g resources but might n e e d to s u p p l e m e n t t h e m by b o r r o w i n g m a i n l y f r o m exporting countries. T h e Fund's recent discussions w i t h these countries b e e n to s o u n d o u t the possibilities for such financing, a n d Iran's p r o p o s a l l o a n s t o t h e F u n d f o r t h e o i l f a c i l i t y is a t m a r k e t - r e l a t e d T h e existing resources of the Fund consist of for rates. holdings a n d currencies w h i c h can be s u p p l e m e n t e d by additional oil have of gold and SDRs (Please turn to next page) 293 borrowing under Article VII, Section 2, of the Articles of Agreement to replenish Currencies of oil exporting countries and changes in other prices create very held by the Fund were equivalent to SDR large surpluses among a number of oil the Fund's holdings of any member's cur- 1.17 billion, including Venezuelan producing countries and a number of very boli- large deficits among both developing and rency. The financing of a new oil facility vares equivalent to SDR 218.5 in part by borrowing w o u l d be an in- Trinidad and Tobago dollars to SDR 63 industrial countries. stance of the Fund's obtaining additional million, Iranian rials to SDR 144 million, stances, he said, it is important that gov- resources f rom its member countries. Iraqi dinars to SDR 81.5 million, Kuwaiti ernments react in an appropriate way, for At the end of January, the Fund's holdings of currencies were equivalent to million, Under such circum- dinars to SDR 45.3 million, Saudi Arabian if they were to. react in the wrong way, riyals to SDR 100.5 million, Algerian dinars applying more or less mechanically old to SDR 97.5 to SDR 5.370 billion, and its SDR hold- SDR 18 million, Nigerian naira to SDR 102 payments ings were SDR 508 million. million, and Indonesian rupiahs to SDR world might face very serious problems. Am&tig the currencies were holdings of U.S. dollars equivalent to SDR 6.129 billion, deutsche marks to SDR 481.2 million, and Canadian dollars to SDR 819.6 million. million, Libyan dinars to classical doctrines of restoring balance of SDR 23.889 billion, its holdings of gold 279.2 million. overcome v equilibrium immediately, the The proposed oil facility, he said, would Proposal of the Shah In Teheran, Mr. immediate difficulties in an ap- propriate way, with the Fund helping to McNamara and Mr. finance the deficits, and for this purpose Witteveen promised urgent and sympa- he said it would be desirable if some of thetic consideration by the World Bank the surplus countries would give their and the Fund of the Shah's proposal for a Regarding the developing countries new lending institution to provide conces- which do not produce oil, Mr. Witteveen sionary loans to developing countries that recognized do not produce oil. Under the Iranian especially acute, and not merely one of proposal, the institution would have total financing the deficit, but also a problem capital in the first year of from $2 billion of the debt burden which has to be met. to $3 billion, contributed in about equal parts by the oil exporting countries and by industrial nations. Iran will present the proposal to the Organization of Petroleum Exporting Countries. The proposal calls for the institution to have a board of governors providing about equal representation for oil exporting, industrial, and developing countries. This board would supervise and direct policy, and would appoint a board of directors, selected on the basis of their economic and financial competence, to conduct normal operations. Technical and administrative work would be done by the management and staffs of the World Bank and the Fund. For the future, it is envisioned that the new institution's lending would be primarily long term in character, and for development projects; but at the outset, it would make shorter-term loans for balance of payments support. Press Conference Comments As explained in the Teheran press conference by Mr. Amuzegar, the Iranian suggestion is for the 12 member countries of the Organization of Petroleum Exporting Countries and 12 industrial countries each to contribute some $140 million to $150 million to the institution to provide its capitalization of $2 billion to $3 billion. Mr. Witteveen welcomed the Shah's proposal as constructive not only under present conditions, but for the future as well. He noted that the higher cost of oil that their problem will be 294 THE ANNUAL REPORT OF THE COUNCIL ON INTERNATIONAL ECONOMIC POLICY February 7, 1974 The Rise of Oil Prices: Implications for the World Economy Export prices have now been divorced from factors such as costs and return to capital and are largely determined by the producer governments. Beginning in February 1971 with the Tehran Pact, effective control over oil prices has rested increasingly with producer countries working through the Organization of Petroleum Exporting Countries (OPEC). Posted prices rose approximately 70% between October 1970 and October 1973. In October 1973, the Persian Gulf producers announced unilaterally that posted prices would rise another 70% immediately. Libya joined them in announcing larger price increases. Nigeria, Venezuela, and Canada—the three largest suppliers to the United States—also declared substantial increases in their export prices—in some cases beyond those imposed for oil from the Persian Gulf. Then in December, the Shah of Iran announced on behalf of the Persian Gulf members of OPEC that the posted prices announced in October would be doubled beginning 1 January 1974. Current oil prices are shown in the table on the following page. Price and Balance of Payments Impacts The drastic increases in oil prices w i l l have a significant short-term impact on both the domestic economies of all nations and on international economic relationships. However, because a pricc change of this magnitude for a basic industrial product has no modern precedent, the extent of the impact is uncertain. Impact on Domestic Economies Even before the recent price hikes, many of the world's economies were already decelerating. It was expected that growth would slow from its recent exceptionally high pace to a more sustainable one, where product shortages and inflationary pressures would ease. The higher oil prices will 295 PRICE STRUCTURE FOR SELECTED CRUDE OILS, 1 JANUARY 1974 (See also oil price tables in Appendix B) US $ per Barrel (34° Crude) (Saudi Arabian) Persian Gulf 11.65 0.10 7.01 (34° Crude) Nigerian (40° Crude) Libyan (26° Crude) Venezuelan 14.69 0.35 8.73 15.77 0.30 9.49 13.67 0.51 8.59 1.46 5.55 0.50 7.61 1.84 6.88 0.50 9.58 1.97 7.42 0.50 10.29 2.28 6.31 0.50 9.60 Posted price1 Production cost Government revenue Of which: Royalty Profit tax Estimated oil company profits .. Estimated safes price (f.o.b.) .. Estimated transport cost* (to US Gulf Coast) Estimated sales price (c.i.f.) (to US Gulf Coast) 1.48 0.67 0.65 0.46 9.09 10.25 10.94 10.06 'Differences in posted prices reflect differences in oil quality and transport costs. 'Transport costs are assumed to be about the same as the average for 1973 (i.e.. Worldscale 100). accentuate this slowdown by reducing consumer purchasing power, slowing demand for petroleumbased products, and causing deferral of some business investment as w e l l as consumer purchases. The result w i l l be a reduction i n economic growth, somewhat higher unemployment than expected and, of course, a continuing h i g h rate of inflation w i t h increased oil costs adding to other price pressures. The reduction of growth, however, should be only temporary. T h e duration of the expected slowdown w i l l depend largely on the ability of each economy to adjust to the new price structure. Production patterns i n the world's industrial countries are n o w beginning to shift to meet demand for products w h i c h contain or use less petroleum. The prime example i n the US is of course the shift tow a r d smaller automobiles. The investments needed to make this structural shift w i l l help to avoid an economic d o w n t u r n , and even to increase g r o w t h in the near future. For these reasons, and because of the general soundness of the w o r l d economy, many observers believe that the economies of most nations w i l l begin to accelerate again d u r i n g the latter half of 1974. This sequence w i l l not come automatically. Governments w i l l have to carefully adjust their monetary and fiscal policies so that they can help to accelerate the structural shifts w i t h o u t adding further inflationary pressures. Further, all nations must cooperate to avoid a competitive trade war, w h i c h could lead to a serious recession: some nations might be tempted to t r y to stimulate employment during this d i f f i c u l t period by providing export incentives or imposing import barriers, and such "exporting of unemployment" could provoke retaliation by other countries. Impact on the World Economy T h e price increases w i l l also affect balance-ofpayments accounts and international financial markets. T h e consuming countries' oil import b i l l w i l l increase dramatically this year if current crude oil prices are maintained. A t present consumption levels, w o r l d o i l imports w o u l d j u m p f r o m $45 b i l lion i n 1973 to about $115 b i l l i o n i n 1974 or about a $70 b i l l i o n increase. E x p o r t i n g countries' revenues w i l l increase i n 1974 to nearly $100 b i l l i o n or three-and-a-half times the 1973 level. As shown below, the Arab states w i l l receive about half of the total revenue increase, w i t h Saudi Arabia showing the largest gain. REVENUES FROM OIL EXPORTS (Billion US$) Total Arab Saudi Arabia Kuwait Libya Algeria Iraq Other N on-Arab Iran Indonesia Nigeria Venezuela Other 1973 Estimated 27 15 5 2 2 1 2 3 12 4 1 3 3 1 1974 Estimated 95 51 20 8 7 3 6 7 44 18 4 8 11 3 Most producers w i l l be able to spend only a small part of their increased revenues on foreign goods and services. Even before the recent price increases, the earnings of Saudi Arabia, Kuwait, and the other small Persian Gulf states exceeded their absorptive ability. Their imports and aid dis- 296 bursements w i l l probably grow substantially in 1974, but by nowhere near the amount of the increase in earnings. Other Arab producers have a greater current need for oil earnings to finance their economic development and military programs, but even in these countries the magnitude of the revenue increase and the normal delays in planning make it virtually impossible to spend all revenue this year. The major non-Arab oil exporters—Iran, Indonesia, Nigeria, and Venezuela—will find it somewhat easier to expand imports immediately. For the most part, these countries have larger populations and greater opportunity for economic diversification than do most Arab producers. Nevertheless, the revenue increases are bound in the short run to outstrip the ability of even these countries to absorb foreign goods and services. I n all, oil-producing countries w i l l probably have extremely large surpluses to invest or deposit abroad. These available investment funds w i l l flow mainly to oil-consuming countries. Some w i l l be invested in long-term assets such as real estate and securities. But because these types of investment decisions take time, most of the funds w i l l probably go into short maturity assets—such as Eurodollars— and dollar deposit accounts. While the international financial markets w i l l be able to absorb these investment funds, their magnitude w i l l probably depress interest rates. Lower interest rates should, in turn, stimulate new investments in productive facilities. The reflow of most oil exporting revenues back to the oil consuming countries w i l l mean that, as a group their overall payments position w i l l be balanced. Individual nations, however, may experience problems, since there is no necessary relationship between a country's higher oil import bill and the reflow of funds from the producing countries. The US w i l l be in a fortunate position because it possesses substantial quantities of domestic oil and alternative energy sources. The sharp strengthening of the dollar in exchange markets in January 1974 reflects in part the expectation that the US balance of payments w i l l be less severely affected than those of other industrial nations. The dollar's renewed strength, however, is a mixed blessing: continued appreciation of the dollar may reduce the competitiveness of US goods in world markets. Developing countries face especially serious problems as a result of the price increases. The non-oilproducing L D C s face an increase in their collective oil import bill of near $10 billion this year, an amount roughly equivalent to the total development assistance being disbursed by developed countires. An undetermined but substantial figure must be added for the impact Of the increased prices for imports which grow out of the increase in energy costs. It may be that some of these countries could borrow to meet increased costs, but, to the extent they do so, their ability to borrow for other purposes is reduced. The alternatives are to reduce their standard of living, receive more foreign aid, or see energy prices reduced. • HO 9560 Gen. TMt m e t 74-33 5 OT THE RISE IN THE PRICE OF CRUtt OIL ON THE WOftLO SCONOMY: Prognosis t n d P o l i c y Options 298 THE IMPACT OF THE RISE IN THE PRICE OF CRUDE OIL ON THE WORLD ECONOMY --Prognosis and Policy Options-Table of Contents I. Impact on Prices 1 II. Impact on Demand and Output 3 III. The Balance of Payments 5 IV. Policy Options for the United States and the Other Industrial Countries 7 A. Reduce price of crude oil 8 B. Policies to offset economic recession 9 C. Balance-of-payments policies --Financing D. V. 10 Less Developed Countries 13 Another Look at the Numbers List of Tables Table 1 - - Impact of October and December 1973 Increase in Price of Imported Oil. Table 2 - - Increase in Oil Revenues of OPEC Countries, 1974 over 1973 Table 3 - - Balances of Payments on Current Account Table 4 - - The Increase in Oil Exports of OPEC Countries, 1974 Appendix Petroleum Exporting Countries: Oil Exports and Revenues 9 9 --Adjustme nt 1 299 T H E I M P A C T OF T H E RISE I N T H E P R I C E OF CRUDE O I L ON T H E W O R L D E C O N O M Y - - P r o g n o s i s and P o l i c y Options - - In October and D e c e m b e r 1973, the O P E C c o u n t r i e s r a i s e d e f f e c t i v e o i l p r i c e s f r o m $3. 45 a b a r r e l landed in N o r t h A m e r i c a and W e s t e r n E u r o p e to roughly $9 a b a r r e l . E v e n i f the A r a b o i l e m b a r g o and c u t - b a c k of production w e r e ended s h o r t l y , the p r i c e i n c r e a s e alone w i l l r a i s e m a s s i v e economic p r o b l e m s f o r the w o r l d : - - I n f l a t i o n , a l r e a d y a s e r i o u s p r o b l e m , w i l l be given a s h a r p s t i m u l u s : s o m e 3 p e r c e n t a g e points w i l l be added to to the r a t e of p r i c e i n c r e a s e in 1974. - - D o m e s t i c d e m a n d , and hence output, e m p l o y m e n t , and r e a l i n c o m e , m i g h t be r e d u c e d s i g n i f i c a n t l y i n 1 9 7 4 - - b y s o m e 2 p e r c e n t a g e points m o r e than would o t h e r w i s e have been the case. - - A c u t e b a l a n c e - o f - p a y m e n t s p r o b l e m s w i l l face m o s t c o u n t r i e s - - n o t a b l y n o n - o i l p r o d u c i n g less developed c o u n t r i e s , but a l s o Japan, the United K i n g d o m , and I t a l y i n 1974. W h e t h e r these p r o b l e m s m a t e r i a l i z e in a s u b s t a n t i a l way w i l l depend in p a r t on the p o l i c i e s adopted by the i n d u s t r i a l countries and the d e g r e e of cooperation a m o n g t h e m . M o r e o v e r , the p r o b l e m s a r e so m a s s i v e , and the r i s e i n the p r i c e of o i l so g r e a t , that it s e e m s u n l i k e l y that c u r r e n t o i l p r i c e s can be long m a i n t a i n e d . T h i s m e m o r a n d u m discusses the above e s t i m a t e s and t h e i r i m p l i c a t i o n s f o r p o l i c y . The e s t i m a t e s a r e n e c e s s a r i l y rough. T h e i r only p u r p o s e i s to p r o v i d e a r e a s o n a b l e f r a m e w o r k f o r the development of e c o n o m i c p o l i c y . I. I m p a c t on P r i c e s The i n c r e a s e in the p r i c e of i m p o r t e d o i l w i l l have a m a j o r i m p a c t on w o r l d p r i c e s . A s can be seen in table 1, f o r the O E C D c o u n t r i e s as a whole the i n c r e a s e d cost of i m p o r t e d o i l should r a i s e d o m e s t i c p r i c e s ( m o r e t e c h n i c a l l y , the G N P d e f l a t o r ) by m o r e than one p e r c e n t a g e point. 300 CRS-2 TABLE 1 I m p a c t of October and D e c e m b e r 1973 I n c r e a s e i n P r i c e of I m p o r t e d QlT E f f e c t s on I m p o r t s $ billions a/ A s % of T o t a l E x p e n d i t u r e s (1973) Selected Countries U.S. 9. 5 0. 7 Japan 8.3 1. 5 France 4. 5 1. 2 Germany 5. 3 1.2 Italy 5.0 1. 8 U. 5. 0 1.8 K. BLEU 1. 5 1. 8 Netherlands 1. 5 1.5 O E C D total 46.6 7.5 1. 2 Non-OECD Grand Total 54. 0 a / The e s t i m a t e s show the e f f e c t of the change i n o i l p r i c e s on the 1973 v o l u m e of o i l i m p o r t s . S o u r c e : O E C D , E c o n o m i c Outlook, P a r i s , D e c e m b e r 1973 and F e d e r a l R e s e r v e e s t i m a t e s J a n u a r y , 1974 ( M e m o r a n d u m of H e l e n J u n z ) . 301 CRS-10 M o r e o v e r , since the increases w i l l be passed along m o r e in percentage r a t h e r than absolute t e r m s (in o r d e r to m a i n t a i n m a r k - u p m a r g i n s constant as a percent of costs), and since wage-push inflation is also l i k e l y to develop, the p r i c e increase for the O E C D countries could w e l l be higher than that i m p l i e d i n table 1. Indeed, it might amount to 3 percentage points or m o r e . (The impact on the United States would be w e l l below a v e r a g e since domestic energy supplies a r e l a r g e . ) II. I m p a c t on Demand and Output The p r i c e i n c r e a s e for i m p o r t e d o i l i s i d e n t i c a l in its economic i m p a c t to a tax on o i l consumption. The net economic i m p a c t depends on the public's r e a c t i o n to the "tax" and the use to which the "tax c o l l e c t o r ' puts the r e v e n u e . Helen Junz of the F e d e r a l R e s e r v e e s t i m a t e s that the d i r e c t impact of the i n c r e a s e in the p r i c e for i m p o r t e d o i l would be to reduce G N P by 1. 5 to 2. 2 percentage points below what i t otherwise would have been, a / This seems reasonable since, as can be seen in table 1, the i n c r e a s e in the p r i c e of i m p o r t e d o i l - - t h e additional "tax" imposed by the o i l - e x p o r t e r s - - a m o u n t s to some 1 . 2 percent of 1973 G N P . As can be seen in the appendix, the " t a x " , or increase in o i l earnings by the o i l - e x p o r t i n g countries, is expected to amount to some $60 b i l l i o n i n 1974 as earnings of O P E C countries, which w e r e $25 billion in 1973, soar to $84 b i l l i o n i n 1974. b / P a r t of this w i l l be offset by i n c r e a s e d purchases of goods and service's by the o i l - e x p o r t e r s . In 1973, these countries bought some $20 b i l l i o n w o r t h of goods and s e r v i c e s f r o m the r e s t of the w o r l d . A 50 percent i n c r e a s e - - a n i n c r e a s e in purchases of $10 b i l l i o n - - c o u l d be r e a d i l y financed but would be d i f f i c u l t to accomplish in one y e a r . Y e t , even if such an i n c r e a s e took place, it would leave the r e s t of the w o r l d with a deflationary i m p a c t of roughly $50 b i l l i o n . A g r e a t e r i n c r e a s e in expenditures by the o i l - e x p o r t i n g countries is not l i k e l y . As can be seen in table 2, a substantial p a r t of tne i n c r e a s e in revenue w i l l accrue to A r a b countries with l i m i t e d absorptive c a p a c i t y - s m a l l populations and unambitious p r o g r a m s for economic development. Even the other oil countries w i l l experience a lag before they can t u r n their increased f i n a n c i a l r e s o u r c e s into effective purchasing p r o g r a m s . a / M r s . Junz uses i n d i r e c t tax e l a s t i c i t i e s d e r i v e d f r o m Bent Hansen ( F i s c a l Policy in Seven Countries, 1 9 5 5 - 6 5 , O E C D , P a r i s , M a r c h 1969) or f r o m n a t i o n a l m o d e l s . b/ The data in the tables a r e roughly consistent. Such inconsistencies as exist do not a l t e r the a n a l y t i c a l or policy conclusions. 302 CRS-4 Table 2: I n c r e a s e in O i l Revenues of O P E C C o u n t r i e s , A r a b Countries with limited absorptive capacity $26. 0 b i l l i o n Saudi A r a b i a Kuwait Abu Dhabi O t h e r P e r s . Gulf Libya Other A r a b C o u n t r i e s 6. 6 Iraq Algeria Other Other C o u n t r i e s 30. 6 Iran Nigeria Other W. A f r i c a Venezuela Other L a t i n A m e r i c a Indonesia Other F a r E a s t USSR & E . E u r o p e OPEC 59. 3 World Total 62. 8 Source: Appendix. 1974 o v e r 1973 303 CRS-10 U n t i l that happens, the impact of the i n c r e a s e in the p r i c e of o i l is c e r t a i n to depress demand and income i n the o i l - i m p o r t i n g countries. The fact that the i n c r e a s e in f i n a n c i a l assets of the o i l - e x p o r t i n g countries w i l l be invested in the o i l - i m p o r t i n g countries does not offset this conclusion. III. The Balance of Payments The i n c r e a s e in the p r i c e of o i l w i l l have a staggering i m p a c t of the balances of payments of a l l countries. The m o s t r e c e n t e s t i m a t e s , shown i n table 3, a r e exceedingly rough but they suggest the following g e n e r a l conclusions: - - T h e o i l exporting countries m a y e a r n some $55 b i l l i o n net i n 1974, compared to $6 b i l l i o n in 1973. - - T h e United States, which r a n an e s t i m a t e d surplus on c u r r e n t account (trade, s e r v i c e s and p r i v a t e t r a n s f e r s ) of $4. 5 b i l l i o n i n 1973 now is p r o j e c t e d to run a deficit of $1 to 2 b i l l i o n (instead of an e a r l i e r forecasted surplus of $9 b i l l i o n ) . - - T h e United Kingdom and Japan e s p e c i a l l y , but I t a l y , F r a n c e and G e r m a n y as w e l l , face l a r g e c u r r e n t account deficits in 1974. - - F i n a l l y , the n o n - o i l producing less developed countries, which r a n a deficit of $9 b i l l i o n in 1973, a r e expected to show a deficit of $23 b i l l i o n in 1974 if i t can be financed. W i t h foreign aid running at $8 b i l l i o n , financing such a deficit w i l l be quite d i f f i c u l t . These e s t i m a t e s , which, to r e p e a t , a r e subject to wide m a r g i n s f o r e r r o r and a r e not f o r e c a s t s , give a reasonable idea of the o r d e r s of magnitude involved in the change in the p r i c e of oil. The swings envisaged a r e enormous. T h e r e would be no b a l a n c e - o f - p a y m e n t s p r o b l e m i f the o i l exporting countries spent t h e i r i n c r e a s e d earnings for goods and s e r v i c e s , though there would be a m a j o r t r a n s f e r of r e a l r e s o u r c e s f r o m o i l i m p o r t i n g to exporting countries. (Indeed, u n t i l the l a t t e r increase t h e i r purchases in other countries, no r e a l burden is placed on the o i l i m p o r t e r s . ) N o r would t h e r e be a b a l a n c e - o f - p a y m e n t s p r o b l e m if the i n c r e a s e d earnings of the o i l e x p o r t e r s came back to the i m p o r t e r s as e i t h e r s h o r t t e r m or l o n g - t e r m investments. This is almost c e r t a i n to happen at least for the next y e a r and m o r e . But these loans and investments would have to equal, country by country, the i n c r e a s e in net i m p o r t s f r o m the o i l countries. This is a most unlikely constellation. Thus, 1974 seems c e r t a i n to p r e s e n t the developed countries and the rton-oil producing less developed countries with m a j o r policy p r o b l e m s . 304 CRS-6 T a b l e 3: B a l a n c e s of P a y m e n t s on C u r r e n t A c c o u n t a / ($ b i l l i o n ) 1972 Oil exporting countries U n i t e d States A l l other countries 1973 Projection: Before Dec. Oil Price Rise 1974 After Dec. Oil P r i c e Rise b/ 1.6 6. 1 12. 5 55.0 -6.2 4.5 9.0 -1.5 8. 1 -1.1 -21.5 -53.5 Japan 7.0 1.5 -0.9 -6.0 France 1.0 0.6 -0.2 -3.7 Germany 2. 2 5.5 3.6 -2.5 Italy 2. 4 -1.4 -2.0 -3.5 U. K . 0.7 -2.4 -3.5 -7.5 -7. 5 -9.0 N o n - o i l producing p r i m a r y producers -17.7 - 2 3 . 0 c/ a / Goods, s e r v i c e s and p r i v a t e t r a n s f e r s . b / The e s t i m a t e s a l s o a l l o w f o r a s o m e w h a t l o w e r v o l u m e of o i l i m p o r t s and a d d i t i o n a l e x p o r t s to the o i l p r o d u c i n g c o u n t r i e s . c j L a r g e l y n o n - o i l L D C s , but a l s o includes S i n o - S o v i e t c o u n t r i e s and e r r o r s and o m m i s s i o n s . S o u r c e : F i r s t two c o l u m n s : I M F , O E C D " W o r l d E c o n o m i c O u t l o o k " D e c e m b e r 26, 1973. T h i r d : c o l u m n H e l e n Junz of F e d e r a l R e s e r v e . L a s t column: O E C D , s o u r c e , J a n u a r y 12, 1974. 305 CRS-10 IV. P o l i c y Options for the United States and the Other I n d u s t r i a l Countries The policy options open to the i n d u s t r i a l countries s e e m c l e a r . M o s t i m p o r t a n t , m o r e than any t i m e since the G r e a t D e p r e s s i o n of the 1930's, economic cooperation among the i n d u s t r i a l powers is essential. T h i s point seems obvious, but r e c e n t developments suggest that the cooperation may be no m o r e forthcoming now that i t was a l m o s t half a century ago. The g e n e r a l lines of policy a r e not in dispute as broad p r i n c i p l e s . communique of January 18, 1974 of the I n t e r n a t i o n a l M o n e t a r y Fund's C o m m i t t e e of Twenty m e e t i n g in R o m e , spelled t h e m out as follows: The . . . i n managing t h e i r i n t e r n a t i o n a l payments countries must not adopt policies which would m e r e l y aggravate the p r o b l e m s of other countries. A c c o r d i n g l y , they s t r e s s e d the i m p o r t a n c e of avoiding competitive depreciation and the escalation of r e strictions on t r a d e and payments. They f u r t h e r r e s o l v e d to pursue policies that would sustain a p p r o p r i a t e levels of economic activity and e m p l o y m e n t , while m i n i m i z i n g inflation. They recognized that serious difficulties would be created for many developing countries and that t h e i r needs for f i n a n c i a l r e s o u r c e s w i l l be g r e a t l y i n c r e a s e d and they urged a l l countries with available r e s o u r c e s to make e v e r y e f f o r t to supply these needs on a p p r o p r i a t e t e r m s . The C o m m i t t e e agreed that t h e r e should be the closest i n t e r n a t i o n a l cooperation and consultation i n pursuit of these objectives. The only question is whether actions w i l l conform to these p r i n c i p l e s . These p r i n c i p l e s , with one m a j o r addition, and t h e i r r a t i o n a l e a r e spelled out below: A. Reduce p r i c e of crude o i l Though not agreed by the C o m m i t t e e of Twenty, the most obvious and most effective policy would be to induce the O P E C countries to l o w e r the p r i c e of crude oil. To do this, the r e s t of the w o r l d would have to show that such action is in the s e l f - i n t e r e s t of the O P E C countries. Such an approach might be f a c i l i t a t e d i f it took place in an atmosphere which does not condone the O P E C action on p r i c e . A r a b spokesmen, c e r t a i n l y , but even a number of i m p a r t i a l o b s e r v e r s in the A m e r i c a n press and e l s e w h e r e suggest that the O P E C action is a n o r m a l and l e g i t i m a t e use of economic p o w e r , analogous to the p r i c i n g policies of A m e r i c a n corporations. I t is also argued that the action is m o r a l as w e l l since income is t r a n s f e r r e d f r o m the r i c h to the poor. Both propositions a r e questionable. 306 CRS-10 If the oil countries were companies operating within the United States, they would be in violation of anti-trust laws and subject to civilian and criminal penalties. Moreover, there is generally a close relationship between the cost of production of a product--the intellectual and physical effort involved--and its price. But Middle East oil costs an estimated 13 cents a b a r r e l to produce a/ and the price to the oil companies is now about $7 a b a r r e l , for a mark-up of some 4, 000 p e r cent. Nor are the price increases accomplishing a more equitable division of world income by taxing the rich to help the poor. As shown e a r l i e r , the non-oil less developed countries, which have incomes of some $300 per person, w i l l be hit hardest. And the o i l - r i c h countries of the Persian Gulf w i l l have per capita incomes amounting to some thousands of dollars per person. The OPEC countries might be persuaded to lower their price for a number of more compelling reasons: 1. They must realize that the large and precipitous rise in the price of oil is creating major economic problems for both the developed and less developed countries. As noted e a r l i e r , the increased price is a major stimulus to inflation and economic recession. With such conditions, all would lose. Sheikh Yamani, Minister of Petroleum of Saudi Arabia recognized this in a statement in Tokyo on January 27th. 2. Balance-of-payments problems and an economic recession would result in trade restrictions and reduced demand for all imports, so that attempts of the OPEC countries to diversify their economic base and to export oil would be inhibited. 3. The OPEC countries must recognize that the increased price of oil is encouraging the development of alternative sources of energy. The result could be lower prices for oil in the future so that oil-in-the-ground would be less valuable than oil sold today. 4. Finally, the OPEC countries must recognize that if business and governments make major investments to develop alternative sources of energy, they will protect these investments through import restrictions if necessary. This implies future economic problems for oil exporters. a/ This is the cost for Persian Gulf oil; other costs are higher: 38 cents in Nigeria, 40 cents in Venezuela, 45 cents in Libya, 75 cents in Algeria, and $1. 08 in the United States and Canada. 307 CRS-10 B, P o l i c i e s to offset economic r e c e s s i o n The developed countries must take positive m e a s u r e s to avoid letting the deflationary i m p a c t of the i n c r e a s e in the p r i c e of o i l r u n its course. And, countries must not let f e a r of b a l a n c e - o f - p a y m e n t s deficits inhibit expansionary economic m e a s u r e s . I f a l l the developed countries move to expand t h e i r domestic economies together, the a d v e r s e b a l a n c e - o f - p a y m e n t s i m p a c t w i l l be m i n i m i z e d . And, as the l a r g e s t single economic unit, the United States has a s p e c i a l responsibility not to let i t s e l f and the w o r l d continue its slide into an economic r e c e s s i o n . C. B a l a n c e - o f - p a y m e n t s policies T h e r e a r e two basic ways countries can m e e t a b a l a n c e - o f - p a y m e n t s deficit. They can finance i t . They can adjust to i t - - e n c o u r a g i n g economic changes which w i l l wipe out the d e f i c i t . T h e r e a r e good reasons why financing the deficit is the p r e f e r r e d route for most countries in 1974. - - F i r s t , the adjustment r e q u i r e d is e n o r m o u s - - o f the o r d e r of $55 b i l l i o n , as can be seen in table 3. --Second, it is c l e a r that a l l countries w i l l be unable to a d j u s t - that the n o n - o i l i m p o r t e r s , as a group, w i l l n e c e s s a r i l y r u n a trade and b a l a n c e - o f - p a y m e n t s d e f i c i t . Thus, the attempt of one c o u n t r y - - F r a n c e , f o r e x a m p l e - - t o get a balance can succeed only at the expense of another c o u n t r y - - t h e United States or G e r m a n y , perhaps. - - T h i r d , c u r r e n c y devaluations or depreciations can only contribute to f u r t h e r inflation and serious s o c i a l p r o b l e m s in the devaluing country. The i n c r e a s e in o i l p r i c e s w i l l throw e v e r y m a j o r country's balance of payments into d e f i c i t . To avoid this having an unhappy psychological effect on policy, o i l i m p o r t s - - o r at least the i n c r e a s e in the value of o i l i m p o r t s - could be excluded f r o m the n o r m a l t r a d e account. This segregation of data would be only cosmetic, but it could c l a r i f y thinking about a p p r o p r i a t e policy. Financing: The o i l producers w i l l have to lend o r invest most of t h e i r sharply i n c r e a s e d earnings to the r e s t of the w o r l d . T h e r e is no a l t e r n a t i v e . Indeed, much of the i n c r e a s e d earnings m a y w e l l a c c r u e to the United States with the m o s t developed and sophisticated capital m a r k e t . The O E C D countries can " r e c y c l e " , or r e l e n d , the loans and investments of the oil countries to those in need of such finance. T h e r e is ample precedent for this. Much of this " r e c y c l i n g " w i l l be done by m a r k e t f o r c e s . H o w e v e r , i f they prove inadequate, governments, the I M F and national c e n t r a l banks can complete the task. 308 CRS-10 If the oil producers buy gold or SDRs f r o m central banks and reduce the amount of monetary reserves thereby, the international community can replace these assets by another issue of SDRs. Adjustment: There w i l l be a temptation for countries to t r y to adjust their balances of payments rather than borrow to finance their 1974 deficits. Some countries may try to hold or attract reserves in a variety of undesirable ways--by raising interest rates above what would be required for domestic economic reasons, or by enduring deflation and unemployment. If they do, unemployment w i l l be intensified and passed on to other countries. There w i l l be a temptation for countries to let their currencies f l o a t - - o r s i n k - - o r to r e s t r i c t imports in order to restore their trade surpluses and slow their losses of financial reserves. But countries must recognize that such actions w i l l not draw funds from the oil producers, but w i l l merely shift reserves f r o m one industrial country to another. The result w i l l be unhappy in both economic and political terms as unemployment is exported to other countries. Real cooperation among the industrial powers is needed. countries w i l l have to work out common policies on: The --interest rates specifically and overall economic policies more generally; --exchange rates—the free market or floating solution could be disasterous in 1974 however useful it was in 1973 and might again become in the future. The argument for coordinating the monetary and fiscal policies of the major countries is clear and not controversial. This is not true of the proposition on exchange rates. The argument against letting the market decide on the appropriate exchange rate during this period of great strain on every nation's balance of payments is twofold. F i r s t , the market generally exaggerates the i n fluence of new factors. Second, as a result, major and partly unnecessary economic adjustments are forced on countries. These can be quite costly in terms of unemployment and inflation. Recent events may provide an example. Since the beginning of the oil crisis the effective devaluation of the dollar has been cut in half. This reflects the assessment of the market that the United States w i l l be relatively much less damaged by the rise in oil prices than the other major nations. The result w i l l be to stimulate U.S. imports and to inhibit U.S. exports. Unless countervailing action is taken, this could result in increased unemployment in the United States. In addition, the depreciation of the European currencies and the Japanese yen w i l l contribute to inflation in both areas with resultant social turmoil, and without affording any clear r e l i e f to their balances of payments. 309 CRS-10 D. Less Developed Countries I t is c l e a r that the n o n - o i l producing L D C s face especially difficult t i m e s . In o r d e r to m a i n t a i n t h e i r recent r a t e of economic growth they w i l l need at l e a s t a doubling of economic aid to finance the b a l a n c e of-payments deficit due solely to the i n c r e a s e d p r i c e of o i l . T h e r e a r e only three ways out of the i m p a s s e : - - F i r s t , the L D C s w i l l have to r e s t r i c t i m p o r t s or reduce domestic demand, i f they cannot finance the i n c r e a s e d d e f i c i t . This means m o r e unemployment, a l o w e r r a t e of economic growth, if any, at home, and i n c r e a s e d deflationary p r e s s u r e on the developed countries. --Second, the usual aid donors could double or t r i p l e t h e i r aid d i r e c t l y or provide a s p e c i a l c r e d i t f a c i l i t y in the I M F or W o r l d Bank for loans to the L D C s . The o i l producers could provide the financing and would ask for guarantees on their investments plus a reasonable r a t e of r e t u r n . This approach has serious drawbacks. The L D C s a l r e a d y have too heavy a burden of indebtedness. T h e i r a b i l i t y to r e p a y new loans is seriously in doubt. And, such loans would not finance capital i m p r o v e m e n t s which would r e s u l t in future i n c r e a s e s in output, but would m e r e l y finance c u r r e n t consumption. Thus, the liklihood is that there would be defaults on the new loans leaving the I M F or W o r l d Bank and, consequently, the m a j o r developed countries with another burden in addition to the one placed d i r e c t l y on them by the oil p r o d u c e r s . - - T h e t h i r d way to m e e t the L D C s p r o b l e m is for the o i l producers to finance d i r e c t l y the i n c r e a s e d b a l a n c e - o f payments deficits of the L D C s . The o i l producers created this special p r o b l e m , they ought to be p r e p a r e d to help ease i t . They have ample financial r e s o u r c e s to help. V. Another Look at the N u m b e r s It is most unlikely that the projections for 1974 in this r e p o r t w i l l actually be r e a l i z e d . T h e r e a r e three basic reasons for this: - - F i r s t , it is unlikely that the less developed countries w i l l be able to finance a l l of the i n c r e a s e d cost of i m p o r t e d o i l . Thus, t h e i r i m p o r t s w i l l l e s s - - a s w i l l their d e f i c i t - - t h a n the projections in table 3. 310 CRS-10 - - S e c o n d , the sharp i n c r e a s e in o i l p r i c e s is l i k e l y to r e s t r i c t d e m a n d . The F i r s t N a t i o n a l City Bank e s t i m a t e s , roughly, that the 140 p e r c e n t i n c r e a s e i n p r i c e s since October w i l l r e s t r a i n w o r l d demand by some 10 p e r c e n t in 1974. In addition, conservation m e a s u r e s , p r i n c i p a l l y in the United States but e l s e w h e r e as w e l l , w i l l also cut demand. - - T h e drop in the demand for o i l w i l l be r e f l e c t e d in a f a l l i n p r i c e . T h i s is put at roughly $2 p e r b a r r e l . The i m p a c t of these f a c t o r s on the i n c r e a s e in earnings of O P E C countries is s u m m a r i z e d in table 4, below. T a b l e 4. - - T h e I n c r e a s e i n CXI E x p o r t s of O P E C Countries, (billions of d o l l a r s ) From OECD countries P o t e n t i a l r i s e in r e c e i p t s F a l l in demand due to high p r i c e s A s s u m e d $2 p r i c e cut in June 1974 A c t u a l i n c r e a s e in r e c e i p t s A m o u n t spent on i m p o r t s A v a i l a b l e f o r investment Source: $50 - 8 - 8 - 8 From non-OECD countries $10 - 2 - 2 6 - 2 4 1974 Total $60 - 10 - 10 40 - 10 30 Monthly Economic L e t t e r , F e b r u a r y 1974, F i r s t National City Bank. The r e s u l t a n t s t r a i n on the w o r l d economy and the policy