How should the U.S. deal with Vladimir Putin’s invasion of the Ukraine? We should do to Russia what Ronald Reagan did to its predecessor, the old Soviet Union. We should drive them into bankruptcy by stabilizing the U.S. dollar.
A reliable maxim of geopolitics is, “When the treasury is empty, the regime falls.” This is exactly what happened to the U.S.S.R. It is also what will happen to Vladimir Putin if we simply stabilize the dollar, something that we should be doing anyway.
It wasn’t Reagan’s massive defense build-up, or his Star Wars program, that drove the Soviet Union to the wall; it was the decline in real oil prices caused by the Reagan/Volcker/Greenspan strengthening of the U.S. dollar.
On an end-of-year basis, real crude oil prices averaged $17.66/bbl (in 4Q2013 dollars) from 1950 to 1972. By the time that Reagan took office, they had almost quintupled, to $85.98. It was this oil price windfall that fueled Soviet expansionism in the 1970s.
The high oil prices of 1980 were not real, and Reagan knew it. They were being caused by the weakness of the U.S. dollar, which had lost 94% of its value in terms of gold between 1969 and 1980.
Reagan immediately decontrolled U.S. oil prices, to unleash the supply side of the U.S. economy. Even more importantly, Reagan backed Federal Reserve Chairman Paul Volcker’s campaign to strengthen and stabilize the U.S. dollar.
By the end of Reagan’s two terms in office, real oil prices had plunged to $27.88/bbl. As Russia does today, the old USSR depended upon oil exports for most of its foreign exchange earnings, and much of its government revenue. The 68% reduction in real oil prices during the Reagan years drove the USSR bankrupt.
In May 1990, Gorbachev called German Chancellor Helmut Kohl and begged him for a loan of $12 billion to stave off financial disaster. Kohl advanced only $3 billion. By August of 1990, Gorbachev was back, pleading for more loans. In December 1991, the Soviet Union collapsed.
President Bill Clinton’s “strong dollar” policy (implemented via Federal Reserve Vice-Chairman Wayne Angell’s secret commodity price rule system) kept real oil prices low during the 1990s, despite rising world oil demand. Real crude oil prices during Clinton’s time in office averaged only $27.16/bbl. At real oil price levels like this, Russia is financially incapable of causing much trouble.
It was George W. Bush and Barack Obama’s feckless “weak dollar” policy that let the Russian geopolitical genie out of the bottle. From the end of 2000 to the end of 2013, the gold value of the dollar fell by 77%, and real oil prices tripled, to $111.76/bbl. It is these artificially high oil prices that are fueling Putin’s mischief machine.
The Russian government has approved a 2014 budget calling for revenues of $409.6 billion, spending of $419.6 billion, and a deficit of $10.0 billion, or 0.4% of expected GDP of $2.5 trillion.
Unlike the U.S., which has deep financial markets and prints the world’s reserve currency, Russia cannot run large fiscal deficits without creating hyperinflation. Given that Russia expects to get about half of its revenue from taxes on its oil and gas industry, it is clear that it would not take much of a decline in world oil prices to create financial difficulties for Russia.
Assuming year-end 2013 prices for crude oil ($111.76/bbl) and natural gas ($66.00/FOE* bbl) the total revenue of Russia’s petroleum industry is $662.3 billion (26.5% of GDP), and Russian’s oil and gas export earnings are $362.2 billion, or 14.5% of GDP. Obviously, a decline in world oil prices would cause the Russian economy and the Russian government significant financial pain.
Over the past 64 years, real gold prices have averaged $544.91/oz (in 4Q2013 dollars), and real crude oil prices have averaged $38.85 bbl. This means that an ounce of gold will typically buy about 14 barrels of oil.
If we fully stabilized the dollar today, we could expect gold prices to fall toward $550/oz, and oil prices to fall toward $40.00/bbl. The huge dollar premiums that gold and oil currently command reflect the value that these easy-to-store commodities have as hedges against dollar instability. If we reformed our monetary control system to guarantee the real value of the dollar, we would eliminate this risk. The risk premiums currently enjoyed by oil and gold would then decline toward zero, as the new monetary system gained credibility.
Interestingly enough, even a decline in world oil prices to $40/bbl would not stop the U.S. “fracking” boom (although it would slow it down).
If crude oil were at $40/bbl, residual fuel oil would sell for about $32/bbl. Right now, spot natural gas prices are only $4.49/MCF, or about $27.00/FOE bbl. In other words, U.S. natural gas prices could rise by 19% from where they are now, before they would hit a price ceiling imposed by crude oil at $40/bbl.
It would not take $40/bbl oil to put an end to Russian adventurism. Even assuming no change in natural gas prices, a decline in world oil prices to $80/bbl would cost the Russian oil industry $120 billion in sales, most of which would have to come out of the Russian government’s fiscal hide. Russia’s foreign exchange earnings would fall by $83 billion/year.
To deal with a fall in world oil prices to $80/bbl (much less $40/bbl), Russia would have to retrench on all fronts. If the Russian government were to resort to printing rubles to try to close the yawning fiscal gap, they would make a difficult situation much, much worse. Capital would flee the country, and their economy would be disorganized by rampant inflation.
Vladimir Putin would have to be lucky, as well as politically skillful, to survive in a scenario like this.
So, if we wanted to drive Russia bankrupt now, what would we do?
All that would be needed would be for Fed Chairman Janet Yellen to implement the reforms contained in Congressman Ted Poe’s monetary reform bill, H.R. 1576. This bill calls for the Fed to name a “date and time certain,” at which time the Fed would stabilize the COMEX price of gold at the market price that pertained at that moment. (Read the bill for the details.)
Facing a situation where dollar appreciation of gold would no longer be possible, but holding costs would continue, gold investors would run for the exits, and gold prices would plummet, taking oil prices with them. The resulting reduction in Russian oil revenues would quickly put an end to Russia’s foreign adventures, and possibly to the Putin regime itself.
Keynesians believe that a weak, falling dollar “stimulates” the economy, but they are wrong about this (like they are about so many other things). George Gilder has it right in his 2013 book, Knowledge and Power.
Gilder writes that a “high entropy,” knowledge-based economy, like that of the U.S., needs a “low entropy” monetary system to carry price signals between people and companies. The Fed’s monetary improvisations over the past 12 years have filled our economy’s principle economic communications network with noise. This monetary noise has interfered with the transmission of the information needed to make optimum economic decisions. The result has been the worst period for economic growth and employment in America’s post-war history.
One element of monetary noise is the distortion of price relationships. Based upon fundamentals, gold is not worth $1,350/oz, and oil is not worth $112.00/bbl. They are worth much, much less than this—perhaps as little as $550/oz and $40/bbl respectively.
Monetary reform would clear the noise out of our economy’s communication channels, and allow the fundamentals of supply and demand to assert themselves. As a side effect, U.S. monetary reform would deprive Vladimir Putin of the revenue and foreign exchange he needs to fund his adventurism.