Why the Saudis Keep Buying T-Bills

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okubow's picture
okubow
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Why the Saudis Keep Buying T-Bills

Why do foreigners keep buying US treasuries?

This question has experts like Peter Schiff and our own, Chris Martenson puzzled.

In his most recent blog post, The Five Horsemen, Martenson states:

"Because of this, I am quite perplexed that the other central banks continue to play along and buy US debt, while the Fed monetizes like crazy and the US government sports a 13% of GDP fiscal deficit."

Peter Schiff has also often voiced his puzzlement over foreign willingness to purchase US debt.

Well I can't speak for the Chinese, Japanese or the tiny Carribean islands now buying $190b to $200b in government securities per month, but I do have some information as to Saudi motives.

Background

In 1973, collective anger over the US' pro Isreal policies, spurred OPEC's Arab members proclaim an oil embargo against the US. The result was a severe decline in the supply of oil flowing into the US closely followed by equally severe price increases. This crisis was by no means minor, and some worried that it could trigger another great depression if something wasn't done.

The US government decided that not only would they need to end the crisis quickly, but they would also need to prevent such a crisis from ever occuring again.

Enter Saudi Arabia

Due to its status as the world's largest producer of crude oil at that time, along with it's influence over other Arab states, and combined with it's poweful position in OPEC, it was decided that US diplomats (both directly and indirectly employed by the government) would have to focus their efforts on Saudi Arabia.

The deal, which according to John Perkins, still holds today, goes a little something like this:

1. The Saudis sell their oil to the US at preferential prices and use their influence to keep OPEC from raising oil prices. Also, if several OPEC members decide to cut production, the Saudis pick up the slack and increase their output.

2. We buy oil from the Saudis for USD.

3. The Saudis take a significant percentage of their petrodollars and use them to buy US securities.

4. The interest on the the t-bills is not paid to the Saudis, instead, it is kept by the treasury.

5. The treasury in turn, takes the Saudi interest (never paid to the Saudis, but kept in the treasury vaults) and pays private US construction companies to build roads, desalinization plants, power plants and other infrastructure in Saudi Arabia. This is completely legal because the interest on the securities is not technically US tax payer money, and therefore, the treasury doesn't have to go through congress to spend it.

6. The house of Saud, the ruling family of Saudi Arabia, gets the military backing of the most powerful military in the world: the US military. As long as they don't launch an attack on Isreal, we've got their backs. If they're unable to quell internal revolts or rebellions or armed seizures of various mosques (1979 Grand Mosque Seizure for example), or should they find themselves under the threat of invasion, the agreement states that young Americans should be asked to risk their lives to preserve their power.

Here is the source of this information:

Ignignokt's picture
Ignignokt
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Re: Why the Saudis Keep Buying T-Bills

Well, that makes sense now.

My aunt is a higher ranking military person.  She was luckily put in charge of a supply depot during the war (luckily). 

I wish I could quote the amount of wasted construction and infrastucture that the military was doing in the area.  But since this has been her life's work I won't.

Billions of dollars have been spent on projects that make absolutely no sense.  Projects that were mandated with the intent to abandon them within 3 months (military personnel leaving that area). 

Under the guise of military spending, we have paid for building up infrastucture and luxury items in the area.  Our tax dollars were being spent on projects that we had no business persuing in that region.  There was absolutely NO logical reason, from any viewpoint that we could conceive, for building shopping areas...movie theaters...huge recreational facilites, in those regions.  Troops were scheduled to leave some areas in less than 90 days and new construction projects were just beginning and scheduled to conclude in 80 days.  10 days of American use and then control turned over to them.  

Our best "theory" revolved around military contracts.  They buy 100 Blackhawks with maintenance contracts, we build a bunch of roads and a shopping mall with a 16 screen movie theater that American soldiers use for a month and abandon over to their countries control when the soldiers leave. 

The bigger picture makes our wasted military construction more logical, in the most illogical way possible. 

I'll try to dig up other sources of evidence to show you, sorry I can't name cities and projects specifically.

Farmer Brown's picture
Farmer Brown
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Re: Why the Saudis Keep Buying T-Bills

Quote:
1. The Saudis sell their oil to the US at preferential prices and use their influence to keep OPEC from raising oil prices. Also, if several OPEC members decide to cut production, the Saudis pick up the slack and increase their output.

Save for the Strategic Petroleum Reserve, which is tiny, the US government does not buy oil.  Oil is often shipped, stored, refined into gasoline, then shipped to gas stations, all through vertically integrated oil companies.  Those would be the big boys: Shell, Exxon, Total, etc.  Oil produced by non-vertically-integrated oil suppliers, i.e., those that only pump it out of the ground, sell it, and let someone else worry about shipping, refining, and retailing, is also not purchased (save for the SPR) by the US government.  It gets sold to private consumers - non-integrated refiners, foreign governments (like mine in Costa Rica, that owns its own oil and gasoline monopoly in the country) etc.  All which brings me to wonder how the Saudis could "sell their oil to the US at preferential prices...".  To the US government?  Really?  The US government is not the sole buyer of oil for US markets, not even close.  This makes me wonder about this entire quote.  

Furthermore, if this was all being done so that the Saudis could "use their influence to keep OPEC from raising prices", then just how exactly did oil get to $150/barrel last year?  Doesn't sound like this quid-pro-quo worked very well, if it even existed at all.

The part about the Saudis "picking up the slack", does have a portion of truth to it.  Supposedly, the Saudis have the largest over-capacity of any oil-producer.  Everyone else is (or was, pre-2008 fall) pumping at capacity, and if they are not, they are pretty darn close.  The Saudis have always been the the little engine that could, in that it could always increase its flow of oil to meet demand.  Whether their hyped up over-capacity is real or not, I do not know, but if there was ever some secret agreement with the US for them to flood the market and cause prices to drop, that sure hasn't worked too well.

Quote:
2. We buy oil from the Saudis for USD. 

3. The Saudis take a significant percentage of their petrodollars and use them to buy US securities.

We don't need some special agreement to force the Saudis to buy UST bonds.  All excess foreign dollar reserves get put into UST Bonds, by definition.  There is no place else for them to go.  They could buy Korean flat screen TVs, Australian yachts, Chinese salad tossers, or Swiss army knives, but each and every one of those sellers, having received the dollars, would then park them into UST bonds.  Eventually, that is the resting place for all foreign US dollar reserves, until they decide to come shopping for US real estate or other assets.

So, there should be no mystery as to why any foreigners "continue to buy UST bonds" with their available excess dollars.  To that question, I ask, what else would you have them do with those dollars?  

Quote:

4. The interest on the the t-bills is not paid to the Saudis, instead, it is kept by the treasury. 

5. The treasury in turn, takes the Saudi interest (never paid to the Saudis, but kept in the treasury vaults) and pays private US construction companies to build roads, desalinization plants, power plants and other infrastructure in Saudi Arabia. This is completely legal because the interest on the securities is not technically US tax payer money, and therefore, the treasury doesn't have to go through congress to spend it.

6. The house of Saud, the ruling family of Saudi Arabia, gets the military backing of the most powerful military in the world: the US military. As long as they don't launch an attack on Isreal, we've got their backs. If they're unable to quell internal revolts or rebellions or armed seizures of various mosques (1979 Grand Mosque Seizure for example), or should they find themselves under the threat of invasion, the agreement states that young Americans should be asked to risk their lives to preserve their power.

As for the last three points, I cannot opine on the veracity.  I suppose all this could be true, but based on the degree of disinformation in the first 3 points, the source cannot be believed (at least by me).

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okubow
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Re: Why the Saudis Keep Buying T-Bills

Farmer Brown,

I really appreciate you taking the time to craft such a detailed response. You've shared some very helpful information and made some very good points which I would like to comment on.


Before I do that, however, I'd like to point out some things that I could have done better in writing this post . . .

"1. The Saudis sell their oil to the US at preferential prices and use their influence to keep OPEC from raising oil prices. Also, if several OPEC members decide to cut production, the Saudis pick up the slack and increase their output."


This is the worst written and most poorly researched point which I tried to bring forward. If I could reword it, I would write:

1. The Saudis use their influence to keep OPEC from raising oil prices, whenever possible. Also, if several OPEC members decide to cut production, the Saudis pick up the slack and increase their output.

My failure to articulate these ideas combined by my misunderstanding of what John Perkins was saying, shouldn't be seen as a reason to completely discredit John Perkins. If anything, just discredit me for failing to summarize his explaination of The US Saudi quid pro quo agreement clearly.

Response to Your Response

Save for the Strategic Petroleum Reserve, which is tiny, the US government does not buy oil.


That's true. When I said the US buys oil, I was referring more broadly to the US market, not the government. Clearly you understand the oil supply chain a lot better than I do, so I'm glad you went on to explain some of that. The point is, the US economy needs refined crude oil to function and a company called Saudi Aramco produces more of that than anyone else. (The company has the capacity to produce 10 million bpd.)

Background on Aramco

Saudi Aramco is in fact a vertically integrated supplier. In 1980 the Saudi government purchased 100% participation interest in the company. In 1984 the company acquired its first 4 supertankers for shipping crude oil. In 1993 Aramco took charge of the Kingdom's domestic refining, marketing, distribution and joint-venture refining interests by buying Jeddah-based Saudi Arabian Marketing and Refining Company (SAMAREC). In 1995 the company completeled a program to build 15 new large tankers for shipping.

Farmer Brown also wrote:

[quote]

"We don't need some special agreement to force the Saudis to buy UST bonds.  All excess foreign dollar reserves get put into UST Bonds, by definition.  There is no place else for them to go.  They could buy Korean flat screen TVs, Australian yachts, Chinese salad tossers, or Swiss army knives, but each and every one of those sellers, having received the dollars, would then park them into UST bonds.  Eventually, that is the resting place for all foreign US dollar reserves, until they decide to come shopping for US real estate or other assets.

[/quote]

This is my biggest bone of contention with Farmer Brown's rebuttal. Perhaps I'm misunderstanding him, but I will give you some examples of what the Saudis can do with their dollars when they don't buy t-bills:"

1984 Company acquires its first four supertankers.

1987 East-West Crude Oil Pipeline expansion is completed, boosting capacity to 3.2 million barrels per day (bpd).
 
1992 East-West Crude Oil Pipeline capacity boosted to 5 million bpd. Saudi Aramco affiliate purchases 35 percent interest in SsangYong Oil Refining Company (now S-Oil Corporation) of the Republic of Korea.

1994 Company acquires a 40 percent equity interest in Petron, largest refiner in the Philippines.

As you can see, they don't "have to buy t-bills." They can invest their profits in expanding production, or trade them for foreign currencies and then purchase equity in foreign companies, purchase foreign bonds, purchase precious metals, buy ferraris, remodel their kitchens go on vacation reinvest them in Saudi Arabia etc. etc.

Everything you said seems reasonable and well founded, but the idea that the Saudis have no choice but to buy US t-bills is totally off the wall in my opinion. Certainly when they trade their dollars for things which are not US securities, the people receiving those dollars will have to put them somewhere, but they're also free to do all of the things that the Saudis can do with their dollars.

To sum it all up, my statement: "The Saudis sell their oil to the US at preferential prices" was flawed. It was the result of a poor choice of words and a misunderstanding on my part. I retract it until I can do some further research. Farmer Brown brought up some very good points and I really appreciate his crituque. I think he has a desire to see that the truth rises to the surface and that disinformation is exposed for what it is. I'd encourage everyone to listen to the John Perkins interview. I may still be summarizing his words incorrectly, but this is not a reason to discredit him. It's just an honest mistake made by someone who is still learning (me).

Orion

PS- Sorry about the blank comments above. I had to remove all of the tags to post this response. The other two were with tags and now I can't delete them. I let the moderator know about it.

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Farmer Brown
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Re: Why the Saudis Keep Buying T-Bills

okubo wrote:
1984 Company acquires its first four supertankers.

1987 East-West Crude Oil Pipeline expansion is completed, boosting capacity to 3.2 million barrels per day (bpd).
 
1992 East-West Crude Oil Pipeline capacity boosted to 5 million bpd. Saudi Aramco affiliate purchases 35 percent interest in SsangYong Oil Refining Company (now S-Oil Corporation) of the Republic of Korea.

1994 Company acquires a 40 percent equity interest in Petron, largest refiner in the Philippines.

As you can see, they don't "have to buy t-bills." They can invest their profits in expanding production, or trade them for foreign currencies and then purchase equity in foreign companies, purchase foreign bonds, purchase precious metals, buy ferraris, remodel their kitchens go on vacation reinvest them in Saudi Arabia etc. etc.

Everything you said seems reasonable and well founded, but the idea that the Saudis have no choice but to buy US t-bills is totally off the wall in my opinion. Certainly when they trade their dollars for things which are not US securities, the people receiving those dollars will have to put them somewhere, but they're also free to do all of the things that the Saudis can do with their dollars.

Hello okubo,

Thanks for the response.  I'm going to leave the whole oil-market-influences of the Saudis aside because quite frankly, it does not interest me that much,  Maybe they do exert influence, maybe they don't.  In the end, while markets can be heavily manipulated, the market truth ends up speaking sometime somehow.

I'd like to address the topic of UST bonds again.  Let's take this step by step:

Saudi's receive hundreds of millions of dollars each day, and billions each month.  They sell +/- 12 million barrels per day.  AT $70/barrel, that's $840 million per day and $25 billion per month.  Doesn't matter if the US is buying all of it or not.  Oil is sold in dollars, so all exports are paid for in dollars.  

What happens to piles of money that big?  The moment they clear into the Saudi banks, there is only one thing that can be done with them and that is put them into US Treasuries.  Let's say they decide to build a pipeline or some oil tankers:

The Saudis will contract all that work out.  They will also avoid, at all costs, paying in dollars.  Why would they pay in dollars, which cost real oil to really be pumped out of the ground, when they can use the Saudi Riyal, which costs nothing?  Furthermore, let's just say they could not get anyone, out of the billions of people in that part of the world, to come work for Riyals.  OK, fine, so they have to spend some dollars.  First of all, those infrastructure contracts and oil tanker contracts are pretty big.  Draws are made at predefined points in the contracts, and in the meantime the money continues sitting in, you guessed in, US Treasuries.  

Then, when the money finally does get paid, I will guarantee you this:  the contractor may have been smart enough to negotiate a contract for dollars, but he sure as hell is not going to pay his workers in USD.  They get Riyals.  So I ask:  what will happen to the millions or billions received by the contractors?  Some will go to some bank to buy Riyals so they can pay their subs and other workers.  What does the bank then do with them?  Treasuries.  The rest the contractor keeps.  Maybe he'll buy some condos in Dubai or play the US stock market.  Someone, eventually,receives them who has no immediate need for them.  They all go into US Treasuries eventually. 

Lastly, you could build one heck of a lot of pipelines, tankers, and apparently cities in the middle of the desert (Dubai) for the kind of money we're talking about.  $25 billion per month!  Now that's a budget I could live with!

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Re: Why the Saudis Keep Buying T-Bills

This is a very interesting video.

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okubow
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Re: Why the Saudis Keep Buying T-Bills

Farmer Brown,

Thanks again. I appreciate your insight and willingness to explain the details of the transactions. I'm more of a student here thany anything else. Just thought I'd share some information which could end up being another piece of the puzzle to someone.

This whole discussion seems to raise the bigger question: is the dollar too big to fail?

Maybe that's a thread for Farmer Brown to tackle?

I'm definitely no economic expert, but the current situation doesn't seem sustainable at all. Seems like the US debt monstor's hunger for more and more debt coupled with the willingness, or as you say, de facto compliance, of foriegners who continue to feed it has locked us all in a race to the bottom. 

Peter Schiff talks about decoupling. Do you think there's any chance of that ever happening? How could it happen when the dollar is the world's reserve currency and all commodities are traded in dollars?

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Farmer Brown
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Re: Why the Saudis Keep Buying T-Bills

Hello Okubow,

Hopefully, we are all students here.  I was drawn to comment on your post because I have thought about the whole foreign UST bond purchases recently and posted about it in two other threads.  Most people look at the decrease in foreign UST bond purchases as a sign they are rejecting them as investments.  My point is that no such rejection is occurring.  Their holdings are decreasing because they have fewer excess dollars due to the global trade slump and most importantly a collpase in US imports (dollar exports).  If you have any interest in reading more about it, the thread is:  http://www.peakprosperity.com/forum/misreading-tea-leaves/25661

I definitely do not think the dollar is "too big to fail".  I do think its fall will take much longer than most people think, and take a course that may surprise many.  The reason is because first of all, we are not talking about the US currency here.  The dollar is, for all practical purposes, the world's currency.  Many people fear a "new world order" and a "global currency".  Guess what?  We already have that - it's called the "dollar".  This entrenchment in the way our very complicated and sophisticated global trade and financial world works makes the dollar a very difficult habit to break.  It's had 70 years to burrow itself into every nook and cranny of our world, and in those 70 years, huge amounts of dollar-based debt has been created - not only for the US government but everywhere.

The other reason  is that despite the US government's incredibly irresponsible, brainless money printing, it is a drop in the bucket compared to the amount of credit destruction that is happening as we speak.  There is an incoming tidal wave of defaults that will make the fall of 2008 look like a Disney movie.  There will be similar default waves in  Europe, Central Asia, the Middle East, Australia, and Asia, not just in the US.  These deleveraging events will force many people to liquidate assets - rapidly and at fire sale prices.  Why?  Because they will be desperate for one thing: cash - specifically, dollars.  They will need to liquidate many assets so they can save a few of them from foreclosure.  I highly recommend these two videos by Steve Keen, who is one of only 12 economists, out of 15,000, that made the right call on the historic crash we are all now witnessing:

It is these upcoming deleveraging waves that I believe will drive the dollar up to unthinkable levels.  Bonds will be dumped at that point - they will be sold below par just to raise cash.  Maybe the Fed or the Treasury will be standing by, (HOW CONVENIENT!) to buy them back at sub-par prices.  True dumping of bonds below par will instantly drive interest rates on new bonds through the roof.

What happens after all that, I would not care to guess.  I think there will be so much disorder, so much ill will against the dollar and the US, that a group of nations will form their own currency, and vow never-again to the dollar.  Maybe a few groups will form a few separate ones, who knows.  And at that point, that is when the world will finally and truly decouple from the dollar and from America.  

My 2 cents. 

plato1965's picture
plato1965
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Re: Why the Saudis Keep Buying T-Bills

Two interesting videos...

Rollover - Scary Currency armageddon -

An islamic version of Ron Paul.. - 

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plato1965
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Re: Why the Saudis Keep Buying T-Bills

 http://www.telegraph.co.uk/finance/economics/6819136/Gulf-petro-powers-to-launch-currency-in-latest-threat-to-dollar-hegemony.html

No mention of a gold dinar / silver dirham .. yet.....

plato1965's picture
plato1965
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Re: Why the Saudis Keep Buying T-Bills

It's the flow, stupid!

http://fofoa.blogspot.com/2010/10/its-flow-stupid.html

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Abbey
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Re: Why the Saudis Keep Buying T-Bills

The point is while there is no exact answer, the world economy will likely suffer greatly along with the US. The same thing would happen if China and Japan would start unloading their debt. Niagara Falls Hotel

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kamranayyub
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I agree as the economy is

I agree as the economy is facing slump andmay be this is the reason.

وظائف في جدة

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