The Secret History of Oil and Money - Part 4

Last time we saw that a series of events had managed to move the power from the oil companies to the oil producing states via OPEC. They used that power first to get an increase in the price in 1970, and then increase it again and add an embargo in 1973. We also saw that in 1971, the amount of Eurodollars floating around caused the U.S. to sever the ties to gold and let currencies float. This meant that there was no limit on the money that could be printed to pay for the oil. The problem was that the money represented real claims against the West. With the increase in price, there was no way the West could sell anything to these essentially undeveloped countries to balance out the money they had to pay to get the oil.

The owners of the oil, everywhere in the world, were four times as rich after Tehran; soon they would be ten times as rich. 

The West Germans, the thrifty, hard-working West Germans, had gone to the office and the factory, and hammered and blowtorched and bolted, and they had infested the world with their Beetle Volkswagens, their machinery, and their chemicals, and they had earned, by 1975, a surplus of $40 billion.  

And the Japanese, with their beehive cooperation, had gone to the factory early in the morning and sung "Hail to Thee, O Matsushita," the company song, and done their group calisthenics, and hammered and buzzed around and swamped the world in television sets and stereos and cameras and little cars, and after years of work they were on their way to multibillion-dollar surpluses.  

The United States and Britain and Italy didn't have any such surpluses at all (though the United States did have the long-term investments from its key-currency heyday). And now, suddenly, one country—one family—had an exchange surplus of $60 billion! Without even working!

While sitting in a gas line, Smith ponders the question asked by the Hungarian banker - if the price of oil had quadrupled, where do we get the money to pay for the oil that we need?

First I thought, This gas line is burning up a lot of gas just trying to get more. Then: How do we pay for the oil quadruple? That is, we, the United States? Well, we could sell something to the Arabs. What are we good at growing or making and selling? Aircraft, wheat, soybeans, maybe some high-technology equipment. Now, what are they buying? Who's in OPEC? We can forget Gabon and Ecuador and Qatar—not significant. Who are we talking about? Iraq: cross off, no relations with them. Libya, Kuwait, Saudi Arabia, Iran. Libya: fewer than 2 million people. Kuwait: fewer than 300,000. Saudi Arabia: 6 million. Small countries. Don't have big airlines. Sell a couple of 727s, a 747 or two; that's about enough oil for ten minutes of gas lines. Wheat, soybeans—small countries don't eat much; we have 120 million cars, each car is sitting in a gas line with its motor running; you could sell all the wheat and soybeans Libya, Kuwait, and Saudi Arabia could eat and only move the whole national gas line one block. Less. Maybe thirty feet. Of course, Iran ... 33 million people. Shah—aircraft? A couple more airplanes, a little more wheat—aircraft, arms. We could sell arms to the Shah. 

But not enough to the other folks. No, what we will buy the oil with is dollars, because the world takes dollars, trades in dollars. And the oil folk will have the dollars, and then they can come and buy what they want. But nobody realizes the scale. Let's just say we pay the import price for half of the oil needs, at let's say, $10 a barrel, carry the 3, times 365 days in the year; my goodness, in one year OPEC could have $100 billion extra, maybe $200 billion soon, then they could come and buy half of the stocks on the New York Stock Exchange, almost half. And that's only one year. The next year the 120 million cars are back at the gas pump, and OPEC has another $100 billion, and they keep piling up those claim checks until they can buy the whole New York Stock Exchange. They keep the claim check, and we move the cars around. We are going to sell America for a product that burns up in the atmosphere. We will be a colony...

The triumph of the Club is something quite unparalleled in history. When else was there such a transfer of wealth? When the Spaniards brought back the gold and silver of Peru? When the British raj (sic) ruled India?

Smith discusses a rumor that Nixon actually wanted the price of oil to go up. Why? To arm the Shah of Iran and keep the Middle East in balance.

Nixon and Kissinger stopped off in Iran on the way home from the Moscow summit in 1972. What they saw was a dangerous situation. The British had withdrawn from the Persian Gulf at the end of 1971; the United States was still involved in Vietnam. There was a power vacuum in the strategic Middle East. The Shah could take it over and would get the arms to do so.  

How would the Shah pay for the arms? By raising the price of oil. No American Congress would have voted billions to arm Iran, it was thought, while troops were still in Vietnam. James Akins reported that the Saudis were worried both by the Iranian buildup and by the prospect of a high price for oil, which they thought would damage the stability of the West, on which their bank accounts and survival depended.

Smith ultimately discards the theory:

If a quadrupled oil price was the cost of arming the Shah, it was one of the most expensive blunders in history. The scale of the transfer of wealth is hard to comprehend, and in this instance the arithmetic makes no sense. If $90 billion a year sounds silly divided into orange juice, it does not make much more sense divided into F-14s...the West could transfer to OPEC one air force, one navy, and still owe $100 billion every year.

The Western industrial economies now had the worst of both inflation and recession. Normally inflation is caused by an overheating economy, not one where people are worried about their jobs and how to pay for things.

The higher oil prices acted as a fiscal drag, a tax. Higher prices for oil meant higher prices for fertilizer and plastics as well as gasoline and heat. If your gasoline bill and your heating bill and your food bill went up, you might defer buying a car; then the automobile manufacturer laid off  some workers, who in turn cut back on their own purchases. The recession of 1974-75 was the worst since the Depression of the 1930s.
And at that same time, inflation went up sharply. In the United States direct and indirect energy costs amount to 10 percent of pretax household income. A 100-percent rise in energy costs meant 10-percent inflation, all by itself. Not all the energy was oil, and not all oil came from the Middle East; but the price of OPEC oil had just gone up 400 percent, and the OPEC price became the world price.

In those days, unions still had power. As gas prices rose, unions demanded wage increases to compensate. Workers did not want to take the hit to their disposable incomes just to get to work. Employers granted the wage concessions, but raised prices to protect profits. This increase in prices caused the unions to once again demand higher wages and so on. A feedback loop was created, sometimes called a wage-price spiral. 

Unions were unafraid to go on strike when their demands were not met, leading to disruption of everyday life. The garbagemen went on strike in New York city causing garbage to pile up and fester in '68, '74 and '81. Coal miners went on strike in England, crippling the economy and leading to the introduction of rationing and a three-day workweek in 1974. This led to the changing attitudes toward unions during this period. Unions, once seen as stalwart defenders of the Middle Class, were seen as causing major inconveniences to the public, and the public mood turned against them. Corporations saw this as an opportunity and unleashed a relentless barrage of anti-union propaganda, playing up their ties to organized crime and depictingthem as corrupt anachronisms that defended lazy workers.

A series of radical energy conservation measures were adopted. Vehicle fuel economy standards were raised. Building efficiency standards were raised; insulation was mandatory. Travel went back to necessity only. The Strategic Petroleum Reserve was created, as was the International Energy Agency (IEA). Government studies looked at energy conservation measures and renewable energy. The speed limit was lowered to 55 MPH and Daylight Saving Time was introduced. For the first time ever, demand for oil fell. The oil usage in 1973 would not be seen again for a decade.

Americans did their part too. Solar "cheese wedge" houses spring up and people turned to the Whole Earth Catalog. The first commercial photovoltaic sells were sold and people experimented with wind energy. American consumers bought small fuel-efficient Japanese cars instead of American gas-guzzlers (the Japanese had no oil reserves and thus had to be efficient). This began the decline of the American automobile industry.

America was dealing with the energy crisis, but it was about to get a whole lot worse. In 1979, the Shah of Iran fell in a revolution led by the religious leader Ayatollah Khomeini. Iran became a theocracy hostile to the West. The American embassy staff was held hostage. Iranian oil production fell from 6 million barrels to 1.2 million barrels, a loss of 4.8 million barrels.

But the loss of oil was not the major problem - the problem was the wave of speculation on the markets caused by the unexpected loss that drove up the price of oil. Normally, oil is traded in a complex series of futures contracts. But there is also something called the spot market. Prices are settle in cash on the spot based on current values as opposed to forward prices, and delivery is expected within a month (Investopedia). In other words, it is immediate oil for short term needs. And by 1979, there were no cusions anymore, so the spot market became the go-to source.

As more and more countries went to the spot market to get oil, speculation drove the price up. The fear of further disruption spurred widespread speculative hoarding. Seeing the higher prices offered, oil sellers went to the spot market to sell in order to take advantage of the higher prices. To deal with this, OPEC raised the price of oil to the spot market price, causing another price shock.

Until the Shah fell, there was a modest surplus of oil in the channels of the world. Higher prices had forced some cutback in demand, and there was additional oil from Alaska and the North Sea. OPEC watchers noted that the cartel was getting less real money, because the Western currencies were depreciating faster than the oil price was going up.

But Iran was among the large producers, at 6 million barrels a day, and when the Shah was deposed, production from Iran's oil fields dropped to a fraction of the previous totals. That missing 6 million barrels a day was enough to create a shortage again, and the scramble resumed.

In the oil trade the "spot" market is called "Rotterdam," because oil can be bought, on a daily basis, from the huge tankers anchored in the Rotterdam harbor. The "Rotterdam" market, though, is all over the world. It is really the Telex through which the trades are made...The Iranian shutdown had made supplies tight. The Israelis and the South Africans could no longer buy Iranian oil, and they were looking for oil wherever they could find it. The Italians had only two weeks' worth of supply in the tanks, and the Spaniards and the Swedes were also low.

The new Iranian regime, with no loyalty to the old contracts with the Seven Sisters, began to sell to the "spot" market. On Monday, May 14, 1979, the Iranians sold oil at $23 a barrel, above the posted OPEC price of $13.34. On Tuesday it was $28. On Thursday it was $34. Ironically, the Seven Sisters were among the bidders; a subsidiary of Texaco secretly made a deal for 2 million barrels at $32. At Kharg Island in the Persian Gulf, there was the usual long line of tankers waiting to take on Iranian oil. The tankers with long-term contracts were told to stay anchored. (They were paying, incidentally, $35,000 a day in parking fees.) The tankers with "spot" contracts went right to the head of the line.

Not surprisingly, the "spot" market began to attract the oil. American oil companies with refined oil in the Caribbean began sending it to the "spot" market, seeking to maximize profits. The price in the "spot" market went as high as $42 a barrel.

Other OPEC nations pulled some oil from long-term contracts and sold it in the "spot" market. Some of the OPEC nations saw the dangers. OPEC was losing control! Libya and Algeria broke the $23.50-a-barrel ceiling set by the cartel. "Prices are out of control," warned Ali Khalifa al-Sabah, the oil minister of Kuwait. OPEC was breaking apart, but on the up side. No one had thought of that.

At the Department of Energy in Washington, officials totted up supply and demand. There should have been an excess of a million barrels a day, so why were prices going up?" The spot price reflects uncertainty, not shortage," said one analyst there.

The First Oil Crisis, in 1973-74, took oil from $2.69 to $11.65 a barrel, about a quadruple. The Second Oil Crisis, following the arrival of the Ayatollah Khomeini, produced roughly a double, to about $28 a barrel in 1979.

The Club was keeping up the game that worked so well: Leapfrog. Cut back the production, and supplies will be tight. Cut back the deliveries, and the oil consumers who can't get oil will go to the "spot" market, which is relatively small compared to the volume of world oil. The price in the "spot" market pops up. Then you say, well, that's the true value of oil, and you call a meeting of the oil ministers and move the OPEC price of oil up toward the "spot" market price. But if the "spot" market moves down again, you don't move the official price back down, because now you have a new long-term OPEC price. And you have room to do this because, taking OPEC as a whole, you need only 22 million of your 30 million barrels a day to pay your bills. The other 8 million barrels are "discretionary," and you can mess around with them, shut in some of them if necessary. Yet Leapfrog was not designed by OPEC ministers; they merely followed political events and took advantage.

Instead of Eurodollars, the world now had to worry about Petrodollars, since oil was denominated in dollars. Where would all those dollars go? They went into Western banks, by-and-large. But with the world in recession due to high oil prices, to whom could banks lend all that money to? Finding uses for all that money was termed Petrodollar recycling.

This problem is called Recycling the Petrodollars. The connection between the Sauds and the Rockefellers is that the Saud family puts its money in the Rockefeller family bank. Then the Rockefeller family bank lends the money around the world, sometimes to the people who need more money to pay the Saud family the new price of oil. Gertrude Stein said once that the money is always the money, only the pockets are different.
If the oil consumers could sell enough to the oil producers, the trade would come out even. If the Kenyans could raise the price of their coffee enough to pay for the increased price of gasoline and fertilizer, and the Saudis would drink enough coffee at the higher price to match that, no problem. But there aren't enough Saudis to drink that much coffee at any price. As we've seen, the oil producers who are "low absorbers" can't buy enough to make up for all the petrodollars they've suddenly earned.  

Ordinarily, oil should be a commodity like any other. But the current scale of the oil transfers, sent through the banks, creates more money.  

A higher price for oil sucks money out of an oil-consuming country. That country then has less money to spend for cars and apples and gasoline. Less money, less activity. recession, unemployment. Deflation—the oil price increase acts like a tax. In the oil-consuming country there is less money; in the oil producer there is more. So far it balances.  

Things being what they are, the tendency is for the oil consuming country to print a little more money to ease the pain of recession. That's politics, not economics or banking. Sending out real assets for the oil means very hard work. The central banker himself may want to tough it out, but the prime minister is already under attack by the labor unions and the parliament is restive.  

The oil producer still has the money paid for the oil, though, and doesn't need it. Into the bank it goes. Now the bank has a deposit, let's say, just to reverse all that OPEC gigantism, of $100. The Federal Reserve says that bank has to keep 10 percent deposit as a reserve. You walk in and borrow $90. You put that money in your checking account; now it's a deposit there, and your cousin Charley can walk in and borrow $81, because that fractional reserve is set aside each time. Your cousin Charley deposits his loan in his checking account, and the bank lends $72.90 to the next borrower. That's the way the multiplier works, and it keeps on going. If the Federal Reserve wants more money in the banks, it lowers that fractional reserve, so that you can borrow and your cousin Charley can borrow $85.50 instead 1. If the Federal Reserve wants there to be less money, it raises that fractional reserve.  

Question: What's the multiplier in Euroland? Theoretically, it's infinite. The Rockefeller bank of Euroland gets an OPEC deposit of $100, and it can lend the whole $100 to you; and when you deposit the $10U in the Deutsche Bank Luxembourg, that bank can lend the whole $100 to your cousin Charley, who puts it into the Banco d'Espagna of Euroland, and so on, so the original OPEC $100 gets quite a bit of mileage.
243-247

It turns out that what they did with the money was loan it out to Third-World Countries for development. That's right - the Third World Debt crisis you heard so much about a few years ago from the likes of Bono et alia had its origins in the massive influx of petrodollars into Western banks at a time of stagnant economies and high inflation:

Ironically, the struggle after 1979 to limit inflation by raising interest rates created a problem for the policy's instigators, the financial institutions, because it created a gulf between the amount money could earn if invested in a typical productive project and the rate of interest the entrepreneurs behind those projects were being asked to pay. Moreover, because the interest rate rise had produced a recession, very few of the institutions' domestic customers wanted to borrow anyway, except, as we have just seen, to pay their interest bills or to stave off collapse. The banks' problem of what to do with their funds was compounded because, as a result of the oil price rise, most OPEC countries had more money than they knew what to do with, having moved from having a small balance of payments deficit of $700 million in 1978 to a surplus of $100,000 million in 1980. Much of this money had been put in British and American banks on deposit.

To find a home for the OPEC cash as well as their own, bankers literally packed their suitcases and flew to the Third World. During a meeting of the Inter-American Development Bank in Madrid in 1981 senior bank officers queued up to offer funds to the man in charge of Mexico's borrowing as he lounged in an armchair at his hotel. A year later Mexico had borrowed so much that no-one was prepared to lend it more to repay old debts as they became due. It threatened to default, alerting the world the crisis the banks had created.

The bankers offered money to potential Third World borrowers at a price based on     based on the London interbank offered rate (LIBOR) plus 1 per cent. This meant that, if world interest rates increased, the rate of interest payable by the borrowing country did as well. It was a lazy man s way ot doing business because it made it impossible for borrowers to calculate the return they had to get from the projects for which they wanted the loans and the risk they were running by taking the loans on. However, the bankers thought their interests would be secure whatever happened to their borrowers' projects and rarely investigated them thoroughly. What mattered was that their profits in the  current year would be satisfactorily increased by the fixed margin they creamed off the top of the loan as a charge for agreeing to grant it. As for the future - well, as one banker, Walter Wriston, said at the time, countries don't go bankrupt, do they?

A factor that added to the banks' dangerous complacency was that they had done some Third World lending to recycle Middle Eastern funds after the 1973 oil price shock. These had generally worked out well, largely because the prices of the commodities exported by the borrowers had increased at an annual rate which exceeded the rate of interest being charged. In other words, there was no overall change in the relative wealth of borrower and lender throughout the period. The debt/export ratio had stayed constant and there was a net inflow of funds to most developing countries.

In the early 1980s, however, the deliberate contraction of demand in the United States and the EC caused commodity prices to plunge while the interest rates the producing countries had to pay were kept high, Consequently, rather than the wealth of both parties increasing in step, as had happened previously, money - or rather, claims on money - flowed from borrower to lender each year between 1981 and 1986 at a rate equivalent to interest at 20 per cent. As a debt doubles every 3.5 years at an interest rate of 20 per cent, the inevitable result was that these countries' ratio of debt to GNP tripled by 1987, although almost no new money was lent.

After the debt crisis became public in 1982 the value of the banks' Third World loans was gradually written down, involving them in showing huge losses. At the time of writing (1993), however, debtor countries have still not been released from their obligation to pay the full amount due, although some have been able to buy up some of their debt at a big discount on the secondary market where it was sold by smaller banks anxious to get cash for a very doubtful asset.

Richard Douthwaite; The Growth Illusion, pp. 67-68

Oil prices went up by a factor of ten in a decade. Right now the price of oil is about $45.00 a barrel, relatively cheap. Imagine looking at $450.00 a barrel oil in less than ten years and ask yourself what that would do. By 1981 unemployment was up over 10 percent and the economy was worse than at any time since the Great Depression. Unfortunately, it is here that Adam Smith's narrative stops. 

The Secret History of Oil and Money - Part 3

The Fall of Bretton Woods and the rise of Paper Money

To understand the background of the situation, you have to remember that the United States went off the gold standard in 1971 leading to the age of “Paper Money,” the main topic of Smith’s book. Today we might say “fiat currency.” The 1971 oil price spike certainly played a role.

When countries want to trade with each other, they need a common medium of exchange. If France and Britain trade, they can’t use French Francs or British Pounds because each would be worthless in the others’ country. What they use is precious metals. Gold, historically, but silver too. Neither of these is valuable in and of themselves, only that the other desires it. Historically, the country with the most gold can raise the biggest army.

However trade in gold has rarely been by exchanging gold coins or bars. Gold is very dense, denser than lead in fact; a bar of gold is heavier than a bar of lead the same size. Hard to transport. Plus you need to guard it constantly against thieves. You want to keep it in a vault. Small-scale trade may have taken place by gold and silver coins changing hands, but it was mostly limited to face-to-face transactions.

For example, consider the island of Yap in the South Pacific. The islanders used stones with holes in them to trade. The bigger the stone, the more valuable it was. Some stones were so big they were hard to transport, so they just transferred ownership “virtually” without actually moving the stones themselves. One stone even ended up on the bottom of the ocean during transport. Since the stone still existed, ownership of the stone on the sea floor circulated among the people as a medium of exchange, even though no one would ever be able to access it in real life. Gold and silver in Europe were much the same.

So in reality, trade in gold has always been virtual. It’s done via pieces of paper, letters of credit, guarantees, bonds, and so forth. It's much easier to use a currency than actual gold, as long as both parties value it.

The key currency is what the world uses as its denominator. The world has been used to saying, "How much is that in dollars?" When we talk about the dollar, we have an emotional involvement that goes beyond the denominator of the System, because this key currency is our currency, what we walk around with in our purses and wallets. 

Let's start with an easy example. The Saudis have sold a lot of oil. They want to build an industrial plant at Jubail, so they ask for bids. The South Koreans come in with the low bid. They send a whole army of workers to Saudi Arabia, who live in dormitories and work like beavers. They bring steel and valves and instruments and piping and plastics, and they put up the plant. Japanese ships bring the goods. The Saudi currency is the riyal. The Korean currency is the won. The Japanese currency is the yen. What do the Koreans get paid in?

The answer is none of the above. The Koreans get paid in dollars. The world trades in dollars. The dollar is the key currency. The deal may be between the Saudis and the Koreans—and this happens to be a real example— and the transfer may take place between the Saudi banks and the Korean banks—or it might go through London or Tokyo—but it is denominated in dollars. Everybody knows what a dollar is, though they argue about what it is going to be worth. And because the transaction is in dollars, sooner or later it has to end up on a ledger in New York.

...there is a whole world out there trading in dollars, banking dollars, investing dollars; and those dollars could ultimately be a claim upon us. Not only could they be used to whisk away the apples and computers and textiles we are about to reach for ourselves, but they allow the holders of those dollars to voice irritation about the state of the dollar.  And not just irritation. OPEC says, "You let the dollar go downhill, we have a lot of dollars in our savings account, we're going to raise the price of oil just to stay even." Then everybody who buys oil gets mad, not just at OPEC, but at us. Because with the oil price up, we have a bit more inflation as the cost is passed through, and the dollar goes down some more, and the price of oil goes up again--a disagreeable cycle. (pp. 111-112)

What are the characteristics of a key currency?

A key currency country has to have the same characteristics as a bank. Essentially, the nation acts as sort of a bank for the rest of the world. A bank with an army. What are these characteristics?

The first is safety. That's first. If you think you won't get your money back, you'll keep it in a mattress instead. "Safety means the bank still has to be there. The country has to be politically stable. A big bank account in Havana in 1958 doesn't mean a damn thing in 1960. So the country has to have solid institutions, a respect for law so that buyers of the key currency don't find the rules changed...That's why American banks advertise, 'Accounts insured to $100,000.'" (p. 113)

The second is liquidity. This means the an ample supply of money and the ability to turn assets into cash. "When you put your money in the bank, you want to be able to get it back when you want it. You don't want to be told 'Fill out this form and wait sixty days.' In other words, you want the bank to have the resources on hand so that you're not tied up...And the country has to protect the value of its currency both at home and abroad. The money has to stay worth what its worth. for that it needs a healthy economy, with economic growth and price stability. This will give it liquidity."(p 113-114)

The third is yield. "[T]he use of money is worth something, so you want to interest, rent on the money...the yield will be taken care of by the supply of, and demand for, the currency. A higher rate of interest might make up for some decline in the currency. Supply and demand in the contemporary world come not only from the marketplace but from the government's bank, the central bank, and that bank must inspire trust." (p. 114)

Pegging a currency to a precious metal doesn't make it a key currency, but it helps to restrict the printing of paper money, because the amount of metal is finite, and thus it might be one sign that some faith in the currency will be kept. But the South African rand is partially backed by gold, and no one deals in it who dies not have to; it is too subject to controls or restrictions. The Swiss Franc and several other European currencies have some gold backing, and there is some devotion to keeping these currencies stable, but Switzerland is a small country, without military or political influence. The world is so hungry for something to denominate in, for something to be the key currency, that the Swiss, with a stable franc, have taken in money from all over the world and profited by handling it. But there simply aren't enough Swiss francs to finance the world's trade. (p.119)

Back in 1717 the British Master of the Mint, one Isaac Newton who also dabbled in science and mathematics, declared that English currency would be worth a specific amount of gold. This meant that British money became a key trading currency because it held its value. Because it could be exchanged for gold, it could be exchanged for what you actually wanted instead of gold because other people had faith in it. Thus trade in British currency took the place of precious metals.

 "As Master of the Mint, he said that one guinea, that is, 21 shillings, would be worth 129.4 grams of gold, and thereby he said, We intend this currency to hold its value, and thereby he created a key currency Almost....you need more than precious metals to have a key currency; you have to want to be the Bank, and history has to give you a place so that you can be the Bank. In the eighteenth century, traders around the world sent money to London, to be held in "sterling," which is what the British currency came to be called....For part of British financial history, sterling was fixed in terms of silver; 11 ounces, 2 dramweight of silver was 20 shillings thruppence." (p. 114)

There were two instances in that long history where the British suspended the convertibility of the dollar, one to fight Napoleon, and one to fight the Kaiser (World War One). The British needed to come up with a lot of money to fight those wars, so the convertibility was suspended. By the way, in order to not be in debt to banks, Napoleon financed his military exploits by selling the Louisiana Purchase to the United States.

After Waterloo, sterling met every test of a key currency. The government was stable, the institutions honored and intact. The Royal Navy sailed the world; trade followed the flag. Britain was first into the industrial revolution, so its manufactured goods spread over the world. The battles were always at the fringes of the empire. 

Every time there was a small crisis about the pound, the monetary authorities would raise the interest rates sharply. That might depress the domestic economy, but the high interest rates would draw in foreign exchange, and the pound would retain its value. Britain bought the raw materials, the commodities, and sent back the manufactured goods; and since the price of raw materials gradually declined, the pound increased in value.

The British government issued "consols," perpetual bonds. Fathers gave them to their sons, and those sons gave them to their sons, and the bonds actually increased in value as time went on. "Never sell consols," said Soames Forsyte, Galsworthy's man of property.

The world brought its money to London and changed it into sterling. London banked it and insured it. Cartographers colored Britain pink on world maps, and the world was half pink, from the Cape to Cairo, from Suez to Australia. In 1897, at Victoria's Diamond Jubilee, the fleet formed five lines, each five miles long, and it took four hours for it to pass in review at Spithead. British capital went everywhere....(p. 116)

It was this currency that bound the world together in trade, particularly the North Atlantic, for a few hundred years. It was used instead of gold, which was a lot easier. It was the “denominator” used in world trade. Trade was denominated in the Pound Sterling. England would never be out of debt for the next two hundred years.

Now, a word about “defending” currency - keeping its value (i.e. purchasing power) high. It all has to do with supply and demand.

If you raise the interest rate attached to a currency, you increase the demand for that currency, as people will want a higher interest rate. People don’t buy currency, they buy bonds denominated in that currency, so a higher interest rate will increase the yield, one of the big three attributes of a key currency as we saw above. A higher interest rate (in let's say in the U.S.) compared to another country's rate will cause the dollar's value to appreciate against that second country's currency (let's say the Euro).

An investor can borrow money in Euros at a lower rate and then buy US dollars and invest in a higher return investment. Since everyone is selling Euros and buying dollars, there is a higher demand for dollars and consequently the price of the dollar goes up. That's called a carry trade. Higher interest rates in the U.S. attract foreign direct investment, which means that foreign investors have to buy dollars in order to invest in the U.S. This also increases demand for the dollar and this increases the spot rate relative to other currencies.

Higher dollar value relative to other global currencies makes imports relatively cheaper but exports relatively more expensive to foreigners, hurting exports overall. Higher interest rates also decrease the amount of loans, slowing down the economy.

Why would the Fed want to keep interest rates low and consequently the dollar lower? If the dollar is cheap, its products are cheaper and thus it can sell more exports which means American companies and by extension the economy, get more business. Low interest rates are typically used to stimulate and economy by enticing people to take out loans. But as we saw above, if the dollar's value went down, because oil is sold in dollars, the price of oil went up to compensate. More dollars means that each individual dollar is worth less. Increase the supply and the demand goes down. More dollars also means less inflation, as more dollars compete for goods and investment opportunities.

So lower interest rates lower the relative value of a currency, but stimulates the domestic economy. More exports, cheaper loans. No inflation. So the theory goes.

You can avoid this by “pegging” a currency, for example saying that one dollar gets you 40 rupees (or whatever) no matter what. Thus, the ratio always remain the same and fate of the two currencies are linked. The Chinese used to do this with the dollar, ensuring their exports would always be cheap no matter what the dollar did.

That said, let’s move on.

The sun would eventually set on the British Empire, as economic gravity shifted to Germany and the United States. The expense of the war doomed the British currency. Eventually, it could no longer defend it and had to let its value fluctuate, that is, "float."

In 1931 the British let the pound "float"; they abolished its convertibility. It was not pegged to gold via a fixed exchange rate, and on any given day it would sell for whatever buyers and sellers agreed on. The international monetary system collapsed. There was no key currency. Trade died. In the United States a quarter of the work force was unemployed. For two hundred years it was the pound that was supreme. The Bank of England stood for riches and power. In the Depression the world broke up into blocs, and each bloc tried to gain an advantage by depreciating its currency so that it could increase its exports and put its people back to work. That game is called beggar thy-neighbor, and it was a disaster. (pp. 117-118)

This, coming in the wake of thee 1929 Wall Street crash, led to ten years of Depression.

Now, the causes of the Depression are in dispute. I would argue that the oversupply of goods compared to what people could actually buy due to things like the electrification of the production line, meant that you needed to dump goods somewhere else, that is, export them. But everyone was in oversupply, and everyone needed to dump their excess goods somewhere to keep the production lines moving and enough people employed. So you get every country simultaneously trying to weaken its currency and countries trying to restrict imports (e.g. the Smoot-Hawley tariff). This "trade war" brought down the currency regime, including confidence in the pound.

After the war, it was decided that the world once again needed a medium of exchange to rebuild. Since the U.S. had loaned all the money out to the allies, and it’s industrial base was untouched, it collected its debt in gold and printed enough dollars to help the world rebuild.

In 1944 the finance and treasury ministers of forty-four countries met at the mountain summer resort of Bretton Woods, New Hampshire. And all the currencies were set in a fixed relationship. If you were a central banker and you brought $35 to the United States, you could have an ounce of gold. (Americans could still not own gold.) All the other currencies were pegged to the dollar.  

The dollar met all the criteria of a key currency. The United States honored its obligations. It had military and political power, its institutions were stable. It had every opportunity for economic growth and price stability. And there was an even more overwhelming criterion: there wasn't anything else. 

Pegging a currency to a precious metal doesn't make it a key currency, but it helps to restrict the printing of paper money, because the amount of metal is finite, and thus it might be one sign that some faith with the currency will be kept...The nations that met at Bretton woods wanted to avoid the currency wars of the 1930s and to have cooperation. Out of the agreements at Bretton Woods came the international institutions of the System: the International Monetary Fund, to govern international monetary relations; the International Bank for Reconstruction and Development, to rebuild the world; and the General Agreement on Tariffs and Trade. (pp. 118-119)

By 1958 the System was so successful that trade was booming, all the major currencies were convertible into each other, and the dollar was better than gold. Better, because why bother with gold? If you really wanted it, you could turn dollars in for it; but gold is sterile, it earns no interest, you have to pay storage charges on it. It was dollars everyone wanted. Now it was the American Navy that prowled the world. American banks with all the flags in their foreign capitals, and American companies that owned, worldwide, the nickel mines and auto parts plants.

...Economists worried about a "dollar gap"; how would the world get enough dollars to trade? It seems a very long time ago, but in the 1950s the United States was producing half of the world's oil, half of its automobiles, and 40 percent of its industrial output...(p. 120)

It turned out this wasn't a problem. The dollar’s status as a reserve currency led the demand for dollars, as did balance of trade deficits. The Marshall Plan sent millions of dollars to Europe after the war to rebuild. Americans traveled abroad and spent dollars. American companies opened subsidiaries abroad. People changed money into dollars, since every currency was pegged to each other. The proliferation of dollars meant that when people changed dollars into their local currencies, the foreign banks had to print enough to cover the difference – the U.S. was exporting a bit of inflation. The foreign banks would then use those excess dollars and buy U.S treasury bonds. The U.S. Treasury would take the dollars back, giving an lOU—a bond—and a promised date for repayment. That financed the deficit.

If other countries needed dollars, they had to export enough to earn them. The U.S. just had to print them. Eventually, many of these dollars became Eurodollars.

A Eurodollar is simply a dollar-denominated account at a bank outside the United States They apparently began when a Russian banker moved his money out of Rubles (which nobody wanted) into dollars in a Soviet-controlled bank with a British charter during the Hungarian uprising in 1956 for safe keeping. The dollars were later loaned out.

As we saw, central banks and governments can regulate the amount of currency via interest rates, tax policy, etc. Because these dollars were located outside the United States, they could not be regulated by the Federal Reserve board or the banks, meaning that the Eurodollar market could operate on narrower margins than banks inside the United States.

International bankers loved Eurodollars, and they began to proliferate. They tended to move offshore banks like the Bahamas and the Cayman Islands, where not only could they escape banking regulations, but also the taxing authorities. The Eurodollar market expanded as a way of avoiding the regulatory costs of dollar-denominated financial intermediation. (Investopedia)

All these Eurodollars were a problem. There simply wasn't enough gold in the United States, or maybe even the world, to cover them all! Too much money had left the United States, the demand for dollars was just too great. Because of higher oil prices, more and more people were showing up at the "gold window." Heading them off that the pass was the safe option, and that's exactly what happened:

In August 1971 the United States Treasury stopped selling gold for dollars altogether. The potential claims on the gold were too great. The claims, from overseas, were in the form of a curious currency called the Eurodollar, which was simply a dollar abroad. Brought to the United States, it was like any other dollar, except that in foreign hands it could be presented for gold...There were too many dollars for the gold; everyone could see that if the Euro holders all cashed in their dollars. Fort Knox would be bare in a day ...When the United States cut the tie between the dollar and gold, the key currency no longer had any kind of backing in a precious metal....The neat, classical world devised in 1944 at Bretton Woods had had the dollar as its centerpiece, gold at $35 an ounce backing the dollar, and all the other currencies fixed in their relationship to the dollar. Now that system was coming apart. (pp. 121; 129)

So what to do now? The major countries tried to patch up the system, to no avail.

The ten leading industrial countries met at the Smithsonian Institution in Washington. They tried a replay of Bretton Woods: a higher price for gold, a devaluation of the dollar, and new fixed rates for all the currencies. But the fix did not even last for eighteen months. During the period of the fix, the world's money suply took another flip upward...More yen, more marks, more everything, in fact...One by one, the world's central banks peeled out of the fixed-rate relationships. The exchange rates floated everywhere. A dollar was worth, on any given day, what the buyers and sellers said it was worth.

"When we left the pound, we could go to the dollar," said Jelle Zijlstra, then of the Bank of the Netherlands. "But where could we go from the dollar? To the moon?"  (p. 129)

Such was the situation in 1971, when the oil prices started their upward climb. Going back on the gold standard presented several problems:

Gold...was reality, a brake on printed money. Alas, in the 1970s ...the crises came; the markets went down and gold went up twenty times and can go anywhere that fear and paper money will take it. Keynes called gold "a barbaric relic"; he believed that rational men could conduct their affairs rationally. Western industrial governments have not been enamored of gold as a standard because it is too confining; it gets in the way of their programs and benefits the two major gold producers, South Africa and the Soviet Union. The industrial democracies do not want to depend on those two countries for the additional gold they would need to increase the reserves behind a currency. 

The Soviet Union, in fact, has the largest unmined gold reserves in the world: about 5 billion ounces in the ground. The total unmined gold reserves in the world are estimated at 7 billion ounces. Thus the Soviets have gold, at current prices, worth roughly $3 trillion. On a full gold standard, the Soviets could give up skirmishing with the West and buy it.

If gold was a brake on the spending of governments, what else could be a brake? There is no automatic brake. The answer is a social consensus in a society that understands the effects of inflation and is willing to take the measures that end it. (pp. 141-142)

The "measures that end it" would be staggeringly high interest rates throughout the 1970s by Paul Volcker, chairman of the Federal Reserve, who vowed to "break" inflation. It worked, but at the price of a decade of painful stagnation. Inflation would not come down through the 1980's, in the aftermath of the 1978 oil crisis, 1981 was the most painful recession since the Great Depression. But eventually they did come down during the reign of the new U.S. president: Ronald Reagan.

Next up - The Second Oil Crisis.

The Secret History of Oil and Money - Part 2

The Balance Tips

Last time we saw how all during the 1950's and 1960's, there was a glut of oil, and it was very cheap. This profoundly affected American post-war society, which grew up around the idea of cars, highways, suburbs, and personal mobility. White flight caused the suburbs to metastasize, and air conditioning caused the Sunbelt to be settled. Wages were rising and inflation was nonexistent. The next major expansion of the welfare state was proceeding, and there was plenty of money for space exploration. Widespread prosperity brought a questioning of social authority.Oil surpassed coal as the predominant energy source.

Oil stayed cheap through the 1960's , and everyone believed the glut would last forever. Then a series of events conspired to drive it off the rails. Even though OPEC was formed in 1960, it had little effect. There was too much oil out there, and always someone willing to sell it for what the oil companies wanted to pay.

After the 1967 war between Egypt and Israel, the Suez Canal was closed and would remain closed until after the 1975 Yom Kippur War.

On 5 June 1967, at the beginning of the Six Day War, Egypt closed the Suez Canal. The closure was sudden and unexpected – fifteen cargo ships known as "The Yellow Fleet"' were trapped inside during the closure. At the end of the war, the Egyptian and Israeli armies were stationed on either side of the canal and the prospects for reopening were very uncertain. The canal remained closed until the end of a second conflict – the Yom Kippur War – and subsequent peace negotiations, eight years later.

http://www.voxeu.org/article/1967-75-suez-canal-closure-lessons-trade

The Suez Canal was closed, but there was a pipeline from the great Saudi fields to the Lebanese town of Sidon as well as the supertankers lifting oil in the Persian Gulf. And there was Libya, right across the Mediterranean from Europe—no canal necessary, no supertankers necessary. Libya was supplying a quarter of Europe's oil. (p. 164)

In 1970 came a Black Swan - the unexpected closure of a vital pipeline to the Mediterranean:

In May 1970 a French bulldozer on a job in Syria accidentally broke the "Tapline," the Trans-Arabian Pipeline running to the Mediterranean. The Syrians refused to repair it until they got higher transmission fees. The Nigerians were in a civil war, with their own oil province of Biafra the chief battleground, and Nigerian production was off. Suddenly—or what seemed suddenly—the cushion was gone. There was still no shortage of oil in the world, but political events had interrupted the delivery of oil. (p. 165)

On September 1, 1969 Colonel Muammar el-Qaddafi seized power from King Idris in Libya. The dependence of Europe upon Libyan oil and the closures of the Suez canal and the Trans-arabian pipeline emboldened him to take on the oil companies to get a higher price. He demanded 40 cents more per barrel. The oil companies offered five.

Most of the concessions in Libya were awarded to Occidental Petroleum, and most of that oil went to Europe. The Libyans decided to pursue a strategy of divide and conquer against the oil companies. In the name of "conservation," they cut back Occidental's oil production. Occidental went to Exxon and asked if they would supply the missing oil at cost so that they could could resist the Libyan demands. Exxon turned them down. With no other recourse, Occidental capitulated. It was a minor move that would have major implications. The floodgates were now open.

"The Libyan success was an embarrassment to other OPEC countries," wrote Abdul Amir Kubbah. OPEC, said Kubbah, had been too moderate. "We wasted ten years not following what our Venezuelan friends had told us," said Kubbah. "Now Colonel Qaddafi had shocked us into action."  (p. 166)

The Shah of Iran was not happy, either. Here he was, the King of Kings, and he had been shown up by some tin-pot military dictator from a minor Arab country. He could do better! He wanted the oil companies to negotiate with him. Countries like Iraq and Algeria were already trying to leapfrog Libya's demands.

The Shah of Iran was miffed at the Libyan initiative. Among his own self-given titles were Shahanshah, King of Kings, Shadow of God on Earth; and here was an upstart colonel leading the Club. His power in the area, he said, was ten times, no, twenty times as great as that of the British had ever been. He warned the consuming countries not to get together behind their oil companies; he warned the oil companies not to get together to defeat the legitimate demands of the producers. The companies, he said, would now negotiate with the Persian Gulf states. That way he, the Shahanshah, could restrain the "wild men" of OPEC. The "wild men," Iraq and Algeria among them, were already leapfrogging their prices to match those of the Libyans. When OPEC met in Caracas in December, though, there was little difference between the "wild men" and the "moderates." A month later the oil companies met the Persian Gulf states in Tehran.

The Shah could see that the British and American governments had left the oil companies without diplomatic support, and he was a grimly determined host. The Libyans had found the way to transfer the wealth of the world; they had used a temporary market condition to kick up the prices. Theoretically, the Tapline break was temporary, the Nigerian civil war was temporary, the Suez Canal closing was temporary, and even the European demand in the summer of 1970 seemed temporarily above normal. ...The Libyans had also shown that a "negotiation" between strong producers and divided consumers scarcely had to be a negotiation at all; it was the exact reverse of the oil situation Perez Alfonso had found when he first got elected to Congress in Venezuela, when the oil cartel dictated the prices. The Shah said that the proper price for oil was perhaps ten times the current price, which would bring it to the level of the price of alternative fuels. (pp. 166-167)

The oil companies started to worry. Rather than play this game of leapfrog with individual nations, it was the oil companies themselves who advised that the oil producing nations unite and fall in behind OPEC. They reasoned that negotiating with one entity would be a lot easier than with each country individually, and they could come out ahead. "The text sent to OPEC by the oil companies had, considering the old history of the oil cartel, an ironic twist: it said that the oil consumers and producers both needed stability, and this business of Leapfrog was very unstable; OPEC should act together and bind its members! The companies did not want to have two sets of negotiations as the Shah suggested; they feared another round of Leapfrog." (p168)

The picture the oil companies had of OPEC was straight out of the scene in Lawrence of Arabia (released 1962) where the Arab tribes, having united behind Lawrence, have taken Damascus and are squabbling among themselves leading to chaos. Economists like Milton Friedman had advised that OPEC would break up after a year. As with so many things, he was wrong. Smith quotes a British observer: "We were used to these chaps always quarreling among themselves, the Iraqui hotheads and the conservative Saudis. The Western countries were not prepared at all for economic blackmail. We know the Iranians were spending twenty percent more than their income, so they had to get a raise, but we were surprised at how very tough all of them had become." (p169)

Rather than quarrelsome towelheads, the people sitting across the negotiating table from the oil companies were highly educated PhD.'s, trained, by and large, at American universities such as Harvard, Stanford, Cornell, and the Universities of Texas and Wisconsin. Many had worked for Western oil companies at one time or another. They were no pushovers. This time the Arab nations were united while the oil companies were divided: "The oil companies were not used to acting in concert, even though they had once been a powerful cartel. They had to obtain a Department of Justice antitrust waiver just to be able to talk to one another." (p 168) After 33 days of tense negotiations in London, OPEC got a raise of 50 cents per barrel, higher than the demand they had gone in with. The agreement was signed on February 14, 1971, which Smith refers to as "the St. Valentine's Day Massacre."

The price rise of the St. Valentine's Day Massacre did not dampen demand; indeed, that demand went up and up, all over the world. Behind the "invisible dike" the price of Texas oil was $3.45 a barrel, frozen by the price and wage controls imposed by the Nixon administration. The United States was now importing 23 percent of its oil, but most of that still came from Canada and Venezuela. The Middle Eastern oil was $2.20 a barrel at Ras Tanura in Saudi Arabia, still cheaper than the Texas oil.  

All through the 1960s the oil companies had worried about the Endless Glut. Michael Haider, chairman of Exxon, said at its annual meeting in Houston, in May 1967, "I wish I could say I will be around when there is a shortage of crude oil outside the United States." A memo from Standard of California in December of 1968 warned Arctic oil would keep the Glut going...Richard Nixon was reelected by forty-nine of fifty states. His energy task force, headed by George Schultz, had reported there was little danger of an Arab boycott and that import restrictions should be liberalized...A whole generation of oil men had grown up with the Glut. 

By 1972 the Glut was gone. The Texas Railroad Commission did not have to worry about how many days a month the wells could pump; they were going flat out, every day. The demand was right across the board: gasoline for automobiles, kerosene for jets, chemicals, weed sprays, fertilizers, plastics...James Akins, the career State Department official who had counseled the companies to make their peace with Libya, defended the State Department position...World oil consumption, he said, in April 1973, would be as great in the next twelve years as world oil consumption through all of previous history. The loss of production from any two Middle Eastern countries would cause a panic, and the price of oil could go to $5 a barrel.

The "invisible dike" around the American oil began to shudder and shake. It had been built to keep the cheap foreign oil from coming in. Now it blew away, not from the supply pressure outside, but from the demand inside. The import restrictions were lifted, and what went roaring out, of course, was dollars. Those dollars went out and competed for oil supplies that were already tight. The administration in Washington did nothing to control the scramble. It had other problems on its mind. It was about to go on trial.

The demand for oil was running ahead of the most extreme predictions. Independent oil companies tried to beat the seven great oil companies to the wellheads. Japanese trading companies tried to beat the independent oil companies. Only Aramco, in Saudi Arabia, had spare capacity, and it had little. By September 1973 the market price had for the first time overtaken the official "posted" price. OPEC could easily read what this meant politically. Its former secretary-general, Nadim al-Pachaci, told a conference, "The Arabs now hold the keys to the energy and monetary crisis. They will know how to use both as a political weapon." (pp. 171-173)

And they did use it as a political weapon. In October 1973, the Egyptians crossed the Bar-Lev line into Sinai intending to reopen the Suez Canal. The United States resupplied Israel despite threats of a boycott. The OPEC countries met, with no oil companies across the table (because they were not invited) and declared the price to be $5.12 a barrel "By ukase, by fiat, by order of the high command. The press release was prepared only in Arabic." (p. 174) The Arabs doubled the price again a few weeks later and added an oil embargo on top of it in addition to the cutbacks to nations which had resupplied Israel in the war (The United States and the Netherlands).

The Arab countries expected bombs to start raining down on them any day for defying the almighty West. The bombs never came. The United States had been humiliated in Vietnam, withdrawing that same year: "Vietnam," said my British friend later, "took the edge off, the great giant brought down by an army in sneakers." (p175). OPEC met again in Tehran in December of 1973. The whole world, not just oil specialists and insiders, were watching. Emboldened by their success at cowing the West, there was debate as to how high the price should go. Too high, and you might cripple Western economies. Sidestepping the negotiations, the Shah called a press conference and unilaterally declared the new price to be $11.65 a barrel.

The Shah, said Jamshid Amouzegar, had ordered a study of alternative fuels. "We were struck," said the eminent Cornell alumnus, "by the fact that in 1951 coal was fifty-one percent of the fuel in the United States, and now it is nineteen percent. Because of cheap oil, alternative sources are being neglected. No one in the West is worrying about what happens when the oil runs out. The embargo had showed the weakness of the West. OPEC's economic commission had determined that the price should be $17 a barrel. 

Sheikh Yamani was apprehensive at so large a boost. "I was afraid the effects would be even more harmful than they were, that they would create a major depression in the West. I knew that if you went down, we would go down," he said. Yamani tried to get in touch with King Faisal, but was unable to. If he kept the price down, it might break OPEC but leave the Saudis isolated. Yamani remained within OPEC, insisting on a smaller price increase, and was later reprimanded by Faisal. But Yamani was stunned when, while the OPEC ministers were still meeting, the Shah called a press conference.

The price of oil, the Shah said, would be $11.65 a barrel. That was even more than Yamani had agreed to. The Shah's arrogance astounded the assembled diplomats and reporters. The new price of oil, he said, was very low and "was reached on the basis of generosity and kindness." As for the Western consumers, it would do them good to economize: "All those children of well-to-do families who have plenty to eat at every meal, who have their own cars, who act almost as terrorists and throw bombs here and there, will have to rethink all these privileges . . . they will have to work harder."

pp.175-176

There were stunned reactions around the world. Smith relates the director of the National Bank of Hungary, Janos Fekete, finding that all his budgets were in deficit. The Hungarians bought oil from the Russians, but the Russians used the OPEC price. "And then somebody—maybe the financial people, like Fekete—would say, 'But now we have to pay four times as much for the oil, and we have no oil. Where do we get the money?'"

Where indeed? As we shall see, this price increase was, in the words of Smith, "The greatest transfer of wealth in world history" After the twin humiliations of Vietnam and Watergate, America was now slammed with a quadrupling of oil prices and an embargo overnight. Lines were forming at gas stations. Suddenly, Happy Motoring didn't look like such a good anymore. Why did we rip up all the streetcars, again?

We'll see what the implications were for the global economy next time.

UP NEXT: The Fallout

The Secret History of Oil and Money - Part 1

The mastermind behind OPEC was not an Arab sheikh, but an austere and fastidious Venezuelan lawyer named Juan Pablo Perez Alfonso. Oil had been discovered in Venezuela in 1922, and provided the bulk of the government's revenues. The problem was that it was so cheap that the country made very little money off it.

Perez Alfonso was what we might call today "Peak Oil Aware." He knew that oil was a finite resource that would someday run out, and that oil was a one-time gift that would help Venezuela modernize and become a wealthy country. But the low prices of this one-time gift were undercutting this ability. Furthermore, the low prices encouraged wastefulness instead of conservation.

Instead, his idea was to find a way to preserve the resource, and raise the revenue gained from it at the same time.

In 1948 the military dictatorship of Perez Jimenez took over in Venezuela and Perez Alfonso went into exile, first in the U.S. and then in Mexico. While in exile, he became acquainted with what would become the guiding inspiration for OPEC. But you won't find it in the writings of Karl Marx. No, the inspiration came straight out of good old red-white-and-blue American corporate socialism: the Texas Railroad Commission.

The Texas Railroad Commission, as the name implies, was first set up to regulate the railroads. When oil drilling came along, instead of creating a new regulatory body, Texas gave the railroad commission the authority to regulate oil production.

At the time, the problem was that because so much oil was being pumped, many of the smaller independent oil drillers had trouble making enough profit because they did not have access to distribution networks, refineries and gas stations like the Big Guys. Because the land rights above did not always line up with where the oil flowed underneath the earth's crust, the independent drillers felt they were being cheated. These independent drillers were still worth millions of dollars despite not making "enough" profit, so they did what rugged individualists in Texas always do - they went running to government and threw their money around to get special rules passed. The Railroad Commission introduced limits on oil drilling--how much oil could be produced. In order to keep oil from outside the United States from undercutting this price, they regulated the amount of oil let into the United States by constructing an "invisible dike:"

The Texas Railroad Commission did not set a price for oil, but it determined what could be produced. The early appointments to its board developed a reputation for fairness, from the point of view of the producers. When the demand dropped, the Texas Railroad Commission gathered the industry and polled it as to what the real demand might be. It then set an allowable rate of production, so many days per month, that oil could be produced. Thus conservation produced a mechanism for stabilizing the market.

If the price of oil started to sag, the Texas Railroad Commission would reduce the number of days per month that oil could be produced. "It became the policy of the Commission," Fortune wrote in 1959, "to keep oil prices high enough for the 'little man'—the marginal Texas producer—to make money. This of course was a wonderful arrangement for the nonmarginal (i.e., the major) U.S. producers. It enabled them to clear as much as 50 per cent per annum. And it was even more wonderful for the major companies overseas."

It was wonderful for the companies overseas because the Texas price was the American price...[a]nd the Texas price became the world price, so oil was leaving the other Gulf, the Persian Gulf, in the tankers of Exxon and Gulf, at $1.80 a barrel—the Texas price— when it cost only 10 cents a barrel.

The trouble was that so much oil was being found in the world that the "Gulf" price, out of Texas, wasn't always sticking. Somebody was always trying to cut the price. The Texas Railroad Commission could keep the American price up by ordering a cutback in production, but oil could still land in the United States from abroad, and move cheaply. The American oil companies then limited imports, by voluntary agreement, which later became mandatory by order of the U.S. government. They constructed, said the British economist Paul Frankel, "an invisible dike against the outside world."

pp.148-149

By 1959 the military junta had fled the country, the reformer Romulo Betancourt was president, and Perez Alfonso was named the oil minister.

Perez Alfonso's idea was to use the Texas Railroad Commission model for the oil producing countries to cut back production, thus conserving the resource by increasing the price. The increases would send money into the coffers of the oil-producing nations and allow them to develop. He started talking to people in Austin.

He had admired the Texas Railroad Commission, he said, for its conservation practices, and he wanted OPEC to be a club that would give oil its proper value and extend its life. It was intended to wrest the power from the great oil companies, and to show the industrial nations how they wasted resources. "The nations of OPEC," he said, "should be an example to the rest of the world in the way they live."

At the time, the price of oil was not controlled by the producers themselves, but by the oil companies, in particular the International Oil Cartel comprised of the "Seven Sisters:"

The [International Oil Cartel] had been formed in September 1928, when Sir Henri Deterding, the chairman of Royal Dutch/Shell, invited the heads of Exxon (then Standard Oil of New Jersey) and British Petroleum to his estate in Achnacarry, Scotland, ostensibly for some grouse shooting. What the grouse shooters did, however, was to agree on an unsigned document that specified principles for eliminating "destructive competition." The three original members later admitted Texaco, Gulf, Mobil, and Socal—Standard of California—to make up what Enrico Mattei, the Italian oil man who could not break their grip, called the "Seven Sisters."

pp150-151

Which just proves the original Adam Smith's famous dictum:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
Chapter X, Part II, p. 152.

The oil cartel set the amount of production, and hence the price, regardless of the needs of the country in which the oil was located. "The oil companies took our oil at a dollar a barrel...BP and Gulf would come and say, 'You can pump a million barrels a day; that's all we will sell.'"  (p.226) The low prices decreased the revenues of the oil producing countries, keeping them poor while making the oil companies rich. Perez Alfonso passed a number of new laws in Venezuela based on conservation, but it was to little avail as long as the oil cartel controlled the international market. If Venezuela cut back production, the oil companies would just get it from somewhere else in their vast empire. And Venezuela only had 7 percent of the world's oil reserves, while the Middle East had 70 percent. "Venezuela could cut back until it was blue in the face and it wouldn't matter; it would be like Pennsylvania starting the Texas Railroad Commission." p150; 152,153

At a meeting of oil producing countries in Cairo in 1959, Juan Pablo Perez Alfonso met a Saudi oil minister named Abdullah Tariki. He explained his proposal:

It would be an international Texas Railroad Commission without the Texans! A Texas Railroad Commission for the whole world! If the price of oil started to go down, all the members would hold back their production until the price went up again. And together, united, the producers of the oil--by which Perez Alfonso meant the countries in which the oil was located--together could stand up to the great industrial nations with their great oil companies. p152

Tariki had studied at the University of Texas and worked briefly for Texaco. He was the director of the Office of Petroleum Affairs for Saudi Arabia. At the time, Saudi Oil was controlled by Aramco - the partnership of Exxon, Mobil, Socal and Texaco. Rather than being dictated to by Western oil companies, Tariki wanted Saudi Arabia to have its own integrated oil company. Tariki, like Perez Alfonso, was not at all pleased with the status quo:

Tariki was fuming because the oil companies had just reduced their prices. Saudi Arabia did not have very sophisticated management, to say the least. King Saud married at least 125 times, and each wife got a house and an allowance. When the king needed money, a courtier would call up Aramco and ask for an advance. Saudi Arabia was perilously close to being out of cash, and Tariki was getting the phone calls, and the oil companies were cutting their prices, which was going to cost Saudi Arabia $34 million.
p. 153

He listened intently to Juan Pablo Perez Alfonso's message and was sold. "Conserve and cut back, unite and control. If you want more money, do not sell more oil; sell less." Now with an ally in the Middle East, Perez Alfonso would spread the idea to whoever would listen:

Tariki went through the Arab states, and Perez Alfonso went to Iran, where he held a press conference even before he got to see the Shah. Later he went even to Moscow. The Russians were as hostile as the major oil companies. Perez Alfonso had to explain that OPEC was not a front for the oil cartel.

They were an odd couple, Perez Alfonso and Tariki, but they got along. Here was this precise, brilliant, balding Latin with his horn-rimmed glasses and his pencil mustache, intense, nervous, his bedside pad always ready to receive his thoughts when he could not sleep; and here was his Arab sidekick, somewhat swarthy—he had sometimes been taken for a Mexican in Texas restaurants— with thick hair and a generous nose. Tariki was as careless as Perez Alfonso was precise. He loved speaking to crowds, though he was personally shy; and when he was speaking, he would drum out, "Aramco—is—stealing, Aramco—is —stealing," and then would rattle off statistics. The statistics bore no particular relationship to reality. "They sound good, no?" he said. "So what? The oil is ours." Tariki lived alone in Jidda, in a house with a walled garden that contained gazelles, chickens, turkeys, and various lame animals which he nursed. His Saluki dogs had the run of the house, and the Salukis remained in their chairs even when visitors entered. Tariki was also a violent Arab nationalist. "I am an Arab, not a Saudi," he said...
pp.157-158.

But what I found most fascinating was the fact that the problem with oil in the middle of the Twentieth century was that there was too much of it! No one needed all that oil, no one knew what to do with it, and the producers had a hard time making a profit because it was so abundant. So rather than scarce oil chasing the needs of consumption, we came up with entirely new ways of wasteful consumption to soak up all the oil being produced so that the oil companies could make a profit  (Carbon Democracy makes this point as well). Rather than too little oil, there was too much.

Oil companies did everything they could do to artificially increase the demand for oil, including buying up streetcar lines and having them demolished. The ostensible reason was that everyone was driving anyway, so the public transportation systems were losing money. Might as well just turn the roads over to cars and run gasoline-powered buses instead (which immediately suffered from neglect and budget cuts). Demand was driven by the cheap prices of a resource that would seemingly be cheap forever.

The [Los Angeles Railway] system was sold in 1945 by [railroad tycoon Henry] Huntington's estate to National City Lines, a company that was purchasing transit systems across the country. National City Lines, along with its investors that included Firestone Tire, Standard Oil of California (now Chevron Corporation) and General Motors, were later convicted of conspiring to monopolize the sale of buses and related products to local transit companies controlled by National City Lines and other companies in what became known as the General Motors streetcar conspiracy. National City Lines purchased Key System, which operated streetcars systems in Northern California, the following year.

The company was renamed as Los Angeles Transit Lines. The new company introduced 40 new ACF-Brill trolley buses which had originally been intended for the Key System streetcar system in Oakland which was being converted by National City Lines to buses in late 1948.

Many lines were converted to buses in the late 1940s and early 1950s.

The last remaining lines were taken over by the Los Angeles Metropolitan Transit Authority (a predecessor to the current agency, The Los Angeles County Metropolitan Transportation Authority (Metro)) along with the remains of the Pacific Electric Railway in 1958. The agency removed the remaining five streetcar lines (J, P, R, S and V) and two trolley bus lines (2 and 3), replacing electric service with diesel buses on March 31, 1963. (Wikipedia)

There was endless glut as far as the eye could see. So we invented a happy motoring utopia, building the interstate highway system and repaved local roads, the distant suburbs driven by white flight away from minorities moving north for factory jobs, and ripped up railway and streetcar lines so that people would become utterly dependent upon the motorcar. People bought a new Cadillac every year and headed to the drive-in. James Dean and Marlon Brando rebelled against authority and Americans got their kicks on Route 66. It was the drive-in future covered in chrome with a hood ornament on top; the Golden Age we Americans still pine for today. It was all part of the plan to increase the use of oil because of oversupply, which would seemingly last forever (forever being a decade hence):

In August 1959 Fortune magazine noticed the itinerant preachings of the Odd Couple. Its tone was one of amusement and skepticism, its point of view, as usual, that of big business. To read it is to enter an astonishing time warp.

The problem, Fortune said, is the Glut. Too much oil. Furthermore, said Fortune, "the glut is certain to last a long time." The reason: "too much oil underground too easy to get at, ready to flow at very little additional expense." The ratio of reserves to consumption had formerly been twenty to one; that is, for every barrel shipped there were twenty barrels underground. Now it was forty to one; in the Middle East it was one hundred to one. Even if nobody ever drilled another well, there was so much oil that the ratio of reserves to consumption wouldn't go back to twenty to one for another decade. 

"The international oil companies do not propose to take a beating lying down," said Fortune. "They are redoubling their efforts to increase the use of petroleum products." General Motors and Socal had already bought the Los Angeles mass transit rail system and shut it down. Exxon promised a tiger in a tank. Everywhere there were campaigns to increase driving and heating. "Glut without end?" read the Fortune subhead. "Today, for the first time in years, the companies are cracking down on salaries, expense accounts and office overhead." The Highway Trust Fund helped by building the interstate highway system. Farther out, suburbs were springing up, requiring more driving. 

pp. 145-155

In 1960 there was a epic oil glut and the price of oil collapsed: "...that summer of 1960 was the glut. The Russians were selling oil; the Italians were selling oil; odd tankers everywhere were dumping the stuff for whatever it would bring." (p. 158). Exxon cut the price of oil without any consultation with the major oil producing nations, whose budgets were dependent on that price. There was widespread anger and fury, not so much from the cut itself as from the fact that the oil companies did not so much as consult any of the oil producing nations before doing it. The Shah of Iran was furious, as were others. "The budgets of Middle eastern countries went out the windows, with a clamor from those countries. ...The price cut was serious for Iran, with its growing population, and for Saudi Arabia, which was planning a major program of social services....The Odd Couple's preachings were recalled. Tariki called a meeting in Baghdad for September 9, 1960." (p.158)

It turned out to be the straw that broke the metaphorical camel's back. At that meeting OPEC was formed, an "exclusive club" of oil-producing nations with "similar interests." How did one become a member of that club? Canada and the Soviet Union were not admitted, but Gabon and the sheikdom of Qatar were, despite not being substantial net exporters. "OPEC's rules were that an applicant had to be accepted by three-quarters of the Full Members, but a blackball by any Founding Member would keep him out." (p.161). Three of the five Founding Members--those with the charter privilege of blackball--were Arab states,as were, eventually, seven of the twelve full members." Thus it really developed as a club of "third-world" oil producers, chiefly Arab states, that is, countries not explicitly aligned with the United States or the Soviet Union. And what did "fundamentally similar interests" mean? In reality, it meant countries that would not sell to Israel.

It turns out, though, that it didn't work. Oil was just so damn cheap, and we had other things on our mind, so we continued Happy Motoring  all throughout the 1960's:

But the price of oil did not go up; in fact, it declined, all through the 1960s. The "posted price" of $1.80 a barrel in the Persian Gulf was for tax purposes; sometimes the oil was discounted to as low as $1 a barrel. Behind the "invisible dike," in Texas, oil sold, at the end of the decade, for $3.45 a barrel.

A contributing factor to the declining price of Middle Eastern oil was the improved ways of carrying it. The tankers in the middle 1950s had been perhaps 20,000 tons. Japanese shipyards then developed the jumbo tanker, and then the VLCC supertanker, 250,000 tons, which sharply reduced the cost of oil as it landed at the refineries.

All during the 1960s, OPEC and the seven great oil companies squabbled over a few cents a barrel. The Shah developed a major spending program and needed more revenue to support it. The Saudis eyed his program nervously. During the Six Day War, in 1967, the Arabs set up a boycott, and the Suez Canal was closed. The boycott was relatively ineffective. The end of the Six Day War left OPEC standing, but in tatters; the Iranians and the Venezuelans had increased their exports at the expense of the Arabs. 

In the United States, in the early 1960s, the rate of inflation was about 1 percent a year. 

p.163-164

So OPEC had formed, but it didn't matter. There was still plenty of oil everywhere, and always people willing to sell it for less to get the money. Oil producing nations were divided. The balance of power was with they buyers, not the sellers--they needed us more than we needed them.

Cheap oil would drive the major social events of the sixties - the Great Migration of Blacks to the North, White Flight to the suburbs, busing, the rise of suburbs and the movement of the population out of the Industrial Heartland to the Sunbelt (aided by air conditioning - a rarity before the War).

This expansion made a lot of people fabulously rich. Not just the automobile companies, but all the ancillary industries, which included everything from muffler shops, to auto parts stores, to drive-in movie theaters and hamburger joints, to the boys who filled tanks at gas stations (back when they did that), to ambulance-chasing lawyers and insurance companies dealing with all the injuries and accidents. Automobile dealers became the richest and most prominent "big wheels" in small communities across the nation, funding all sorts of advertising and charity events.

The buildout of suburbs for the "nuclear family" generated wealth for the homebuilders and the road builders. It also generated a lot of wealth for the banks. Between the auto loans and the home mortgages, finance became a part of everyday life for everyone thanks to cheap oil. Cities like Phoenix and Los Angeles ripped out streetcars and elevated bike paths and built sprawling metropolises centered totally around the car. Phoenix, with the population of Manhattan, spread out over 200 square miles of parched desert.

 The critical environmental damage done by cars is not caused by the fuel that they themselves consume, although they do plenty of that. (Direct fuel use by cars accounts for roughly a third of U.S. fossil-fuel use and carbon output.) The critical damage is caused by all the other consumption that driving fosters—consumption that would not occur on the same scale if drivers couldn't move around as easily as they do. Before cars, most people had to live close to other people and to the places where they worked and shopped, even if their homes were in small, isolated towns, far from other communities. Cars permanently changed that, by transforming the way their owners arrange themselves in relation to one another. 

The major carbon-spewing energy drain in a sprawling American suburb isn't the car in the driveway; it's the driveway. That is, it's everything the car makes both possible and necessary: the oversized house, the three bay garage, the manicured yard, the unused swimming pool, the miles of connecting asphalt, the redundant utilities, the schools, the hospitals, the shopping malls, and all the other accoutrements of inefficient suburban living—none of which would exist on anything like the same scale if residents were less able to move around at will. Cars are consumption amplifiers; driving is the pump that enlarges the sprawl balloon. And countries with rapidly modernizing economies, like China and India, are now following the American mobility example at extraordinary speed, by acquiring new cars and building new roads at a pace seldom matched even in the United States. It will be a while before those countries overtake Americans in impact per capita, but in absolute numbers they nave already begun to make us look demure. And, as with us, the main driving-related environmental impacts will always be the indirect ones. 

David Owen; The Conundrum, pp. 65-67

We don't realize it now, but until this time oil had been a relatively minor energy source, even though Henry Ford's assembly line started up in 1914. The age of oil began in 1859, but it took one hundred years for oil to become the world's predominant energy source. One hundred years from the Drake Well in 1859 was 1959, coincidentally the year that Perez Alfonso met Abdullah Tariki in Cairo.

The change in energy habits was from coal to oil, and no wonder. Coal was bulky, hard to transport, and left irritants in the atmosphere when burned. Mining it was an unpleasant and hazardous task, whether in Pennsylvania or Wales or Lorraine, and there was always trouble with the miners. The automobile population of the world was increasing geometrically, as if the idea of bigger families had also spread to vehicles.

In 1940 coal accounted for two-thirds of the world's energy. In 1970 it provided less than a third. In the United States coal as a percentage of total energy consumption dropped from 47.2 percent to 18.6 percent in the same period.

p. 163

The good times were rolling during the "Golden Age of Capitalism." But it was not to last. As we approached 1970, all that was about to change in a big, big way. "It took two wars, a gradual change in energy habits, and a French bulldozer to bring about the control first envisioned by Perez Alfonzo." (p. ) That's what we'll cover next time.

UP NEXT: The balance tips.

Modern Work Patterns Make No Sense

From "Lancashire" by Leo Hartley Grindon.

The BBC’s In Our Time did a show recently about the Lancashire cotton famine – basically when the British textile mills were cut off from their main sources of cotton in the American South due to the Civil War. The British had outlawed slavery, but were all too happy to take advantage of the slavery practiced by their trading partners. How convenient, and a nice way to claim the moral high ground. Slaves aren’t useful for value-added work anyway, and that was the key to Britain’s prosperity, but, hey, we’ll gladly make use of the cheap cotton produced by your slaves and pat ourselves on the back for our morality!

In any case, some have claimed slavery was no big deal anyway for capital formation because Britain just pivoted to getting cotton from Egypt and, especially, India. But Indian cotton, although not grown by slaves, was grown by subsistence farmers who were dragooned by the British authorities of the Raj  into producing cotton in sufficient quantities for export. How did they pay for the transition? Loans, of course. You can’t eat cotton, and it’s very vulnerable to variations in the monsoon rains.

Fast forward today, and what are all those small farmers committing suicide at a staggering rate growing? You guessed it, cotton (now woven in Bangladeshi sweatshops instead of Lancashire mills). And now it’s genetically modified cotton, which is produced by Western corporations and bought via debt upfront, with all the risk laid at the feet of the small farmers. This means the farmers also need to buy the pesticides, the upside being that they can always drink it if the rains fail to show and the debts come due, which is exactly what many of them are doing.

So, one again, an attempt to wash the blood off the hands of the creation of capitalism falls short.. But what I want to highlight this part which put it in a historical context:

[5:30] Melvyn Bragg (host): Who are the people working in the cotton industry?

Emma Griffin: Well, in Lancashire everybody’s working in the mills; some of these mill towns have the vast majority of the populations working in these mills,. And whole families will be employed. They offer a lot of employment for children. Children can start working from the age of nine. Now they’re not going to be doing very skilled work or operating the machines, but they’ll be doing menial work around the factory. And as they enter their teens they’ll start to become machine operators, and as Lawrence has already mentioned, and quite unusually, there’s a lot of employment for women, and in many mills women will actually outnumber the men. But all of the tasks within a factory are usually divided up according to gender, and of course it will be no great surprise to hear that women tended to have the lower paid jobs whilst men had the most senior positions – the overlookers, the engineering, and the heaviest work. That always came with the greatest pay, and of course with the greatest status.

I think one point that is important to emphasize is that we tend to think of factory work as low skill and low pay, but for nineteenth century Britain, that simply isn’t  true at all. In the context of the time and given that these are relatively uneducated workers, these workers are able to command a real premium for working in the factories. It is regarded as skilled work, that these are valuable workers, and this is particularly true for the women. The other alternatives for them are things like domestic service, or cleaning, or laundry work. By contrast, the money they can earn in the factories is very significantly better than the alternatives there.

MB: And the background to this is at this the end of village industry, really. Village cottage industry where everyone was at the loom if they weren’t in the fields.

EG: It is. There’s been a very significant switch in the way that things are made. So traditionally people are paid for making things according to how much is made. So a shoemaker gets paid for his shoes when he’s made his shoes and is not really paid for his time--he’s paid for what he actually accomplishes. In the factories that logic doesn’t really work because the employers have spent money invested in very expensive machinery, and that means they’ve got to keep the machines running all through the week, as long as possible. So they’ve got to get workers to the factory early in the morning, they’ve got to get them working intensively throughout the day, staying until late into the evening. And that’s a very different kind of working pattern that’s being introduced. So instead of people dovetailing working at home with managing a cotton garden or something, now they’re going into the factories. And it’s the beginning of modern working patterns that we’re familiar with, where we’re effectively paid for our time rather than what we manage to get done.

MB: But there was a preference for people to work in the factories rather than to stay in the countryside in these not idyllic village in these lousy conditions.

EG: There’s a real draw. I mean it’s clear that population is moving into Lancashire so workers are very clearly…there are some push factors from the rural sector as well, but there are clearly attractions to the factories. And one of the attractions is that there’s a lot of employment for children. So if you imagine a family in rural Norfolk of five or six children, many of those children won’t be at work because there is no work for them to do. You make the move to somewhere like Manchester or one of the mill towns all round about, and suddenly all of your family is at work. So you go from having one breadwinner to having four or five wage earners in your family, which makes a very significant difference to living standards indeed. So, yes we’ve got basically, since the end of the eighteenth century, we’ve got rural migration into the towns, whole families are moving and taking up these new opportunities.

Getting paid for what you actually accomplish. What a concept! Instead, most of us are chained to our desks for forty hours a week regardless of what we actually accomplish. What sense does this make? In fact, all we do is “fiddle around on computers all day” (as David Graeber puts it) and actually accomplish very little. Yet we must sit there and put in our forty hours regardless of whether there is four hours of work to do or forty. Not to mention the odd idea of selling a concept as ephemeral as time – how bizarre that is. One’s time on this earth is so limited; something feels wrong about selling it to the lowest bidder. Indeed, before the invention of precise timekeeping that wasn’t even possible. The clocks that were designed to help monks time their prayers evolved into shackles for the working class.

Of course people take the modern work situation for granted because the authorities do their best to induce historical amnesia and make us think that the way things are is the way they have always been. This is what George Orwell meant when he said that whoever controls the past controls the present (and by extension, the future). That is why Americans are kept as ignorant of history as those in power can make them.

As Emma Griffin points out, those work patterns make sense when you work in a factory where every second the machine isn’t running it’s a loss of profit. This is also why agricultural societies have always been more leisurely than industrial ones--working harder won’t make the plants grow any faster, after all – once the land you’ve got is seeded and watered, it’s several months minimum before you harvest your crop with little to do but pull weeds and wait. By contrast, a machine never gets tired, and you will give out before it does, hence the Stakhanovite working hours of the early Industrial Revolution (only ameliorated by brutal strikes where workers often sacrificed their lives in a hail of government-sponsored gunfire).

But in case you haven’t noticed, not a lot of people are working in factories anymore. Yet, bizarrely, the entire structure of society is designed as if we do! We all get into our cars and head to work at the exact same time every day (causing epic traffic jams), and file home at the exact same time (causing yet another traffic jam). We all work Monday-Friday (with a few exceptions). During that time we’re chained to a desk for eight hours regardless of what we actually accomplish. It doesn’t matter if there’s four hours of work to do or forty – we’re parked there whether we like it or not. But there is no spinning machine, no power loom, no drill press, no drop forger. No machine at all except sometimes a computer which can go anywhere and work anytime. We’re not producing any goods at all! Graeber again:

...through some strange alchemy no one can quite explain, the number of salaried paper-pushers ultimately seems to expand, and more and more employees find themselves...working 40 or even 50 hour weeks on paper, but effectively working 15 hours just as Keynes predicted, since the rest of their time is spent organizing or attending motivational seminars, updating their [F]acebook profiles or downloading TV box-sets.

The "efficiency" of factory working patterns in a post-factory age.

I think the crux of the problem is that we've built our society around the expectation of a steady income. In fact we need to have a steady income, otherwise we are homeless. Every single month we have to write that rent or mortgage check to keep a roof over our head. So getting paid intermittently is difficult unless we own the home, and even then we have to pay utility bills. We simply aren’t structured for a world of  intermittent work. This is because the entire market is predicated on people getting a steady paycheck. In other words, everything is still predicated on the industrial/Fordist model in a post-Fordist world. And we have no real clear idea of how to move beyond it.

What we have is a very serious mismatch between the design of the post-industrial world and the requirements of its economy. We all know this selling of time makes no sense anymore, yet we cannot move beyond it. We’re accustomed to it. Making it worse is the fact that (in America, especially) so many things are tied to our jobs like health care and retirement.

Being in modern industrial society practically requires us to be in debt. That means being yoked to a steady repayment schedule. This is a major barrier to the kind of society we need where we get paid by what we produce. Even that is tricky, because most of us don’t produce a damn thing; we do “interpersonal/ administrative” work, i.e. push paper. Compare this to back when people lived on the land for generations making a living, and almost nobody outside of entrepreneurs and monarchs/governments had to worry about debt.

Of course, now there are less and less places interested in buying your time anyway. Getting paid for what you produce is a nice idea, but it's harder than ever. In the Middle Ages you had carpenters, coopers, cobblers, wheelwrights, blacksmiths, thatchers, brewers, butchers, tailors, etc. Today, our stuff is produced by factories filled with robots, often on the other side of the world. You can't hand-produce an automobile or microwave or refrigerator in your basement workshop, and even if you did, there is no way you could sell it for less than GE or Toshiba. Even food is produced by vast factory farms undercutting anyone without enough land. Our notions of "self reliance" are completely at odds with this reality.

And the kind of stuff you can produce is almost impossible to sell nowadays. Musicians, writers and other artists are seeing their livelihoods disappear because everyone expects free stuff, and it's hard to make a living crocheting for Etsy, despite all the pronouncements of techno-utopians. See this: From bestseller to bust: is this the end of an author's life? (Guardian)

Rupert Thomson is the author of nine novels, including The Insult (1996), which David Bowie chose for one of his 100 must-read books of all time, and Death of a Murderer, shortlisted for the Costa Novel of the Year awards in 2007. His most recent novel, Secrecy, was hailed as "chillingly brilliant" (Financial Times) and "bewitching" (Daily Mail). According to the Independent, "No one else writes quite like this in Britain today." Thomson has also been compared to JG Ballard, Elmore Leonard, Mervyn Peake and even Kafka. In short, he's an established and successful writer with an impressive body of work to his name.

After working seven days a week without holidays, and now approaching 60, Thomson, you might think, must be looking forward to a measure of comfort and security as the shadows of old age crowd in. But no. For some years he has rented an office in Black Prince Road, on London's South Bank, and commuted to work. Now this studio life, so essential to his work, is under threat. Lately, having done his sums and calculated his likely earnings for the coming year, he has commissioned a builder to create a tiny office (4ft 9in x 9ft 11in) at home in his attic, what he calls "my garret".

The space is so cramped that Thomson, who is just over 6ft, will only be able to stand upright in the doorway, but he seems to derive a certain grim satisfaction from confronting his predicament. "All I want is enough money to carry on writing full time. And it's not a huge amount of money. I suppose you could say that I've been lucky to survive as long as I have, to develop a certain way of working. Sadly, longevity is no longer a sign of staying power."

Thomson is not yet broke, but he's up against it. The story of his garret is a parable of literary life in Britain today. Ever since the credit crunch of 2008 writers have been tightening belts, cutting back and, in extreme cases, staring into an abyss of penury. "Last year," said novelist Paul Bailey, speaking to the Observer in 2010, "was sheer hell". Off the record, other writers will freely confide their fears for the future, wondering aloud about how they will make ends meet. Hanif Kureishi, for instance, recently swindled out of his life savings, told me how difficult his life had become. Never mind the money, the very business of authorship is now at stake.

We’re actually going the opposite direction as it gets harder and harder to get paid for producing something. So the modern working pattern we’re familiar with simply don’t work anymore! We’ve moved on, but we can’t escape from them. And this make no sense.

What we should be doing is moving to a society where we do not have to rely on the steady paycheck and get paid for what we actually produce. That means severing the ties between a job and social benefits. Yes, that means universal healthcare and retirement pension. Housing is a stickier issue, but an important one. When Classical economists like Ricardo talked about “rent,” what they meant was the crops (or money from the selling of crops) paid to the landlord who was distinct from the farmer in order to use the land. What do you do when the land produces no revenue? Classical economics doesn’t really address the issue (Georgist economics does).

The other point I wanted to make based on that snippet has to do with employment. One sneer often hurled at “luddites” by economists and other Cornucopians is how we all left food growing and cotton spinning and dirty factories and all that behind and yet we still have plenty of jobs. Case closed--jobs will always self-create in sufficient numbers without any sort of planning; to claim otherwise is the “Lump of Labor Fallacy,” and all that. But note that it’s an apples-to-oranges comparison. In the early Industrial Revolution, as noted above, everyone worked--men, women and children, young and old included.

That’s a huge amount of the population that is just not in the job market anymore. That is actually forced out of the job market by law – it’s illegal to hire anyone below sixteen with a few exceptions. That is, we artificially keep children out of the job market. That a huge portion of the population – actually the majority of the population in some countries (less so in the West – which is not coincidental). Again, we just think of this as the normal state of affairs, but as the above points out, it is anything but. In fact, like selling our time instead of anything useful, it is the aberration for most of human existence. We just take modern working patterns for granted thanks to Shifting Baseline Syndrome. In the movie of human existence, the industrial model would be the last few frames, yet we tend to assume it was the entire movie.

We also used to keep women out of the workforce too, as any viewer of Mad Men knows. Women were expected to get married and keep house – and yes, that had a lot to do with making sure there were enough jobs for the men. I’m sure my readers know that the women who worked on the assembly lines during World War Two were politely asked to step aside when the men came home. The generation who lived through the Great Depression would have never accepted the nonsense spewing from today’s economists about the "Lump of Labor" fallacy – they lived through unemployment rates as high as 25 percent and a decade of people being tossed out into the street.

Women tentatively slipped their toes back in the water in part-time jobs as long as they were not taking jobs from male breadwinners (e.g ‘Kelly girls’). Eventually that changed as feminism (encouraged by business) “liberated” women to enter the workforce regardless of the effect on men’s jobs and wages (because jobs are always unlimited, declared economists, “Lump of Labor,” and all that - see The Rise of the Permanent Temp Economy). Now women actually dominate the workforce. Women have essentially won the gender wars. Note also that the wheels came off the economy in the late 1970’s opening the door for Neoliberalism and ending thirty years of rising fortunes for the middle class in America. Coincidence?

We are also keeping people out  of the workforce ever longer thanks to increasing education requirements (even though for most jobs it’s useless). In other words, a degree is nothing more than a job-hunting license.

Now you may scoff at this, but consider the reason why we take children out of the workforce and stick them in the warehouses/gulags we call schools for over a decade. Ostensibly, it’s to train them in the necessary skills they need to do the kinds of jobs that modern post-industrial society demands. Except their skills are now useless – we now all take it for granted (thanks again to the economics priesthood) that a high-school diploma is worthless and not worth the paper it is printed on and enables you to do nothing but work the deep fryer, stock shelves, or, if you’re lucky –swing a hammer or hang drywall - A College Degree Is Now Required of Basically Everyone (Jezebel). And we assume that such people deserve to have no healthcare or vacation or a decent, reliable  income because they have no “skills.” “Skilled” labor, by which economists mean a piece of paper from a degree-granting member of the education cartel, allows one to actually make a living at less than poverty wages. Yet now even that is not enough! Anyone who can’t remain out of the job market until age thirty, well, to hell with you, I guess. And I’m not even going to get started about how it’s entirely on our backs to make ourselves amenable for the few jobs that are on offer.

We also count people over sixty as “retired,” whether they are retired or not. As the progress harpies constantly point out, we’re living longer today. So that’s not properly counted either.

All this is to say that we’re now holding an awful lot of people out of the job “market” for ever-longer periods of time, skewing the job-abundant present situation constantly proclaimed by economists ever further from an apples-to-apples comparison with the past, even the fairly recent past (and even then the workforce participation rate keeps dropping). Economists like to claim that employment has not vanished at all in the two hundred years of productivity gains since we left the farms and factories behind, but they keep moving the goalposts. An apples-to-apples comparison keeping all things equal would consider anyone over the age of nine until death not working as unemployed.

What would that look like?

Our gains in efficiency have eliminated a massive of jobs, we’ve just dodged the bullet by redefining who needs a job. Children (and formerly spouses) were able to be supported by one breadwinner. Not anymore. It’s almost as if school (and retirement) were a design to camouflage the amount of jobs lost over the last few hundred years. And now the creeping normalcy of endless requirements for “more school” is yet another attempt to camouflage this fact. And we’re not even discussing bullshit jobs, or guard labor (which I’ve discussed before) All part of the plan, with economists fulfilling their roles as normalizers and chief propagandists, of course.

Another thing to point out is how much the economy has changed since back then even though today's economic priesthood declares that working less is pie-in-the-sky and unrealistic. We went from men, women and children working in factories and sweatshops, to single male breadwinners to two-income families in the last few hundred years. We went from sixty-hour, six-day workweeks to forty-hour five day workweeks (all while the economy grew). We went from  unionized jobs to temp work. Yet now, if you even dare suggest shorter workweeks or less working hours, you are met with stories abut how the economy will fall to pieces and everyone will be thrown into poverty. Another case of historical amnesia.

Stupid Luddites (sneer).

Finally, it’s worth noting that shifting children from economic boons into economic burdens, and sending women into the workforce in droves is the secret mechanism that industrialism is gambling on to halt worldwide population increase. One can't help but wonder about the limits to that approach.