From the formation of OPEC to the modern monetary crisis

You may have seen by now that this will, very sadly, be the last week when I write to you via this newsletter, UK Uncensored.

It’s been a wonderful year, trying to navigate these crazy markets. I do hope you’ve found it valuable and/or interesting!

You can continue to hear from me, if you so wish, at Exponential Investor, alongside my brilliant colleague Sam Volkering. There are also some other, very exciting things in the pipeline, which you should be hearing about soon…

Anyway, on to today’s note, which is a book review of Paper Money, one of the best books on money, finance and economics I have ever read!

It’s written under the pseudonym of Adam Smith, but many people believe it was one George Goodman, now deceased.

It’s a high-level, personal, witty, entertaining walk through of the state of play in the 1970s.

Oil crises, inflation, the formation of OPEC, the onset of the fiat currency regime we know live in…

It was all happening, and “Smith” makes learning about it easy, enlightening and hugely entertaining all at once, in a feat rarely seen in this genre.

The only sad thing is, it’s an old book with limited availability so you might have to scout around a bit – but if you can pick up a copy, I do very heartily recommend it!

But how the hell do you sum up all its brilliance in a thousand-word book review though? Well, don’t waste any more words with meaningless waffle like this for a start.

It’s a book written at the peak of the American inflation in the early 1980s, detailing how it came to pass that Americans were “no longer saving and were borrowing as much as they could” and were talking, almost obsessively, “about prices, about things – real estate, houses, especially houses… The unarticulated theme of those conversations was this: How do I get out of the currency and into something that will hold its value, or increase? The assumption, quite correctly, was that to hold dollars was to lose.”

My favourite insight was on the transmission effect of higher oil prices on the world economy and inflation, and the extraordinary extremity of it all.

For oil-producing nations (OPEC), if oil goes from $10 per barrel to $20 as it did (and some more!) during the formation of OPEC in 1974, it makes basically more money than it could ever know what to do with. With production of 30 million barrels per day, OPEC’s revenues have grown by $109.5 billion per year.

Smith writes:

Now go to the Grumman plant on Long island. Walk around an f-14 (fighter jet), kick the tires. There it is, completely, equipped, tinted glass, AM-FM… Grumman can turn out eighty F-14s a year, at $9 million each. Bring pilots and fly the lot away, and that’s $720 million.

Add 100 F-15s for a slightly higher price – $1.2 billion.

What else? How about the biggest ticket in defense – a nuclear powered aircraft carrier, retailing in 1974 at between $770m – $1.3bn. Take two. Take some destroyer escorts, take a couple of missile cruisers. Have some submarines.

The West could transfer OPEC one air force and one navy and still owe $100 billion more… every year.

The wealth creation to nations which had been mostly farming peoples until the 1960s was extraordinary.

And with the rest of the $100 billion, they didn’t buy – they banked.

With oil prices rising, money is created and sent to the oil-producing nations. Having bought just about everything imaginable, they reached the bottom of their shopping list, and started banking the rest.

When $100 billion starts getting deposited in US, European or newly formed national banks in the Middle East, it has a knock-on effect.

It creates the ability to lend.

If a US bank has a reserve ratio of 10%, then this $100 billion allows for a full trillion ($1,000 billion) worth of lending. That’s how truly new money is created – not in the central banks but at the commercial ones, who lend a hundred pounds on reserves of a tenner, creating debt on your account and credit on theirs with a flick of the pen, or a tap of the keyboard.

But who to? With that much money to lend, Smith says you run out of quality creditors pretty quickly – the world only needs so much.

So banks, simply to do something with this tsunami of money into their balance sheets, started lending to less and less creditworthy borrowers.

This two-fold effect of flooding the system with more debt, and of a lower quality, creates inflation and also heightens the risk of a banking crisis.

That’s how rising oil prices lead to inflation – not just through input costs for businesses, but also by increasing bank reserves, therefore increasing lending, therefore increasing the amount of money in circulation.

I’d never thought about it like that, but it makes perfect sense.

Outside of these insightful observations, the book is full of amazing anecdotes and stories – like how OPEC was formed by copying an American cartel in Texas, originally founded by grouse-shooters in Scotland.

The result was that the greatest transfer of wealth in history occurred in a space of 15 years…

Or, Smith discusses how during inflationary periods, simply being in the right currency (“swissies”, “deutschies”, and other endearing terms) can be hugely profitable.

But by using real characters from his impressive and vast personal experience (lawyers, consultants, advisers, central bankers…) he manages to make the extraordinary economic turmoil in the 70s into something akin to a thriller, a comedy, or a piece of fiction.

Combining deep insight with a knack for storytelling and a delightful turn of phrase, it’s a truly delightful read.

To finish, here are some of my favourite quotes…

Fifty men in Riyadh can decide if we’re in a depression or not.

All investments are speculation in the Age of Paper Money.

The Deustche Mark may look solid, but when the Russian tanks get to Frankfurt, it’s Kleenex.

The expectation of inflation as a psychological force Is easily the equal of all the technical economic forces.

And, describing economists’ failure to include reality in their many assumptions,

What if there was a sorehead colonel in an oil country deciding that Allah wished the Prime Minister to meet with a nine-millimeter bullet.

If you can find it, enjoy! There are a few on Amazon, but not many at a reasonable price.

So, that’s probably my last book review for you.

We’ve looked at John Kenneth Galbraith’s The Great Crash 1929, Russell Napier’s Anatomy of the Bear, Jen O. Parsson’s Lessons of the Great German and American Inflations, Michael Lewis’ Panic!, Jim Slater’s The Zulu Principle, Alice Ross’ Investing to Save the Planet, AKO Capital’s Quality Investing, Howard Marks’ Mastering the Market Cycle (and The Most Important Thing), Marathon Asset Management’s Capital Returns, Edward O. Thorp’s A Man for All Markets, Peter Bernstein’s Against the Gods: The Remarkable Story of Risk, Benjamin Graham’s The Intelligent investor, Hans Rosling’s Factfulness… And even a film – Dark Waters.

It’s a pretty decent reading list!

You can find all of these, and all past editions of UK Uncensored here, on our website, for the time being at least…

Going forwards, I’d simply like to ask you to look at a couple of things.

Firstly, Exponential Investor, where I’ll be continuing to write my weekly musings alongside the brilliant, tech and crypto specialist Sam Volkering.

And also, Sam is seeing a potential catalyst for bitcoin right around the corner. It’s a pretty significant development for UK crypto investors.

To find out more… click here now.

Otherwise, just very best wishes from me, and have a great week.

Kit Winder
Editor, UK Uncensored

1 Comment
  1. […] Oil prices, the corona-crash and your portfolio. […]

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