Trying to Cope with the Looming Crisis

At a classically chic diplomatic dinner in a stately residence on Washington's Embassy Row one night last week, the conversation flowed as easily as the vintage French wine. The guests, all elegantly dressed, were a sprinkling of the capital's elite: the envoys and finance ministers of half a dozen nations, American and British financiers and top White House Aides Robert Hartmann and Philip Buchen. The host, the modern equivalent of a Levantine legate, was Ardeshir Zahedi, Iran's Ambassador to the U.S. There was pearl-sized gray caviar from the Caspian, of course. But the most remarked-upon item was the menu itself: it was lavishly printed on oversize imitation American dollar bills, British -L-5 notes, Swedish crowns and twelve other currencies. And dessert might have symbolized the grand new wealth of an oil power: a chocolate mousse topped by a miniature money tree, festooned with artificial gold coins.

Choking the System. The ambience of that ambassadorial dinner contrasted severely with the somber mood that pervades Washington and much of the non-Communist world. The root problem is the enormous cost of imported oil, now more than $11 per bbl.,* a fourfold inflation in only one year. The increase has enabled the oil exporting countries to earn an almost inconceivable amount of foreign currency: about $100 billion this year. Unless prices weaken, next year's total will swell to $108 billion. By the end of this decade, the 13 nations of the Organization of Petroleum Exporting Countries (OPEC) could have a surplus of gold, dollars, pounds, marks, francs and other foreign currencies amounting to $650 billion; by contrast, the U.S.'s reserves are now $15 billion.

Already the OPEC countries have been the recipients of by far the greatest international transfer of capital in history. Because many nations are becoming poorer while the oil exporters become richer--and much of the oil money is neither spent nor placed in long term deposits or investments--the huge transfer of wealth threatens to choke the international monetary system and strangle world trade.

Mining Oilfields. In chancelleries and countinghouses nearly everywhere, officials fear economic crisis leading to political instability. The evidence of this gloom was clear and plentiful last week. The price of shares on the stock exchanges continued to plunge--not only on Wall Street but also in London, Paris and other major cities. In Washington, a pall of pessimism hung over the annual meeting of the International Monetary Fund and the World Bank. Representatives of more than 120 nations listened attentively to cataclysmic predictions that they would have dismissed immediately a year or two ago. The atmosphere was such that sober, responsible people from Beirut to New York were ready to believe that it was no longer impossible that one or more Western powers might in some dire future contemplate military intervention in the Persian Gulf to secure control of petroleum reserves. There were even unconfirmed stories in the Middle East that Kuwait had mined its oilfields and tightened security around its pumps and pipelines.

There was a deepening perception of the potential impact of continued high oil prices: accelerating inflation that indiscriminately threatens both industrial and developing nations; increasing strains on and a collapse of the international banking networks; widespread recessions (or even a worldwide depression) with levels of unemployment unprecedented since the 1930s; and ultimately, perhaps, a corrosion of democratic political institutions. Secretary of State Henry Kissinger, in private conversations, confided his deep concern about what the spreading economic malaise--caused largely by the high cost of oil--will do to Western Europe's stability. He is especially concerned about possible Communist gains in Italy, Greece and Portugal (see THE WORLD).

To the industrial nations it was becoming clearer that they could not afford to continue hemorrhaging vast amounts of their financial resources to the oil exporters unless they were ready to see a shift of the globe's geopolitical balance. The OPEC nations, with great financial clout, would be able to wield decisive influence in the world's political councils and could become arbiters in tune of crisis. The mood of urgency was intensified at midweek, when Kuwait and Venezuela announced further tax increases of 3.5% on the oil that they export.

Throughout the week the U.S. continued its verbal offensive, launched last month, to bring down oil prices, or at least keep them from going any higher. At the IMF meeting, the Americans concentrated on the need for lower energy costs rather than new international lending institutions to ease the balance of payments problems of petroleum-importing states.

Wasteful Americans. This was also the U.S.'s position at the conference on Sept. 28 and 29 among Kissinger, Treasury Secretary William Simon and Federal Reserve Board Chairman Arthur Burns and their counterparts from Britain, France, West Germany and Japan--the energy-consuming Group of Five. They analyzed the possibilities of coordinating their policies and efforts on energy.

What they said remains unannounced (at the insistence of the Japanese and the Europeans, who all fear antagonizing OPEC), but it is known that there was no talk of military confrontation. Instead, the U.S. proposed that major industrial nations reduce oil imports by enforcing strict energy conservation measures. Kissinger and Simon urged that each nation cut back by the same percentage. The British and German officials disagreed, arguing that since the U.S. buys only about one-third of its oil abroad, compared with about 80% for Europe, America should cut its imports by about twice the percentage the others do. This would impose an equal burden on the economies of all the big oil users. Britain's Chancellor of the Exchequer Denis Healey, after returning to London, added that Americans should be made to tighten their belts more than others because they "waste" so much energy. The U.S. so far has balked at the British and German arguments, probably because the American officials fear what a cutback would do to an already weakened economy. Congress would also raise a furor over really strict conservation measures.

Though this particular summit ended without agreement, the fact that the five had met (and that France had agreed to participate) was encouraging. The meeting might create a momentum leading to a kind of "energy NATO" that would give the U.S. a chance to try its strategy for bringing down oil prices. If the citizens of the oil-importing countries can be persuaded to adopt conservation measures, and if a formula for limiting exports is accepted, then--the Americans optimistically reason--the oil exporters would start to quarrel over how to share the shrinking market. This could eventually weaken and perhaps break up the oil cartel, permitting prices to respond to the demands of an uncontrolled marketplace.

U.S. officials believe that the time for concerted action against OPEC may be approaching, in part because there is currently a surplus of 1.5 million bbl. of oil per day--or 2.7% of the total used --on the world market. Reasons: the fourfold increase in the price of oil has already led to a drop in consumption and the world's slowing economies use less energy than before. Even though several OPEC members reduced their output in a countermove, oil storage tanks in the consuming nations are nearly filled to capacity. Moreover, unlike the situation during last winter's embargo, the oil importers will soon be able to coordinate their response to the cartel's moves. Next month the U.S., Canada, Japan and all the Common Market nations except France will form the International Energy Agency (IEA), headquartered in Paris. This new group, whose members use 80% of the world's petroleum, plans to deal directly with OPEC and the oil companies and will allocate petroleum among its members during an emergency. Cooperation would be tested if OPEC slapped on an embargo during any future confrontation. To prevent capitulation to the cartel, IEA'S members would be asked to share energy resources.

Hot Sales. Of course, any strategy for bringing down oil prices will require the consuming nations to impose energy-conserving measures. While there was much talk of this during the Arab embargo, many conservation efforts quickly faded when the oil started flowing again. But recently some further progress has been made. Last month French President Valery Giscard d'Estaing set a ceiling of about $10 billion on what his country would pay for imported oil next year. Because that will amount to a 10% reduction in the volume of petroleum imports (at current prices), France will have to introduce stringent conservation. Gasoline rationing coupons have been printed, and a 68DEGF. maximum for heating homes has been set. Stores report hot sales of bathrobes, sweaters, nightcaps, slippers and heavy blankets.

France's incipient conservation measures were praised by officials in the U.S., which itself could do much more to save energy (see box page 34). The U.S. is planning to move on another front to reduce its dependence on imported oil. Last week the Interior Department revealed it is prepared to lease 10 million acres on the continental shelf off Alaska and in the Atlantic to private oil companies for development.

How High? The Shah of Iran has also lauded conservation programs, though they are partly aimed at pushing down oil consumption. On a visit to India last week, the Shah stressed that "we should save oil as much as possible, and every one of us should do that." The Shah was less agreeable on the subject of the oil consumers' implied threat of a confrontation with OPEC. Earlier in the week, while in New Zealand, he snapped: "The big consuming nations could only lose in any confrontation with the oil-producing nations. I would not recommend it to consumers!"

No one in the OPEC countries seemed intimidated by the U.S.'s policy of tough talking (TIME, Oct. 7). After Venezuelan President Carlos Andres Perez rebutted American criticism of OPEC's pricing, he became unquestionably the most popular man in his country, applauded by the Communist Party and the Chamber of Commerce as well as all groups in between.

In the Middle East, newspapers derisively labeled the U.S. policy as a "Zionist-sponsored campaign." Beirut's left-leaning Al Shaab rejected America's stern talk as "blackmail" and ridiculed the arguments that steep oil prices were fueling the world economic crisis. The Middle East's governments, said the paper, are responsible only for the welfare of their own citizens and "not for improving living conditions in America, Europe or Japan."

Nearly every OPEC member--with the exception of Saudi Arabia--rejects the notion that the price of oil is now too high. "What do they mean by high?" asks Iran's Minister of the Interior, Jamshid Amuzegar, incredulously. He reasons that the price is about equal to what it would cost to obtain an alternative form of energy, such as gas produced from coal (see box page 35). Thus he and the Shah insist that $9.70 per bbl. is a fair price.

Much of what the consumer today pays for oil is inflated, stress the OPEC members, by the "obscene profits" of the international oil companies and by the enormous taxes on oil imposed by the industrial countries. (Taxes account for about 71% of the price of gasoline in Paris and about 25% in Chicago.) The Shah maintains that the oil possessors had to raise their prices to halt the erosion of their purchasing power caused by the soaring costs of the commodities and manufactured goods they were importing. He says: "The oil-consuming nations are selling their wheat, their sugar, their vegetable oil and so on at the price they seek. We have nothing to say about those prices. They say 'Take it or leave it!' and we have to take it."

These arguments simply do not hold up. U.S. economists calculate that because of its ripple effect in the economy, high oil prices have contributed, not two percentage points to America's current inflation as the oil producers say, but considerably more than four percentage points--roughly one-quarter the general price rise. The higher price of oil has added, for example, to the cost of clothes because of the need for oil in producing synthetic fibers and for shipping the finished product.

American Limousines. The oil possessors are also on weak ground when they argue that they are now receiving a fair price for their resources. As TIME Economic Correspondent John Berry reports: "Such an argument implies that prices should have a 'moral' component, the nature of which is determined by the sellers. Thus they seem to be rejecting the play of free market forces in determining prices. In such a market, the price of a product is closely related to the cost of producing the last unit of supply that is demanded by a buyer. No one anywhere in the world is pumping oil that costs $10 a bbl. to 'produce.' The cost of bringing up a barrel ranges from 100 hi Saudi Arabia to 600 in Venezuela to $3 or so in the U.S. OPEC'S defenders seem to have the notion that somehow market forces have never properly recognized the value of oil, that its price always should have been higher. This tosses rational economic analysis out the window."

It is probably also incorrect for OPEC to compare --or link--the price of the oil that they export with the goods they import. Many of the products that OPEC nations buy are either agricultural goods, whose prices are set by a highly volatile market based on supply and demand, or sophisticated manufactured goods, in which the price represents raw material costs, labor, machinery and R. and D.--and then is kept as low as possible by the pressure of international competition. Even when the U.S. attempted, unsuccessfully, to limit its agricultural output, the purpose was to prevent market prices of food from falling below farmers' cost of production in order to keep the farmer in business--an argument that hardly applies to OPEC. Since 1960, when the cartel was founded, the wheat that OPEC nations import, the planes they buy for their airlines, the steel they use for their industries and the American limousines that some sheiks enjoy, have increased in price much less than oil (see chart page 33).

The OPEC nations cannot argue that the price of oil is set by production costs. They do not actually "produce" petroleum; they merely--by a quirk of geography--possess it. Foreign technologists found and developed the oil, and foreign risk capital built most of the rigs, pumps, refineries, pipelines and harbors. Only the existence of the OPEC cartel, with its ability to impose prices by fiat, keeps up the cost of oil.

Although some OPEC members argue that their policy aims at narrowing the gap between rich and poor countries, it is precisely the very poor who are suffering most from the quadrupled world price of oil. Called the "Fourth World" by World Bank President Robert McNamara, they comprise nearly one billion people in some 40 underdeveloped nations in Africa, Asia and Lathi America. For them, today's price of energy and key petroleum-based products--fertilizer, chemicals and drugs --has meant a further reduction in an already pitifully low living standard.

No nation has suffered as much as India. This year it will spend about $1.3 billion (approximately two-thirds of its foreign currency earnings) to import oil, compared with $265 million last year.

There is little money left to import the fertilizer and chemicals needed for India's agriculture, or to buy the 5,000,000 tons of grains needed to feed its 580 million people after this year's poor harvest, which was due in part to the fertilizer shortage. Fearful of antagonizing the rich oil exporters, representatives of underdeveloped nations have not spoken out against the cartel. Yet during last week's U.N. General Assembly meeting, some Africans began to break the silence. Tanzania's Foreign Minister John Malecela warned: "To many of the developing countries, the current high oil prices amount to economic near-strangulation."

Petrodollar Overhang. The impact of oil prices on the Fourth World was a major concern at last week's meeting of the IMF and World Bank. The delegates regarded the plight of the poor nations as part of a much larger problem called "recycling the petrodollar overhang." That means the orderly lending of surplus billions by the OPEC nations to those countries desperately in need of money to finance oil imports and development projects.

The recycling problem is primarily due to the Arab members of the oil cartel. With the exception of Algeria, their relatively small and nonindustrialized populations have only a limited ability to utilize all their oil money. On the other hand, most of the non-Arab OPEC states, notably Iran, Venezuela, Nigeria and Indonesia, have large populations and ambitious development programs.

Thus they spend most of then-- oil earnings on imported goods and services, sending funds back to many of the states that bought their oil. Iran this year has bought a 25% share of the steel-producing branch of Germany's famed Krupp and $3.5 billion of armaments from the U.S. Last week Iran's state-owned Bank Melli agreed to lend Long Island's ailing Grumman Aircraft Corp. $75 million for four years at interest rates of 11% or more.

This normal circulation of funds in the international monetary system has worked fairly smoothly so far for the nations that can sell manufactured goods or basic commodities (although most are suffering from balance of payments deficits). But the less developed nations, which have almost nothing to sell, are left out of the cycle of flowing funds. Once they pay an OPEC nation for oil, they seldom see their money return. Moreover, the Arab OPEC members understandably prefer to deposit their surplus funds in stable American and European banks rather than banks of the Fourth World.

At the IMF and World Bank meeting, several schemes were suggested to create funds, or "facilities," financed in large part by the oil-possessing nations. These funds, in effect, would serve as bank accounts from which oil importers could borrow the money to buy the oil that they need from OPEC. IMF Managing Director H. Johannes Witteveen of The Netherlands proposed creating such an account which would probably be capitalized at from $5 to $10 billion in loans from OPEC. This has been nicknamed "Witteveen Mark II," to distinguish it from "Witteveen Mark I," a similar fund established earlier this year with $3.4 billion. That fund will be completely exhausted by year's end, having lent its money to 18 nations. The new account will be able to lend money to advanced nations that cannot meet their oil bills, as well as to the Fourth World.

The U.S., however, was unenthusiastic about Witteveen's proposals. Treasury Secretary Simon opposes new recycling schemes, regarding them as stopgap measures. They can do no more than delay the day when the oil importers face the reality that they can no longer afford to pay the cartel's price. After all, the money that OPEC channels into a recycling facility is not donated; it is lent and must be repaid--with interest.

Eventually the indebtedness of the oil importers will be so enormous that even industrial nations will start defaulting --perhaps as early as next year.

Nations would then be tempted to take unilateral action to get the funds they need to pay OPEC. Through subsidies and dumping, nations would drive all-out to increase their exports; meanwhile, through stiffer tariffs and quotas, they would wall out imports. Such a mercantilist policy could lead to a tragic rerun of the 1930s, when most of the industrial nations were intensively trying to "beggar their neighbor." The result was a disastrous contraction of world trade and paralysis of the international monetary system. Thus the answer to the crisis created by high oil prices, conclude Simon and Kissinger, is not a recycling mechanism but a concerted effort to bring those prices down.

Unusual Gesture. While the oil possessors are entitled to enjoy and perhaps even flaunt their wealth, they may be well advised to contemplate more carefully the long-range consequences of their action. The Saudis have apparently done just that. Before last month's OPEC ministerial meeting, King Faisal, in a most unusual gesture, sent the Shah of Iran a personal letter urging him to join Saudi Arabia in pushing for lower oil prices. The Shah refused. The Saudi monarch, say officials close to him, wrote the letter because he is worried that the impact of high oil prices on both the industrial and underdeveloped world will improve the relative position of the Soviet Union and China, since they are largely self-sufficient in oil. Moreover, in the Saudi view, economic disruption would strengthen leftist radicalism around the world. Faisal's letter stressed that "a worldwide depression would hurt oil producers as well as consumers." So far, despite their professed fears, the Saudis have refused to act alone and sell their enormous supply of oil at a price below the OPEC level.

Of course the oil-deficient but otherwise potent industrial nations would never permit themselves to become impoverished. They would first act boldly through energy sharing and saving and political and economic boycotts to stem the drain of money and transfer of power to OPEC. If the major oil consumers form some common front, they may be able to meet with OPEC and negotiate a reduction in prices. The limited first steps that the oil importers have taken in the past few weeks may lead to that concerted action. In the meantime OPEC's members might want to recall the story of King Midas, whose obsession with gold became a curse that almost caused his starvation.

* This is the so-called "posted price," a figure set by oil exporting countries upon which taxes and royalties are based. The effective selling price, however, ranges from $9.40 in Saudi Arabia and $9.70 in Iran to $14.43 in Venezuela and $14.65 in Libya.

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