In July 1974, a former bond trader turned politician named William Simon boarded a private plane out of Andrews Air Force Base for a two-week tour of Europe and the Middle East.
Simon had been Treasury Secretary for all of two months, and the government had a problem.
Three years earlier Nixon had cut the dollar loose from gold. Then came the Arab oil embargo, led by King Faisal of Saudi Arabia after the 1973 war, and the price of oil roughly quadrupled.
The real business was a four-day stop in Jeddah, where Simon’s job was to talk the Saudis into financing America’s deficits.
The deal was simple: Saudi Arabia plows its oil dollars into US government bonds, i.e. Treasuries, and in return America buys the oil, sells weapons to the Saudis, and guarantees the kingdom’s security.
Faisal said yes, on one condition— nobody could know.
So the Treasury let the Saudis buy bonds in special sales that never showed up in the official totals.
It stayed secret for 41 years, until Bloomberg pried the numbers loose in 2016: the Saudis held $117 billion of US debt, and a former Treasury official said the real figure was probably double.
The part of the deal guaranteeing security was never written down, but everyone understood it. Jimmy Carter said it out loud in his 1980 State of the Union: any attempt by an outside force to control the Persian Gulf “will be repelled by any means necessary, including military force.”
That was the deal, and it held for fifty years. It also meant Saudi oil would continue being sold exclusively in US dollars.
That forced the rest of the world to hold dollars, if only to buy oil from OPEC. Pretty much every country on the planet needs oil, so foreigners stockpiled US dollars… and, by extension, US government bonds.
As a result, the US government is able to get away with the fiscal equivalent of murder: $40 trillion in debt, more than the entire US economy produces in a year.
But this week a Trump envoy told the Gulf that America’s half of the deal is over.
Tom Barrack is the US ambassador to Turkey and Trump’s special envoy for Syria and Iraq. In an interview at a Doha security conference, he said American protection for Gulf oil no longer fits what America wants.
“America as the guarantor to the world, for the last 80 years, it is no longer there,” he said. Americans don’t want to sacrifice their lives for the Middle East, and the Gulf should look to smaller alliances like the new Saudi-Pakistan-Turkey defense pact.
Then he added: “What’s happening in this administration is not an abandonment. It’s a message for realignment. And that message is like raising a teenager. It’s not easy.”
Bear in mind who the teenager is here: Saudi Arabia.
The war the US and Israel launched against Iran in February has opened a second front in Yemen, where Iran-backed Houthi militants are firing missiles and drones at Saudi Arabia. They hit Riyadh’s airport on October 10, killing at least 13 people, and on Wednesday hit Dammam’s airport and an Aramco oil field, killing four more.
Crown Prince Mohammed bin Salman has asked Trump for military help at least twice. So far he’s gotten intelligence and targeting help, but no American strikes.
Mr. Barrack’s answer: Trump supports Saudi Arabia and will supply “the backing that they need logistically.” But Yemen’s Houthis, Lebanon’s Hezbollah, Iraq’s militias? “That’s not America’s job.”
On Wednesday, the day after that interview, the State Department ordered non-emergency US employees and their families out of Saudi Arabia.
So America’s message to the Gulf, boiled down, is this: we won’t protect you anymore, but please keep selling your oil in US dollars and buying Treasury bonds.
It’s absurd when you think about it; foreigners don’t need any more reasons to stop buying US government bonds.
The sheer incompetence of America’s collective political class make Treasury bonds look uninvestable. They can’t manage to pass a budget. They can’t manage to cut even the most obvious fraud. And no one seems to care as the deficits grow year after year.
Throw in all the other shenanigans, from the on-again, off-again tariff debacle, to the weaponization of the dollar, and foreigners are really throwing their hands up in exhaustion.
The trend is already showing up in the numbers. Fifteen years ago, foreigners owned nearly half of all marketable US Treasury bonds. Today they hold less than a third.
That’s a big deal, because with $2 trillion annual deficits to fund, America needs all the lenders it can get.
Bottom line, America is telling everyone it won’t be the world’s policeman anymore… but it still wants the funding that came with the job.
Foreign governments and central banks have already been reducing their Treasury holdings, and this move could accelerate the trend.
That means interest rates will continue to surge… until eventually the Federal Reserve finally steps in to bail out the Treasury Department by manufacturing an inflationary bonanza.
We hope that cooler heads exercise good judgment and reverse America’s course. But hope is not a course of action, and that’s why it makes so much sense to have a Plan B.
P.S.
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