As we start a new year, it is important to look back as well as forward. We have been clear in saying that a global cyber-economic war is underway. We've been absolutely right about that in a way that few people would have imagined five years ago or even at the start of 2014 for that matter. But as right as we have been, there's always a twist or two. In this case, we were certain that the U.S. dollar would come under attack by a Putin-led coalition. And, it did. But, we were not prepared for the incredible unleash of currency retaliation against the Russian Ruble. The collapse has been mind-boggling to say the least. Combine ramped up sanctions with a collapsing oil price and a global cabal of active hedge funds and it is as if the hounds of Hell were unleashed against Mother Russia. And yet, Putin has stood with most of his teflon popularity intact.
The point is this: the world IS singing the tune of cyber-economic warfare. We were just focused on the wrong verse over the last part of 2014, not expecting the blitzkrieg of oil's collapse to alter the landscape so powerfully and so rapidly. But this does not change the general truth: Economic warfare has arrived.
Here are a few facts worth noting:
- Putin has been working to undermine the dollar. It doesn't look very successful at the moment but that's not due to a lack of trying. In fact, his scheme has been in place for several years. And despite the Ruble's collapse, he is still moving forward. There are massive currency movements hidden underneath recent dollar strength.
- The oil weapon became perhaps the most powerful weapon unleashed to date in this war. We have discussed the weapon of oil in our work before and at length in Secret Weapon. It involves setting production levels above or below market demand to push prices. Many believe that the Saudis have led like-minded OPEC nations this direction with the tacit complicity of the United States. Even more importantly, however, oil can be a financial weapon waged in the financial markets. Excessive speculation can move prices higher or lower very rapidly. Simply withdrawing speculation was considered sufficient to cause a price drop. At one point Exxon-Mobil CEO estimated that speculation added about $43/barrel to the price of oil. One of the arguments against speculation was that if it could drive prices higher, it would also at some point drive prices lower. Guess what? That's been happening. In this way, Wall Street, both knowingly and unknowingly has been a force multiplier with regard to the oil weapon in both directions. There are suggestions that even Putin has endorsed manipulating oil prices through financial markets.
- The cyber weapon was used as expected but only to a measured degree at least as far as is known publicly. When fully unleashed, this will be even more devastating than oil. For now, however, the effort was sufficient to seriously undermine a global corporation like Sony and to embarrass the Central Command (Centcom) of the United States Military by the likes of North Korea and ISIS. Less publicized but even more threatening is the awareness that Iran hacked much of our nation's critical infrastructure. This is, unfortunately, just the beginning of something that will become far more serious and much more sinister.
- 2014 was also the year that sanctions became the weapon of choice, even waged against one of the more powerful nations of the world, a permanent member of the UN Security Counsel and nuclear superpower. Certainly sanctions have been used against Iran and others. But this past year they were ramped up against Russia. The use of sanctions became so prominent in U.S. policy that David Cohen has been moved from Treasury to become a Deputy Director of the CIA.
Obviously, this is just a small sampling of some of the examples from last year. And yet, these four literally altered the global landscape. Venezuela is on the brink of collapse with hyperinflation. There has been a massive shift of wealth. And there are some emerging trends that have the potential to dramatically alter the course of history. Here are a few things to watch out for in 2015:
- The death of the domestic shale oil industry. While we certainly hope that this won't be the case, the simple fact is that the Saudis and Russians agree on this matter. It is not a subject really even open to interpretation. OPEC has clearly taken direct aim at American energy development. This is significant because hydraulic fracking had led an energy renaissance that made America the number one nervy producer in the world. It produced jobs and economic growth—so much so that Texas and North Dakota were responsible in large part for setting America back on top in just a few short years. The problem, of course, runs far deeper than simply losing some oil production. Hundreds of billions of dollars have been borrowed and invested to make this happen. With the falling oil price, beneath the cost of production in many cases, this dream could well become a nightmare. Some have even compared the risk to that of subprime loans before the 2008 collapse. While many producers have hedged their risks by selling forward at higher than current prices, the other party in these derivatives will face serious losses. And the speculators are being forced to dump. Hopefully they weren't too leveraged. Regardless, if the money needed to fund fracking dries up (and it seems to be doing that now) it could be a long while before the American energy industry recovers. There is about $2 trillion at stake.
Of course, there are some positive benefits to falling crude prices as consumers retain spending power previously given to the gas pump. It remains to be seen, however, if this saved money will do much more than offset debt. When interest rates begin to rise again, either after the Federal Reserve abandons ZIRP (Zero Interest Rate Policy) or a stronger economy pushes rates higher, consumers may have to put their gas savings and more toward debt service. So, it remains to be seen if the vaunted consumer savings will really provide the expected boost to growth.
A third issue, largely unexplored, is that lower oil prices mean lower oil revenues for producer nations. This in turn means lower national savings that would be put into U.S. dollar based reserves. In fact, the likes of Saudi Arabia and Kuwait, once extremely flush, may even have to sell Treasury bonds to cover social obligations. This is the downside for the petrodollar as reserve currency. Fewer nations will need dollars if oil prices stay low. This is a serious wild card and might even play into Putin's hands. He says the petrodollar "must die."
The fourth issue is that falling prices might solidify opposition to hydraulic fracking around the world. Russia has notoriously funded anti-fracking efforts with some degree of success in Europe and Asia. But the United States held out, proud of its energy renaissance. With falling prices and some expected financial blowback, this may be the perfect opportunity to turn American laws, regulations, and public opinion against domestic energy development. We've discussed this at length and even the former Secretary-General of NATO has acknowledged publicly that Putin has funded anti-fracking efforts around the world. We've even seen the city of Denton, in the heart of energy-rich Texas turn against fracking. Maybe now the world will come to appreciate Matt Damon's UAE-funded anti-fracking film.
It is worth noting that there are a few who believe the shale industry will not only recover but through technology can dramatically lower their cost of production–even below most of OPEC. If that is correct, it will be very significant.
- The truth is that the dollar has become freakishly strong in recent months, at least relative to other world currencies. This is what Wall Street calls a very crowded trade. Crowded trades have a nasty habit of reversing themselves rapidly based on unexpected events. In the mid 1980's during the last American energy renaissance, for example, the dollar strengthened dramatically before later collapsing—"a pop first, and then a crash" is how the Financial Times described it. So far, the decreased demand for petrodollars has been more than offset by increased investment demand. But, if and when that reverses, there may be little support left. The problem is that total Federal debt now exceeds $18 trillion, up from about $10.6 trillion just six years ago. That is an increase of almost $85,000 for every full-time private-sector worker. Debt gapped $100 billion higher in a single day at the end of last year. [This, of course, does not include the additional more than enormous unfunded liabilities some estimate over $200 trillion that would have to show on a balance sheet if the government were a corporation.] It is becoming increasingly important to be able to rollover the old debt each year. At the moment, demand for Treasury bonds globally and a still-easy Federal Reserve keeps the scheme rolling. But what happens if the Fed starts to tighten to normalize rates just as global investors seek opportunity elsewhere? This too can create a feedback loop that could prove particularly troublesome. If it happened just as oil prices started to rebound we could be faced as a nation with a terrible dilemma, having to choose between the evils of inflation and the horrors of recession. Putin has been buying gold in preparation. If he survives sufficiently to be in a position to move against the dollar, look out below. The Chinese have apparently offered to help. If they succeed, we may have to watch our vaunted currency come under global attack.
- There is always a risk of Russian-led retaliation especially in the Cyber realm. If North Korea could shakedown Sony (and it was either them or some really good independent hackers aided by traitors inside the company) and ISIS can embarrass Centcom, just imagine what an unleashed Russia could do. We already know that Iran has hacked extremely sensitive infrastructure. What would happen if Russia chose to take out the stock exchange? Or cause a major national power outage? We have been warned about the very real potential for a Cyber Pearl Harbor. We cannot afford to ignore this possibility. After all, would a nation that told us they had the capability to turn America into radioactive dust really hesitate to hack a few computers? In response to what he describes forthrightly as economic warfare, Putin has considered backing out of peace talks regarding Ukraine. Some believe he has also launched a cyber attack against Germany. And there is little doubt that he has attempted to rally the rest of the word against America. Some sage advice? Beware the wounded Bear!
Now, we can never be certain as to whether or when these concerns might manifest. Hopefully, we can escape 2015 without a serious problem. If we are smart we will use any peaceful period to shore up rather than decimate our energy industry, to get our fiscal house in order, and to prepare both improved cyber offensive and defensive capabilities. There should be little doubt, however, regarding the fact that the world is singing the global cyber-economic warfare song. The only question is what verse will be sung next.