The Dividend Cafe - The Country No One is Talking About

Episode Date: March 25, 2022

We all know that the Russian invasion of Ukraine has been the biggest story of 2022 thus far, not just for markets but for the entire news cycle. Ten minutes do not go by on the news without hearing the word “Russia” or “Ukraine” – for good reason (there is a war going on, you know). And there are other countries that do not exactly hide in the background, either. China is never far from our dialogue, both because of their role in the COVID pandemic that swept the globe in 2020 and because of their sheer size as an economic powerhouse. In fact, U.S.-China relations may be the most talked about geopolitical story of the last ten years (also for good reason). But there is another country that is rarely discussed these days, and perhaps offers as many economic implications as Russia, Ukraine, and China. And when I say economic implications, I mean the full portfolio of categories – geopolitical, financial markets, and macroeconomic. And that country is the subject of this week’s Dividend Cafe. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe podcast and video. I am at a remote location here on this Friday. It's been a whirlwind of a week. location here on this Friday. It's been a whirlwind of a week. I may have enjoyed a couple days last weekend for March Madness, but hit the ground running this week. And actually, with a 24-hour trip to Washington, D.C. in between, and a whole lot of client meetings and speaking different things, it just has been incredible. And yet, I actually feel really, really excited right now because there's been a significant amount of new reading, new research this week that has me fired up. There's never anything that fires me up more than just being able to really have that focus

time of research and reflection. And I also feel like this week was maybe the first week in the news cycle, financial news cycle particularly, where, look, there's still plenty of volatility day by day. There's plenty of uncertainty around bond yields, around commodity prices, and obviously all centered around the ongoing saga in Russia-Ukraine. But it does seem as if there's a little bit of a willingness or interest in talking about some other stories besides Russia-Ukraine. And it's starting to settle in a little bit that the Russia-Ukraine thing is not going away anytime soon. Both sides of the conflict have accepted that there's not an imminent ending coming. And I think that's a bad thing. But I merely comment that it seems to be a little bit more accepted.

So with that said, I want to focus our attention this week on a topic that is not Russia-Ukraine and is not the Fed and is not even really directly, but is indirectly China. And that is a country that I think no one is talking about. And you can always pick some country somewhere, you know, 200 countries on earth, there's some country no one's talking about, and they're not talking about it for good reason, because it doesn't really necessarily matter a whole lot in the grand scheme of financial markets or geopolitical news or what have you. But Saudi Arabia is not one of those countries. It matters. It matters economically.

It matters in global macro. It matters in geopolitics. It matters in U.S. foreign policy. And yet I believe that for the most part, if anyone is U.S.-focused in talking about global developments, they talk about China or maybe nothing. And if they talk about anything that isn't China, it's Russia, Ukraine, and they've talked about it for a whopping six weeks. But when one considers the profundity of what is taking place around the world and has been historically such a significant alliance,

and now what appears to me to be the thawing of that alliance, I am not convinced that ignoring this story is a good idea. The problem will be by the time you're at the end of this podcast, you're going to say, well, what is the takeaway? What have you concluded has to be done? And I haven't concluded any such thing. I don't know where it's going. I don't know what it will eventually mean, but I do know what questions to start asking and what things to be following. And that starts with an historical understanding of how we got to where we are. So I want to talk about Saudi Arabia a few minutes, and I hope you'll learn something from today's Divinity Cafe. And I certainly will welcome any questions you may have after the fact.

If you go back, I won't spend a ton of starting in the UK and their acceptance of Saudi Arabia into the global international community, if you will. The U.S. recognized diplomatic relations with Saudi, but there wasn't anything formal until after World War II. And it was pretty well accepted, hey, they have a lot of oil, and we're going to need it. And more or less from FDR on, there was informally and at certain points more formality around a relationship between the U.S. and Saudi Arabia that was not very complicated. It was pretty much, we're going to protect you. The U.S. is going to protect Saudi to some degree. We're going to sell you things like military equipment, jets, missile systems, and we're going to buy oil from you. And then what you're going to do, Saudi, is you're going to sell oil to us and you're going to help maintain a certain order, a stability in world energy markets. And there have been points at which the relationship was frayed on the margins in the 70s.

There's always been periods where the U.S.'s relationship with Israel was not Saudi's favorite thing. There are periods where pockets of terrorists that existed in Saudi jeopardized U.S.-Saudi relations. But that economic core relationship was always there. And then at the point at which it was max tested, you could argue, was the peak strength of the U.S.-Saudi relationship was Saddam Hussein's invasion of Kuwait in 1990. The U.S. put over 500,000 troops in Saudi Arabia, 500,000, basically saying, no one's going to hurt you tonight, not on our watch, okay? I've watched The Few Good Men a lot of times. And so a lot of people have different opinions about U.S. Middle Eastern policy over the years. I'm really only talking prescriptively right now, not prescriptively. You know, various nooks and crannies of what ought to be policy. I could do that another time, but I don't have strong opinions

on the aspect of what I'm getting at now. I'm just saying it is indisputable and non-controversial that descriptively the U.S. had a pro-Saudi policy, and it was rooted in what was deemed to be mutual interest. We needed their oil. We needed some form of stability around the Middle East. Middle Eastern extremists traditionally do not say when they're mad, let's go after China or Japan. Their targets have always been the West, not the East, and that's usually us, sometimes Western European allies. So there's been a desire to limit fanaticism,

and there's most certainly been a desire to maximize economic stability out of the region. And Saudi has had an incredible leverage there based on being the world's largest holder of oil reserves. So you fast forward and the new century has brought a lot of changes. And some of them were rather abundant in the first 10 years. You had 9-11, and that definitely began a bit of a thaw in U.S.-Saudi relations. 15 of the 19 hijackers were from Saudi Arabia. They were not Saudi nationals. They were fanatics and al-Qaeda terrorists. But there was a lot of questions as to why money was able to flow around Saudi the way it was.

It was enough done. There's many who, you know, continue to believe that the U.S. did not hold Saudi to account for what transpired the way it could have. But nevertheless, coming out of the Bush administration and going into the Obama administration, there was still a very fraternal relationship between the U.S. and Saudi Arabia, but with some hair on it, beginnings of some thawing of that relationship.

But the biggest change that has just been totally underappreciated by not only investors, but I think most observers of the world stage, is fracking. I think most observers of the world stage is fracking. The U.S.'s capacity for domestic oil and gas production out of the shale revolution just substantially changed. We were importing over one and a half million barrels per day in the United States from

Saudi alone, not even referring to other OPEC countries. And we now import less than 500,000. So you've had over a 67% drop in our need for Saudi oil. So the economic dynamic change and the potential for a real substantial change in that leverage of Saudi oil reserves and now the U.S.'s domestic capacity changed a bit. States, which there are some parts of I agree with. I myself am very interested in limiting the emission of carbon. And yet, you know, there's very strong disagreements I have with the environmental movement that would operate as if wind and solar were somehow currently adequate to meet our needs. And so I think I take a pretty nuanced, balanced, realistic view towards the subject. But there's no question that one of the things that was very friendly for Saudi in U.S.-Saudi relations was the American environmentalist movement that sought to limit America's export capacity.

to limit America's export capacity because even though U.S. now needed to import less because of our domestic production ability, it's one thing to have been less of a customer to them, but to become more of a competitor to them probably would have escalated the stakes even more. And the environmental movement was really quite opposed to our production capacity being used as a weapon for more exporting and competition to kingdoms like Saudi Arabia. And so, you know, we kind of were surviving in our relationship even out of the shale revolution. But I think a lot of that was because we weren't necessarily a big export competitor yet, and still aren't yet. But then the geopolitics of the last 10 years, the Arab Spring in 2011, 2012, the U.S. largely sitting

out some of the conflicts that were existing. The Muslim Brotherhood prevailing in removing democratic leadership in Egypt. That former leadership had been U.S.-friendly and Saudi-friendly. Muslim Brotherhood was not. The civil war that broke out in Syria. The prevailing party that was largely Russian-backed was anti-Saudi. The U.S., again, kind of sat that one out. There's a lot of people that are really supportive of the U.S. sitting it out. There's other people that are critical. That's not my point. My point is merely that it was a contributing factor to an ongoing thawing

of relations between the U.S. and Saudi Arabia. Then you fast forward a little bit, and there was this famous killing of a journalist, and the U.S. is subsequent, not only Saudi denials of it and cover-up, but U.S. condemnation of it, really serving to embarrass Saudi Arabia on the world stage. And the U.S.'s deal at the later portion of the Obama administration with Iran, effectively bringing Iran back onto the market for daily oil production that Saudi was vehemently against. Well, let me mention one more event. 2019, and this is now in the Trump administration, not in the Obama administration, but a very massive terrorist drone attack. Iranian terrorist groups took credit for it, although the nation of Iran denied involvement.

But you had a pretty significant drone attack on Saudi oil fields. And again, the U.S. neglected to kind of get involved there. So, you know, 75 years of an understanding on the world stage with two of the richest nations on earth, that understanding was really kind of undone in the last 10 years. And I don't think anyone's talking about it. I don't think anyone knows what to say about it, what the real implications will mean. March of 2020, I think in a sense, Saudi declared economic war on the U.S. and on much of the world by flooding world oil markets. A glut of supply just as the pandemic was breaking out

for no other reason than to impose pain. And that got quickly undone through a variety of things I won't get into now and ultimately resulted in an OPEC plus arrangement that remains in effect to this day. But they were playing for keeps in the initial stages of COVID there. And now you say, where are we? Well, U.S. and Saudi don't really talk. Saudi is not taking phone calls from the White House now as the Russia-Ukraine thing is going on. And there's the posturing of them inviting President Xi to come to Riyadh and the talk of them going against what has been really since Bretton Woods, an understanding of petrodollars being the currency for purchasing global oil.

Well, over 80% of oil, and I think it's all of oil bought from Saudi Arabia, is denominated in the U.S. dollar. And there's been no decision yet or contract or announcement, but again, discussions of China purchasing oil from Saudi Arabia, which they do already, but now doing it in Chinese yuan instead of U.S. dollar. Does that kill the dollar? No. does that kill the dollar no is that a symbolic gesture of trying to limit the dollar's effectiveness as a reserve currency i'm sure it is i think there's a sense in which anything that were to force more accountability for the dollar which the yen and the euro have been unable to do for a long time because of their own problems and structural impediments.

I think anything that could force greater credibility for the dollar is a good thing in a sense. But then the question is, well, is there more going on here? Is there a weaponization of currency that's really behind this? I don't know how anyone could really deny that at least some pump faking around that is what is at play. So does this mean go long

oil or short dollar or long China or short Saudi or whatever? I have no idea. Anyone who tells you they do doesn't. It means this. For 75 years there's been a relationship between US and Saudi that I think is gone now.

Does that mean the new relationship is hyper-adversarial? No. Not yet? Maybe, maybe not. It means that there's a thawing out of the relationship that now leads us to a period of uncertainty. And the uncertainty is not with the United States and Qatar or United Arab Emirates. It is with Saudi Arabia, a gigantic Middle Eastern kingdom of profound religious, political, and economic significance. It means that it gives opportunity for triangulation with China, opportunity for triangulation with China, with Russia, with other trading partners. It means the U.S. oil market has a greater incentive to become self-sufficient. Our production of U.S.-based energy, potentially our aspirations for exporting are enhanced. It means that there's more questions around where currency will fit into this

as we evolve through the ongoing decades of this already rather unsettling 21st century. So we're going to keep talking about China. We're going to keep talking about Russia, Ukraine, but we're going to talk about Saudi Arabia because it's what our job is to try to evaluate not only the things that everyone's talking about, but the things people aren't. engaged in this and looking for both opportunity and threat to potentially manifest itself in our portfolio decision making. I hope this has been helpful. I welcome any questions you have. If you are not a client of Bonson Group and you're listening to this and find it intriguing,

send the video or podcast to your advisor. Maybe if there's someone out there not thinking about Saudi Arabia, this will make them think about it a little. You can always question why they're not thinking about it too, but I'll save you the commercial. Listen, enjoy your weekends, a lot going on in the world. I look forward to being back with you on Monday at the end of your day. Thank you as always for watching and listening to The Dividend Cafe. with Hightower Advisors LLC, a registered investment advisor with the SEC.

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