Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

17 December 2014

A Moral Equivalent of War, or Why Oil Prices Dropped so Rapidly


Introduction: the wisdom of the ancients
Seeking an effective moral equivalent of war
Examples
Conclusions

The wisdom of the ancients

Ancient Greece and Rome didn’t incarcerate mavericks or misfits from the ruling class. In fact, they didn’t incarcerate much of anyone, at least not for years-long sentences like today’s. Lengthy stays in dank and vile dungeons were an invention of the Dark Ages; the ancient world simply didn’t have the resources—or the cruelty—to sustain or even invent them.

The ancient Western World punished serious political crimes with death, as in Socrates’ and Cicero’s cases. Lesser crimes it punished with exile. At least it did so when dealing with members of the elite having what today we would call substantial political clout.

Imperial Rome, for example, exiled the poet Ovid when his satirical democratic and “subversive” writing became too much for the new imperial regime to bear. His writing made him too popular to “proscribe” like Cicero, and his “crimes” were not so directly subversive.

In those days, exile was a much more severe punishment than ostracism, which Greek society also used on “errant” elite. To the elite living in them, ancient Greece and Rome were not just the height of human society. They were the best of human civilization, if not its all.

There was no Internet or electronic communication in those days. So exile meant depriving the errant not only of all current contact with his native society, but of most information about it and any chance of influencing it.

For those reasons and others, exile was painful. An elite Greek or Roman accustomed to what was then the height of human cuisine, music, literature, science and erudition felt exile as psychological torture. An analogue today would be sending an elite New Yorker housed on Park Avenue to live in West Africa (even sans ebola) or rural Colombia.

How do we know? Among many other things, Ovid wrote letters telling us so. An erudite and social man, he suffered exquisitely from exile, so much so that it broke his rebellious spirit.

So what does all this have to do with the price of oil? Stay with me.

Seeking an effective moral equivalent of war

From a modern perspective, exile seems a singularly clever kind of punishment. It avoided the brutality of state-sponsored murder, let alone state-sponsored torture. It kept the victim alive and well in case—as often happened—the political climate at home changed and made him welcome again. Yet it got him out of the way of the current ruling elite. And it inflicted real pain, as any punishment should.

Ever since nuclear weapons made wars between major powers too costly to wage, our species has been looking for a moral equivalent that is both less costly and more effective. If the truth be told, the need for such an expedient began dawning many decades before the Nuclear Age. Our own bloody Yankee Civil War, the vast and pointless slaughter of World War I, and the near-global devastation and slaughter of World War II, with its estimated 50 million premature deaths—of which those in Hiroshima and Nagasaki were only a small fraction—made the point with increasing clarity. Or at least they should have.

But it took the near-brush with species self-extinction in October 1962 to wake us humans up. And even then, it was only the acts of three wise and cool-tempered individuals—two Russians and one American—that saved us. No one can accuse our species of being quick learners.

Yet however long it took us to get there, we humans appear to have decided, at least tentatively, that “total war” is not the best means of resolving disputes among nations. Since the first nuclear weapon fell in anger, there has been no major war between major powers fighting each other on their own territory, anywhere in the world.

So how do major powers resolve disputes if they can’t go to war? Our species has been chewing on that problem for 69 years and counting.

For a while, we tried diplomacy and discussion, like reasonable adults. There was a flurry of activity in these fields just after World War II. Among the results were the United Nations and the Bretton Woods economic forum, which eventually morphed into the WTO. There were also innumerable bilateral discussions and agreements.

But all these expedients met three obstacles, of which the UN is a prime example. First, the structure of institutions often made it hard to reach durable and effective decisions. Some powers were more equal than others, as in the UN Security Council, where the Soviet Union and China, now Russia and China, vetoed action that most of the rest of the world wanted to take. Second, the UN General Assembly was too big and unruly to generate a consensus on all but a handful of issues.

Third—and vitally important—there was no real enforcement mechanism. There was only a resort to “self-defense,” individually or collectively. That, of course, invited the very thing (war) that the UN had been set up to make obsolete.

The WTO is similar. It provides dispute-resolution panels. But, at the end of the day, all they can do is authorize retaliatory economic action by an aggrieved nation. And what is retaliatory action? Temporary protectionism, i.e., the very tariffs and quotas that the WTO was set up to abolish.

What was and is missing in these institutions is an enforcement mechanism that is flexible, effective and spontaneous, much like war, but without all the blood and destruction. We humans needed, and still need, a mechanism for resolving disputes that won’t ultimately convert a bunch of our cities, and the people in them, into radioactive rubble.

This year, 2014, we may have found one. The precise means is hardly permanent, for reasons we will discuss. But the general trend relies on ancient wisdom.

It goes without saying that you can’t exile a whole errant nation in the modern, global economy. Since our Yankee “Moon shots” ended in the late 1960s, we haven’t even been able to get a few good men and women off our planet. So exile is out.

But what about its ancient cousin, ostracism? Ostracism can inflict real pain, as Iran knows and Russia is beginning to understand. But much like war, it requires big alliances to be effective.

No single nation, even one as rich and powerful as ours, can impose effective economic ostracism on another. The global economy is too rich, varied and diverse. Economic ostracism only works when there is enough of a global consensus to severely constrain the economy of the target. So ostracism is not an instrument for vendetta of one nation against another, although (as will see) it can incidentally serve that purpose.

In sum, economic ostracism—what we now euphemistically call “sanctions”—has much the same characteristics as war, but without all the agony, blood, and rubble. It has the virtue of acknowledging the preciousness and fragility of human life, while allowing a significant global consensus to work its way.

And unlike the UN, ostracism suffers from no veto power. Economic ostracism works whenever there are enough nations, with enough collective economic power, to inflict real economic pain on the target, even though others do not participate. It’s a variant of majority rule by nations, with their individual votes weighted by the strength of their individual economies. (The West should take particular note of this point, as China is soon to become the world’s most powerful economy.)

Examples

Having spent so much time on an abstract introduction, let’s see how economic ostracism works in practice. The examples so far all depend primarily on the commodity that, at present, makes the world go round, namely oil.
    Iran’s nuclear program
For two reasons, we shall not spend much time on Iran’s nuclear program. First, the story is well known, at least in general terms. Second, it is still untold. The crucial negotiations are still unfolding as I write these words.

But the salient outlines of the story are worth retelling. Iran has a proud and ancient culture and a smart, resourceful and entrepreneurial people. One recent survey rated it the fourth most entrepreneurial nation in the world, even in its present, economically hamstrung state.

In 1953, Iran was a budding democracy, with a duly elected prime minister. But it made the diplomatic blunder of being the first nation in the Middle East to nationalize its foreign oil companies, chiefly American and British ones.

This we Yanks and the Brits could not tolerate. So we used our spooks and collective influence to stage a coup, depose Prime Minister Mossadegh, and install the Shah as Iran’s leader. As first, the Shah was not so bad. But as the Cold War and consequent Western demands for obeisance wore on, he became a puppet of the West abroad and a brutal dictator at home.

The inevitable revolution followed, in 1979. Because our misguided Western policy had destroyed Iran’s democratic institutions, the local religion (Islam) was the only social power strong enough to begin and sustain the revolution. And so we have the Islamic Republic, with the Ayatollah as the Supreme Leader, superimposed on what is beginning to look like the same sort of healthy democracy that we Yanks and the Brits body-blocked in 1953.

In sum, nearly all the things we Yanks don’t like about Iran today are direct results and consequences of our own misguided policies. That being the case, we might try to make amends with a heartfelt apology, like the one Colin Powell wisely made to China after the spy-plane incident, and decree a slow rapprochement.

But not so fast. Bad foreign policy has sad consequences. Many Iranians have grown to hate us Yanks, not without reason. They call our nation, “The Great Satan.” Having no power to do us serious harm, they take it out on our innocent protege Israel, which has never done Iran any direct harm and, if the two nations cooperated, could make the Middle East’s collective economies, fueled by oil, rise faster than the “Tigers” of Asia.

So Iran picked a fight with Israel and demonized it, in part just to hurt us Yanks and reduce our regional influence. Now Israel is justifiably paranoid at the thought that Iran might go nuclear.

At the same time, Iran itself has become paranoid of us Yanks after watching the mess we have made of Iraq. Its leaders, apparently, do not yet dare to believe that we Yanks, after suffering real, sad consequences of our own, have finally tired of Dubya’s unnecessary and misguided foreign military adventures. So there are still those in high places in Iran who would like to have an unnecessary nuclear deterrent, not so much against Israel, but against us far more powerful and aggressive Yanks. Thus do the consequences of our own many bad policies threaten to spin out of control.

There are those in our own country who would like to dispel the consequences of our own bad policies by making war on Iran. But the other major powers are more reasonable. With visions of the world’s largest oil reserves becoming radioactive or unrecoverable due to yet another unnecessary war, they want Iran to give up its nuclear ambitions.

For them, it’s bad enough that Israel has nuclear weapons and a prime minister who, with his references to Judea and Samaria, seems driven more by ancient scriptures and grievances than modern reason. These major powers see the Ayatollah as yet another potential fanatic driven by similar motives, albeit somewhat different ancient scriptures. They recognize that it takes two to tango, and that having both Iran and Israel with nuclear weapons makes it much more likely that they will be used, or that other nations in the region, like Saudi Arabia and Turkey, will seek them.

And so we have a global consensus, including even Russia and China, that Iran should not seek nuclear weapons. The so-called “sanctions” on Iran are the enforcing instrument of ostracism to realize that consensus.

As we have noted, the full story is not yet told. But ostracism has brought Iran to the bargaining table. If it produces an acceptable compromise, with acceptable assurances against a nuclear-armed Iran, it will have been the first successful use of economic ostracism in the postwar era as a moral equivalent to war. So much rides on the current talks and on John Kerry’s skill at diplomacy.

    Russian’s foreign-policy sins
And so we come to the much more complex case of Russia. It may have broken the letter of international law in annexing Crimea. Yet Crimea was historically a part of Russia, has a clear majority of Russian people, is the site of an absolutely essential Russian naval base, and was given to Ukraine only at a time when no one dreamed that Ukraine would ever become independent of the Soviet Union or today’s Russia. So there are good reasons for the rest of the world to wink at the letter of the law and give a Putin-esque shrug at Russsia’s bloodless fait accomplis in Crimea.

The Donbass (Donyetsk and Luhansk) is another story entirely. No part of it has a Russian-speaking majority. It has no historical claim to be part of Russia, although Russians helped develop its industry. And, unlike Crimea, it cannot be said to be essential to Russia’s defense, now or in the past. So Russia’s recent activity vis-à-vis Eastern Ukraine is hard not to interpret as a sheer land grab, or at best an attempt to resurrect Imperial Russia’s (and the Soviet Union’s) failed policy of forcing neighbors into the mold of weak vassal states, rather than healthy nations.

More important, Putin’s policy toward the Donbass has created wholly justified international paranoia. Russia is not just a nuclear state. Along with us Yanks, it is one of the only two nuclear states that have created such a gigantic surplus of nuclear weapons as to threaten, in the event of their use, not only human civilization, but the Earth’s entire biosphere.

For this reason if no other, no one other than stateless terrorists is ever going to attack Russia on its own territory again. Surely Putin, as smart a leader as most major powers can claim today, knows this.

So when an unassailable country like Russia, with a single, macho man unquestionably at its helm, masses troops on a neighbor’s border, lets many of them cross, and supports a bunch of bloody and undisciplined extremist rebels inside the neighbor’s territory, causing a civil war and, willy willy, a great deal of ethnic cleansing, the rest of the world understandably quails in fear and horror. Russia’s former Soviet satellites in Eastern Europe quake especially violently.

There are times when paranoia is justified, and this is one of them. Surely the leader of the most-attacked and most-invaded major power of the last two centuries ought to know that.

Unfortunately, Putin’s abysmal policy in the Donbass is not without recent precedent. Through his inept and mindless support of Iran and Assad, Putin has become an accomplice in reducing Syria to rubble and making it a sustained killing field—something that he would not for a moment tolerate inside his own country. In the process, he has helped burden the entire Middle East with a constant and growing stream of impoverished and terrified refugees, and he has fostered the rise of IS.

As a result, there is probably no nation in the Middle East besides Iran that considers Putin’s foreign policy rational and helpful, let alone effective. Since the sad consequences of Putin’s blunders also threaten the world’s oil supply (except, conveniently, that from Russia), we have a strong global consensus to sanction Russia for its foreign-policy sins.

And so we have a second, more recent, application of ancient ostracism as a moral equivalent of war. In this case, we have perhaps the strongest possible combination of motives: (1) strong indignation at policies that contravene not only international law, but most conceptions of morality, ethics and religion; and (2) a reasonable fear that those misguided policies, if continued, will eventually disrupt the flow of oil from the world’s most plentiful oil reserves, thereby destabilizing the global economy and global civilization, which runs on oil.

China has waffled a bit, not knowing whether to treat Russia’s actions in Ukraine and elsewhere as an internal or external matter. But strength of the consensus to ostracize Russia for its sins, at least in Eastern Ukraine, was never much in doubt. It is self-evident that Putin’s disastrous foreign policies lie at the heart of the worst wartime devastation and (except for ebola) the worst humanitarian crises taking place in the world today.

Yet until recently, the effectiveness of the consensual ostracism was in doubt. Europe, which trades most heavily with Russia, was reluctant to participate fully. But as Putin appeared to be doubling down on his blunders, the consensus hardened, and the ostracism did, too.

Still, there was a problem with this moral equivalent of war. Russia had just begun the slow process of integrating into the global economy, after seven decades of Communist isolation. So some of its less prescient leaders, apparently including Putin, saw a false way out: back to isolation.

That was the situation until recently, when the oil-price crash hit home. Now there is no question that Russia’s economy, 25% dependent on energy, let alone its government, 50% dependent, are hurting. More than anything that came before, the plunge in oil prices is setting Russia back and making it leaders introspect.

All this brings up an interesting and current question. Was the unexpected and surprising plunge in oil prices part of the ostracism or a separate and unrelated event? Let’s analyze.
    The oil “weapon”
To begin our analysis of the recent oil-price crash and Russia’s ostracism, we must first address the conventional wisdom for what caused the crash. It suggests the cause was the shale oil boom inside the United States, which has vastly increased our Yankee oil production.

There is a good reason why this explanation makes no sense: timing. The so-called “shale boom” in US oil production has been going on for years now. Its effect on US oil production and oil prices should have been gradual, not sudden, at least if the global market for oil is anything like the free market it is supposed to be.

Instead, the price drop came suddenly and recently, 40% in the six months since June, of which about half (20%) came in just the last few weeks. If the US oil-shale boom were the real cause, then the entire industry of oil analysts and traders—perhaps the globe’s most important trading industry besides finance itself—have been asleep at their computer screens for several years.

That’s always possible. We should never underestimate the stupidity and herd mentality of financial traders at their computer screens, especially after the Crash of 2008. But it’s unlikely. So, if that’s not the real reason for the oil-price crash, what is?

The most immediate reason is OPEC. It reportedly accounts for about 40% of global oil production, which is about 90 million barrels per day. As I have discussed at length, oil is an extremely price-inelastic commodity, in both supply and demand. In the period 2005-2008, for example, the price of gasoline in the US (which tracks the price of oil) rose from $2 to $4 per gallon, while demand fell only 1.3%. If we take that US elasticity of demand for gasoline as a proxy for the global price-elasticity of oil, we can conclude that a decrease in global supply of oil in the amount of only about 1% would have wiped out the entire recent 40% drop in oil prices. (In a reverse of the 2005-2008 shift, a 1.3% increase in demand would have produced a 50% drop in gasoline prices).

Since OPEC produces but 40% of global supply, it would have had to reduce its own output by 2.5% to produce a 1% decrease in global supply. Could it have done that?

Sure. After all, it’s a cartel. Not only could OPEC easily have done it collectively. All by itself, Saudi Arabia, which produces nearly 12 million barrels per day [click on “Latest Year” after “Petroleum”], could easily have cut production by the 1% of global production (0.9 million barrels per day) needed to keep prices from falling.

So why didn’t OPEC or the Saudis alone hold prices stable and high by cutting production accordingly? There are only two possible answers. First, they might have wanted to maintain their own or OPEC’s members’ oil revenue. Second, they might have wanted to use the oil price drop for a political purpose.

The first answer is possible, but doubtful. Because of oil’s vast price inelasticity, maintaining production could not preserve revenue nearly as much as cutting it. Cutting total OPEC production by 2.5% would have maintained oil prices, with no drop at all. It therefore would have reduced total revenue (production x price) of all OPEC members collectively (assuming production cuts were shared in proportion to production) by only 2.5%.

If the Saudis’ alone had absorbed the production cuts, their own revenue would have dropped by roughly 0.9 million / 12 million = 7.5%, the amount of their production cut. At the same time, all other members’ revenue would have been unchanged, because neither their production nor oil prices would have changed.

In contrast, maintaining production and allowing prices to drop would, and did, reduce revenue of all OPEC members by the amount of the price drop, or 40%. Perhaps the Saudis refused to bear the brunt (a 7.5% revenue drop) of production cuts all alone, even though that refusal increased their own revenue losses by more than a factor of five, to 40%. Perhaps the members tried but failed to agree on across-the-board production cuts (and consequent revenue losses) of just 2.5% in order to avoid universal revenue losses of 40%.

Both these reasons are possible. But strictly speaking, neither would have been economically rational, if “rational” implies entirely an economic calculation of reducing one’s own revenue losses as much as possible.

So why did OPEC instead, with the Saudis in their usual lead role, condemn all members to a 40% cut in oil revenue? It must have had a non-economic motive for refusing to make the production cuts and keeping prices high.

Non-economic motives are not hard to find. As the initiator and ever-dominant player of OPEC, Saudi Arabia is well acquainted with using oil as an economic weapon, beginning with the highly successful Arab Oil Embargo of 1973-1974.

In this case, three non-economic motives are likely. The first goes right back to the path-breaking aim of this moral equivalent of war: curtailing Iran’s nuclear ambitions.

With the possible exception of Israel, no nation on Earth is more leery of Iran getting nuclear weapons than Saudi Arabia. Iran and Saudi Arabia are arch-enemies and rivals for both regional dominance and the control of global oil reserves. Their enmity goes back to the millennial split between Sunnis and Shiites, long before Israel was a gleam in Zionists’ eyes. By keeping oil prices low before the US-Iran talks conclude, the Saudis: (1) put additional economic pressure on Iran to abandon its nuclear ambitions, (2) pressure Russia to pressure Iran to make a deal, and (3) remind both Iran and Russia that Saudi Arabia has a potent economic weapon, which it can assert independently of any outcome of the talks.

Saudi Arabia’s second motive is adding to the pressure of international sanctions on Russia. In the last several years, Russia has poked its thumb in Saudia Arabia’s eye by: (1) giving financial and military support to Iran, Saudi Arabia’s arch enemy, (2) supporting Assad, whom Saudi Arabia opposes, and thereby increasing the extremism of Syrian rebels, for which Saudi Arabia, with its “charities” and madrasses that foster Islamic extremism, rightly gets blamed. The Saudis’ may simply be reminding Imperial Putin that they have power to be reckoned with, too.

Finally, the Saudis may be piling weight on the ostracism of Iran and Russia in order to regain the trust of us Yanks, the Saudis’ patrons and defenders, which they have gambled and partially lost by supporting Islamic extremists throughout the Middle East and South Asia. In fact, our own President Obama, who is among the cleverest and subtlest of leaders, may himself have suggested this way for the Saudis to “redeem themselves” with us Yanks.

Conclusions

The recent oil-price crash may be upsetting to day traders in commodities and stocks. It may roil “The Markets,” further debunking the myth that modern financial markets are some sort of celestially neutral arbiter, not controlled, like everything else in our social lives, by actual people. But, most likely, it is simply collateral economic damage from an emerging kind of dispute-resolution mechanism—a new moral equivalent of war.

It’s about time we humans discovered such an expedient. Even before the nuclear age, our “total wars” were getting increasingly bloody, irrational, and catastrophic. After the advent of nuclear weapons, they promised to be species-suicidal. Indeed, in 1962 they nearly were.

Now we humans have a new mechanism, to add to interminable and often fruitless discussions in bodies like the UN, whose structures, based on pre-existing power relationships, often produce vetoes and gridlock, just as do our filibusters and “Hastert Rule” here at home. That mechanism is economic ostracism, aka “sanctions,” and it’s now undergoing its first real tests with Iran and Russia.

All of us had better hope and work as hard as we can to insure its success. The alternatives are too horrible to contemplate, while a successful precedent will make human life much safer and more enjoyable. Like the Barons’ troops arrayed against King John’s men on the fields of Runnymede, ostracism might eventually produce a sort of effective global democracy, in which voting takes the place of sanctions, with their power ever in the background.

In the meantime, we should all remember an essential truth. Unlike war, economic ostracism seeks to change behavior, not to cripple a presumed enemy, let alone annihilate him. Like any punishment, it works better as a deterrent and behavior changer than as a means of retribution.

That may be precisely why the oil price drop seemed to happen so suddenly. It bites the hardest just as the talks with Iran are coming to a head, and just as Russia’s Putin seems to be contemplating courses of action in Eastern Ukraine that make no sense from any perspective besides misplaced national pride.

Now Saudi Arabia, whose past financial and verbal support for Islamic terrorism has come close to making it a pariah state, is adding the weight of its considerable oil reserves on the side of ostracism. But Iran and Russia both should know that ostracism is, by design, a temporary measure. As soon as Iran gives up its pretensions to nuclear weapons, it can enjoy the boom of prosperity that its budding democracy and people’s skill portend. As soon as Russia settles the Ukraine crisis reasonably, and cooperates to do what can yet be done to heal the open wound of Syria, is can resume its push to become a normal country and a productive part of the global economy.

That’s the beauty of ostracism. It kills no one and destroys nothing. It therefore ought not to foster hate. It can be reversed at any time. All it does is apply the persuasive power of a global consensus that the target, for whatever reason, is departing from the path the rest of humanity thinks best.

Erratum: An earlier version of this post garbled the numbers for the production cuts that the Saudis alone would have had to make to keep oil prices stable. It also failed to note that, in taking the entire hit, the Saudis would have incurred a revenue loss of 7.5%, while the other OPEC members would have incurred no revenue losses at all. These errors affected the strength of the conclusion that the Saudis’ calculation was political, not economic, but not its direction. I regret the error and the omission.

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