The Economic Implosion of Saudi Arabia

Written By Geoffrey Pike

Posted March 30, 2015

houseofsaudSaudi Arabia has been in the news as the government has launched air strikes against the Houthi group in Yemen. This is a Shiite Muslim group that has captured parts of Yemen, including the capital city there.

But a new war is not all that is going on in Saudi Arabia.

Stocks in the Gulf Arab region took a hit last week, even with oil prices going higher with concerns over the airstrikes. Stocks in Saudi Arabia were extremely volatile, losing 5 percent during one day of trading.

In addition to all of this, it is now being reported that Saudi Arabia is drawing down foreign currency reserves for the first time since 2009. This is due to a growing budget deficit, much of which is being blamed on lower oil prices.

This is rather ironic given the accusations that were being thrown at the Saudi government in the latter part of 2014. It’s not to say that these accusations were false, but it just shows that markets are more powerful than they are given credit for.

It’ss no secret that there have been tensions, to say the least, between the U.S. government and the Russian government. The U.S. government has gone so far as to put sanctions on Russian officials.

It’ss also no secret that the U.S. government and the Saudi government are allies. Maybe many Americans don’t like this fact, but that’s the way it is. If it weren’t for the backing of the United States government, both militarily and economically, then the House of Saud would likely fall there.

So with the high tensions with Russia, along came falling oil prices. Meanwhile, when Saudi officials met with the other OPEC members, it was decided that they would not cut down on oil supplies.

Some analysts accused Saudi Arabia – under the influence of the U.S. government – as purposely wanting oil prices to drop to hurt the Russian economy and the Russian government. Since Saudi Arabia has a lot of money and a lot of oil, it was figured that it could take the temporary blow of lower oil prices.

Other accusations were that Saudi Arabia was trying to bankrupt some of the new oil projects in the U.S. that depend on fracking that’s more expensive.

The Free Market Eventually Wins

I don’t necessarily disagree with all of the accusations against Saudi Arabia. Many people making the accusations were not necessarily condemning the decision of Saudi officials. Some saw it as a good strategy to take Russia down a few notches.

But it was rather naïve to think that this would not significantly hurt Saudi Arabia, which relies primarily on oil sales for its money.

It’s not the same place as Dubai, which is a major tourist destination and a major hub for international finance. Saudi Arabia is mostly rich due to oil and the United States government’s support.

Now the Saudi central bank has reduced its foreign assets by 1.4 percent from last year. While this isn’t a huge amount in relative terms, it is still a notable development.

The big question is, how long can Saudi officials hold up with oil hovering around $50 per barrel. You almost have to wonder if they favor more war in the Middle East just to get oil prices up, as long as it isn’t directly on Saudi Arabian soil.

If oil stays around $50 for another year, how much more is the Saudi central bank going to have to dip into reserves in order to cover the increasing deficits? What’s the breaking point before it announces a cut in production as a desperate move to drive prices higher?

But even with OPEC controlling its output in order to supposedly control prices, this can only work for so long. If a country cuts production to drive up oil prices, then the lower volume in sales will offset the higher prices in terms of revenue.

Even though there is little in the way of a free market when it comes to oil, it’s amazing that the free market somehow still prevails. Most of the oil being pumped out of the ground is either owned by various governments, or owned by companies that are heavily controlled by various governments.

Still, oil is a fungible good and the price will reflect supply and demand. The Saudi government, or any other government, can temporarily affect oil prices, but it ultimately comes down to consumer demand and available worldwide supplies.

With Saudi Arabia selling off a small portion of its foreign reserves, it’s telling us that it has far less control over the oil market than we think.

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