Greekexit, Varoufakis and German Cynicism

In the early days of this humble soapbox, I wrote quite a bit about Greece and the unfortunately named PIGS countries.

(In case you don't know, that stands for Portugal, Ireland, Greece, Spain. In the beginning it was PIIGS to include Italy but somehow Berlusconi's departure and Mario Draghi's selection to head the ECB were all that was needed to get Italy off this club).

It was interesting to watch how Merrill Lynch tricked the Irish government to guarantee private loans and destroyed the country's economy. Or how the diversified, modern and relatively debt-free Spanish economy was declared bankrupt on the basis of some of its banks being over-leveraged, a condition that existed throughout the Eurozone.

To top it all off, as the solution, they devised an utterly destructive austerity program and imposed it first on Greece and then the rest of the PIGS.

In all this, what especially got under my skin was the combination of laughable arguments, crude ideological choices and overtly racist innuendos that were served to explain the austerity programs.

Half a decade later, Greece has 25% unemployment (50% among young people), its economy contracted by 25% with its GDP back to where it was a decade ago. The average monthly salary is €600. And it owes more money to its creditors than it did at the start of the program with its debt being 175% of its GDP.

Yet, Germany, the Netherlands and the so-called troika (ECB, IMF and the EU Commission) are arguing that Greece should continue to implement austerity measures.

This expectation for a different outcome from the same course of action may sound like the definition of insanity to you. But there is more to it than ideological obtuseness.

Allow me to give you a short recap as it is relevant to understand what is going on and why certain logical solutions are not readily available.

There were two main causes behind the crisis.

Cheap Money and Bankers' Greed 

One was the greed of bankers (or banksters as I used to call them) who shoveled cheap money into these economies with the clear knowledge that they would be unable to pay them back. They knew it in Iceland, they knew it in Ireland and they knew it in Greece. In Iceland, Ireland, Spain and Portugal they lent the money to the banks.

And in Greece, they gave it to both the government and the banks. In fact, Goldman Sachs was nice enough to teach the Greek government how to hide those funds from European regulators (and true to form, they turned around and shorted that debt).

If your bank manager insists on giving you a large line of credit and fudges the application on your behalf to get it done, how is it your fault when you are unable to pay the money back?

In any event, the crisis had little to do with the periphery being profligate and living beyond their means.

In the case of the eurozone, the sudden stop to capital flows in 2009 indiscriminately hit all of the periphery countries, regardless of how well they had managed their finances. Spain and Ireland, for example, were more fiscally responsible during the boom years than France or Germany, yet that wasn't enough to inoculate them from the sudden end to the capital flow bonanza. So even if Greece and Portugal (which did run large budget deficits) had been paragons of fiscal prudence, it’s quite likely that they would still have been hit by the sudden stop to the capital flow bonanza. That’s why the best predictor of which countries were hit by this crisis was not budget deficits, but rather the size of the capital flows they were receiving.

That huge inflow of capital to PIGS was driven by French and German banks that were in search for better returns. In that sense, the initial bailout had very little to do with Greece. It was necessary to save the German and French banks (like Deutsche Bank and Société Générale): collectively, Northern European banks were on the hook for almost a trillion dollars in PIGS countries.

When the euro zone crisis began in October 2009, it was German and French banks that were most exposed in the periphery.  More than 40 per cent of the foreign claims on the periphery of Greece, Ireland, Portugal, Italy and Spain were French and German, and the proportion was much higher when considering only members of the euro zone itself. The German banks were particularly exposed in Spain, Italy and Ireland. (...)

Far from involving domestic sacrifices imposed to save the euro, Germany’s handling of the euro zone crisis thus far has been, first and foremost, an opportunity for Germany to ‘Europeanise’ the burdens of its banks.

Now that we have this settled, do you remember how this was presented to the general public?

The corporate media was full of openly racist insinuations about those lazy and no-good Greeks living above their means at the expense of the oh-so-frugal-and-sensible German tax payers. German newspaper BILD's headline on 27.10.2010 was "Sell your islands you bankrupt Greeks"

Here are some other common charges found in the German media:

-The Greeks are lazy
-The Greeks are constantly on holiday
-We are paying luxury pensions to the Greeks
-The Greeks have been feathering their own nest well
-The Greeks have been living above their means
-The Greek state is over-inflated
-Greece is not capable of competing
-The Greeks are corrupt

If that sounds familiar to my North American readers, that is because a version of this discourse was used when the US real estate bubble burst. It was not the fault of the banksters who gave loans that exceeded the value of the property to literally anyone who asked. It was the fault of  poor people, Latinos, Blacks, first time home owners, who got too greedy and bought a big property that they could not afford.

To this day, the average European thinks that the Greeks had it coming because they wanted something for nothing. And the average American (especially Fox News watchers) believe that the real estate crisis was the fault of some minorities who wanted to buy luxury homes they did not deserve.

But no one ever brings up the professional bankers who made those loans. And the reckless banking practices like these.

Even now, Deutsche Bank, the largest of the German commercial banks, remains in an extremely risky position. It is quite probably the most highly leveraged bank in Europe, as well as having the largest gross derivative exposure in the world, a staggering €55.6 trillion according to its 2012 accounts.

Just as no one mentions banksters' role in all this, no one ever questions some curious German policy choices allegedly triggered by traumatic memories.

Destructive German Policy Preferences

The other cause of the crisis was the German insistence to have 1 percent inflation for its economy and the European Central Bank (ECB) enforcing this norm for the entire Eurozone.

As Krugman worked it out at the time, because of the 20 percent differential in prices and wages between the core and the periphery, for Germany to have a 1 percent inflation, PIGS would have to have a massive deflation.

A reasonable estimate would be that Spain and other peripherals need to reduce their price levels relative to Germany by around 20 percent. If Germany had 4 percent inflation, they could do that over 5 years with stable prices in the periphery — which would imply an overall eurozone inflation rate of something like 3 percent.

But if Germany is going to have only 1 percent inflation, we’re talking about massive deflation in the periphery, which is both hard (probably impossible) as a macroeconomic proposition, and would greatly magnify the debt burden. This is a recipe for failure, and collapse.

If you were Germany and the numbers told you unequivocally that this level of inflation would be catastrophic for several European economies, why would you insist on it?

The corporate media told us why: apparently, the German collective consciousness was still traumatized by the hyperinflation that ravaged the Weimar Republic in late 1920s. Consequently, no German government could allow even the smallest inflation.

Yes they said that with a straight face. Even though most young Germans don't know the meaning of the term inflation let alone having a visceral reaction to it.

When people use this argument on me, I tell them that as the huge rise in anti-Semitic attacks in recent years indicates, German national memory seems to be rather selective. It is odd that the idea of a postage stamp costing one billion Reichsmark has such a strong hold on the German psyche but the more recent memory of gas chambers and six million victims is rapidly fading.

I don't mean to insult anyone, but if I were German, I would not want you to use this argument.

In any case, the reality is a little more prosaic and involves a lot of self-interest.

Germany insisted on low inflation not simply because it was good for their assets, which it was, but also because German economy benefited the most from the conditions this policy created in the periphery.

First of all, the crisis discourse that was generated around the PIGS countries ensured a steady capital flight from the periphery to the core and Germany was he biggest beneficiary of that.

In fact, the EU cross border payment system called TARGET 2 became a conduit for capital flight towards Germany.
(See my short primer for TARGET 2)

This is also true of the new money created by the ECB. The more bailout money doled out or the more quantitative easing implemented, the more Germany benefited.

And since the Syriza government came to power, the capital outflow from Greece to Germany has reached a whole new level.

The Bundesbank’s latest report on what’s called “Target 2”— the eurozone’s cross-border payments system that records transactions between member countries — showed that 54 billion euros ($61.91 billion) were transferred to Germany last month, the largest amount since September 2011 and March 2012. 

Secondly, after Germany successfully "Europeanised" their debt and offered destructive bailout packages to PIGS, the German insistence on low inflation had the intended effect and, as Krugman predicted, it magnified the debt burden.

And despite formally leaving its bailout program, Portugal will still need decades to pay down the total of €738 billion ($1 trillion) in public and private debt the country has amassed.

In other words, these countries found themselves under a massive debt burden which precluded any growth possibility and starved their private sector.

That, in turn provided Germany and other core countries with an amazing economic opportunity.

Two-tier Europe

You see, since 2009, German companies (the famed Mittelstand) have been investing in PIGS countries. Can you guess why?

That is in large part due to the economic and labour market reforms bailout countries have been forced to implement - making it easier to hire and fire and reducing wage costs - which less stricken countries such as France have been slower to embrace. (...)

Himmelskamp says he has seen a 30 to 40 percent increase in German acquisitions of Spanish firms since 2009, when the euro zone debt crisis first flared in Greece.

When I posted "Can anyone tell me what is wrong with Spain?" I did not know why such a modern and healthy economy was declared bankrupt and why Spain with one of the lowest GDP/debt ratios in the Eurozone (63%) could not borrow to meet its obligations.

Now I know.

German firms have been buying up financially sound and technologically advanced competitors at fire sale prices.

German firms are buying up strong competitors, clients or suppliers at a time when those companies are struggling to stay afloat through years of recession in their home markets and as shaky banks restrict access to credit. 

AZ Group, a German fittings maker, bought Italian competitor Fiber in 2012, when insolvency loomed under its previous owner. 

German material producer SGL Carbon bought Portugal's fibre maker Fisipe last year.
And Happich, an interior outfitter of buses, acquired its rival Auto Carrocerias Riu last year. 

While these firms rarely publish the amount they pay for acquisitions, Himmelskamp said the price tag was in the low double-digit million euros range.

In case you assume that this consists of a few anecdotal transactions:

A study by DZ bank showed last year that one in four Mittelstand firms already present in euro zone crisis countries was willing to invest more there, in contrast with 14 percent of all Mittelstand firms.

When you look at the rest of the PIGS the picture is the same. Almost 71 percent of Foreign Direct Investment (FDI) to Portugal is from Benelux, German, French and UK companies. And they get special labor concessions.

The leading case of successful foreign investment in Portugal is that of «Autoeuropa», a Volkswagen project in the Setúbal peninsula with an initial investment of 2 billion euros. Because it was so large, the State moderated the negotiations on salaries etc.

In the case of Greece, the pillaging was done using the stricken banks.

Restructuring specialist Haris Stamoulis, the chief executive of Athens-based LEADfinance, says Greece has many good companies which are saddled with bank debts they cannot pay.

Because Greek banks have been forced to write down such debts, Mr Stamoulis says, investors can gain control of companies through buying their debts from the banks.

And state-owned profitable assets were put in the market at fire sale prices.

Other investment opportunities are in the offing in the shape of Greece's vast array of state-owned assets - valued at up to €125bn (£109bn).

In the currently depressed economic conditions, Greece has been reluctant to put such trophy assets onto the market.

But with the European Commission, the IMF and the European Central Bank - collectively known as the troika - putting Greece under increasing pressure to sell state assets to help reduce its debts, new bargains are likely to appear.

In short, the proposed solution (austerity measures in the periphery and low inflation for the Eurozone) to the crisis triggered by German banks turned out to be very beneficial for Germany.

The same solutions enabled German companies to eliminate their competitors and to buy them up fairly cheaply. It also allowed them to set up manufacturing in low labor cost countries that are within the EU. The new labor rules imposed by their government made hiring and firing a breeze and high unemployment guaranteed a very docile workforce.

To give you an idea, in Greece, the average labor cost was €14.70 in 2013, which was less than half of the German and about a third of Northern European labor cost. It is like having your own China next door.

How do I know this was not just a fortuitous outcome of things naturally evolving?

Well, one of the first conditions imposed on Greece was to reduce minimum wage to €550 from €750. If your economy is export-based, this would make your products cheaper and therefore more competitive. But if yours is a service sector economy like Greece's, all this would do is to lower domestic demand further and push your economy into an even more severe recession.

It makes zero economic sense unless your goal is different from what you stated. Tellingly, Germany opposes Syriza's plans to increase the minimum wage back to where it was, that is €750.

If you ask me, what the bailout packages and the accompanying austerity measures achieved was the enactment of an old idea known as "two-tier Europe."

The notion of a core group of European countries leading weaker peripheral member states and enjoying different privileges has been around for decades but it has always been resisted by the peripheral countries.

With the crisis, they've lost their veto power.

What Will Happen Next? Will Greece Exit?

The majority of financial columnists believe that Europe will find a way out of this impasse.

There are several good reasons for that.

The most obvious one is the fact that, everybody, including the combative German Finance Minister Wolfgang Schaeuble, knows that there is no way Greece can pay back its debt nor can it find a way to grow. The troika could keep the status quo going for a century and nothing would change.

If anything, it would get worse as the debt would keep growing. And sooner or later Greece would have to default.

Secondly, Europe is teetering on the edge of deflation and even Germany acknowledges that some stimulus is needed to get the European economies going. This is why Bundesbank approved ECB's one trillion euro Quantitative Easing program (while expressing skepticism on the side).

Thirdly, the first-tier Europeans are aware of other looming threats on the horizon. In Spain, Podemos made huge gains within a year of its creation and they are likely to win big in the upcoming Spanish elections. They made it clear that they will ask for re-negotiations. Portugal cannot be far behind.

In short, the wheels of the two-tier Europe might be coming off because of the greed and intransigence of the core countries. They cannot browbeat them all.

Indeed, PIGS may fly. And that would be the end of the Euro.

Having said that, I am not as confident as finance pundits on a possible solution.

For one thing, the austerity camp has a huge problem on their hands. How could they change the terms of the deal when they campaigned so hard and so long to impose those terms? How could they say, instead of austerity and balancing the books we need stimulus spending?

Renouncing austerity now is like admitting that they were wrong and applied the wrong medicine and nearly killed the patient. More importantly, they believe in the medicine. It is not an act, they are fully committed to it. Look at the Bundesbank President. Look at Britain.

To paraphrase Digby's dictum on conservatism, austerity cannot fail, it can only be failed.

Moreover, they sold the original crisis as "lazy Greeks living off of our savings" and they used a lot of show-and-tell anecdotes to achieve that. Consequently, this idea is very firmly embedded in the Northern European psyche: there is no way for German or Dutch or Finnish politicians to walk it back without being accused of catering to their lazy-swarthy-southern-neighbors.

It is like having to tell CNBC viewers that state-owned enterprises could be profitable or to Fox News watchers that Obamacare could be beneficial. The cognitive dissonance is simply too big.

Merkel might have been in a position to give it a try as she is not running for Chancellor in the next elections. But Syriza and its outspoken Finance Minister made it very unlikely with their Basil Fawlty routine and mentioned the war. Schaueble nearly had a fit.

His testy appearances on Greece comes after a report in the Frankfurter Allgemeine Zeitung late last week drew attention to a cartoon in the official newspaper of Tsipras' political party Syriza which depicted the German finance minister in a Wehrmacht uniform saying: "We insist on the soap from your fat. We’re willing to discuss the compost from your ashes.”

The irony is that the German banks were much more vulnerable at the outset and if Greece exited then (as I and a few other better known luminaries suggested), they and the German economy would be in deep trouble.

By now, the core countries and especially Germany implemented the necessary protective measures and a Greekexit would only hurt Greece. Even before he became Minister of Finance, Varoufakis was aware of that and in 2012 he wrote an essay entitled "Weisbrot and Krugman are wrong: Greece cannot pull off an Argentina."

But since doing nothing is not an option either, I suspect they will try to come up with a solution to prevent the breakup of the Eurozone. It might be an anti-deflationary package with a small print that gives PIGS some breathing space. Or some other technical trick to ease up on budgetary controls. They will do so with an eye on Spanish elections. If Podemos wins, life will be tough for austerity politicians.

In any case, it will not be a simple straightforward arrangement. As true-believers, austerity proponents will resist every step and the periphery countries will have to push back very hard.

There is more than a decent chance that this will not end up well.

The Future Is Bleak For The House of Saud - Part II

In the first part of this series on the future of Saudi Arabia, I argued that succession woes that have yet to surface could become a serious risk for the stability of the ruling family and its increasingly problematic relationship with the House of Wahhab.

I also maintained that the falling oil prices could exacerbate these succession concerns and they might lead to new challenges from within the House of Saud. Especially, if the King refuses or is unable to put his economic house in order.

To my mind, the House of Saud has very little wiggle room in either of these situations and regardless of how they move they are likely to end up in hot water.

To make matters worse, in this second part, I want to highlight two more structural issues that also tie the royal family's hand and force them to make certain choices. Since these choices stem from immutable factors, I cannot see how the royal family might opt for a different course.

And in the current situation, these choices will almost certainly damage the House of Saud and the Kingdom.

Let me explain what I mean.

Ties to Terrorism and Fundamentalism

Because of its symbiotic relationship with the House of Wahhab, the House of Saud has always been implicated in financing Islamist and Jihadist movements.

While it is certainly true that both Reagan and Thatcher (and of course the CIA) encouraged the Saudi government to promote Jihad in some areas of conflict, their push worked because it coincided with the Saudi desire to unleash the Salafist Islam promoted by the House of Wahhab. That is to say, regardless of the shortsighted and stupid anti-communist exhortations of successive American Administrations, after the 1979 siege of Mecca, the House of Saud would have done what it did anyway because its own survival depended on it.

But the Western support made the whole thing easier and more efficient and allowed it to be handled at the highest levels.

In that sense, the new King is a case in point, as he was the royal family's designated man for raising hundreds of millions of dollars for Islamic insurgencies in Afghanistan and Bosnia and for al Qaeda affiliated organizations.

In 2001, an international raid of the Saudi High Commission for Aid to Bosnia, which Salman founded in 1993, unearthed evidence of terrorist plots against America, according to separate exposés written by Dore Gold, an Israeli diplomat, and Robert Baer, a former CIA officer.

After the Bosnian war, Salman continued to support al Qaeda and other Jihadist organizations through murky Islamist charities, including the Abdulaziz bin Baz Foundation, named after a fundamentalist cleric who died in 1999.

Besides channeling hundreds of millions of dollars to Jihadist activities, these charities were instrumental in providing a lofty platform to fundamentalist clerics. For instance, Bin Baz's infamous ruling that women who studied with men were to be considered prostitutes, reached a much wider audience thanks to this Foundation.

Salman nominated Aqeel al-Aqeel to the Foundation's Board even though he was sanctioned by the US and the UN for assisting al Qaeda operations in 13 countries.

Aidh Abdullah al-Qarni

His eventual replacement, Aidh Abdullah al-Qarni, the handsome fellow on the right, named one of the 500 most influential Muslims, was a notorious anti-Semite who said about the Israeli Palestinian conflict that “throats must be slit and skulls must be shattered. This is the path to victory.”

The new king has also embraced Saudi cleric Saleh al-Maghamsi, an Islamic supremacist who declared in 2012 that Osama bin Laden had more “sanctity and honor in the eyes of Allah,” simply for being a Muslim, than “Jews, Christians, Zoroastrians, apostates, and atheists,” whom he described by nature as “infidels.” 

By themselves these actions would not surprise anyone who knows something about the House of Saud and its cynical dealings with Jihadis. But recent revelations by Zacarias Moussaoui claiming that the royals actually funded the 9/11 attack gave them a whole new dimension.

Mr. Moussaoui describes meeting in Saudi Arabia with Salman, then a prince, and other Saudi royals while delivering them letters from Osama bin Laden.

He named other Saudi royals supporting Bin Laden and al Qaeda.

Among those he said he recalled listing in the database were Prince Turki al-Faisal, then the Saudi intelligence chief; Prince Bandar Bin Sultan, the longtime Saudi ambassador to the United States; Prince al-Waleed bin Talal, a prominent billionaire investor; and many of the country’s leading clerics.

Saudi Arabia issued fierce denials but given what is known of Salman's past activities and the billions channeled through Islamist charities, Moussaoui's accusations are a lot more credible now than they might have been a couple of years ago.

I expect this to be a major headache for the House of Saud, especially if the classified sections of the 9/11 report were to become public. While I doubt that they contain a smoking gun, there might be enough there to make it rather sticky for the House of Saud.

And I think the White House might currently be inclined to provide that ammunition to the enemies of the House of Saud, because the religious and political fear and loathing that motivate the royal family put them in a collision course with their global and regional allies, i.e. the US and Turkey.

That, in turn, forced the Obama Administration to implement a complicated new strategy in the region.

The schisms in Islam and the House of Saud

Non-Muslims usually have a hard time to grasp the deep divisions within Islam, like the profound hatred the Sunni and Shia have for each other.

Ever since Muhammad's cousin and son-in-law and the last of the Rashidun caliphs Ali was assassinated and the Caliphate was grabbed by Muawiyah, there has been a deep divide between these two denominations of Islam.

In fact, contrary to what you might have heard, before modern times, Muslims had no real animosity towards Christians and Jews, as they are People of the Book. But almost since the beginning, Sunnis considered Shias kuffar and Shias, because of what they did to Ali and his two sons Hassan and Hussein, viewed Sunnis as usurpers of Allah's will and cheaters and murderers.

That is still the case. That's why ISIS declared that killing Shias takes precedence over fighting Israel and have been slaughtering them viciously. That is why most conservative Sunnis and Sunni ulema cannot bring themselves to condemn ISIS.That's why Pakistani extremists routinely target Shias.

Or that's why, despite their well-known anti-Semitism, the House of Saud happily aligned themselves with Israel and cooperated with the Likud government against Iran.

And that is also why Bahrain, Saudi Arabia, UAE, Kuwait and Pakistan are all fearful of their Shia minorities and have been trying to contain or suppress them.

The Sunni camp is not a unified bloc either. But the most important cleavage is within the so-called political Islam: the Wahhabis and the Muslim Brotherhood are bitter rivals and detest each other with passion. Wahhabis, as muwahhiddin, believe that their interpretation of Islam is the truest and all Muslims should unite under their banner. The Muslim Brotherhood, as mujaheddin and the precursor of al Qaeda, believe that their fight represents the true Jihad.

It is a zero-sum game. They cannot be both right. And they cannot co-exist.

The key difference is that Wahhabis accepted a symbiotic existence with the House of Saud and they owe their prominence to that relationship. Whereas Muslim Brotherhood would never accept a power sharing arrangement with a separate political body. As former CIA analyst Robert Baer put it:

A core tenet of the Muslim Brotherhood is that there can be no separation between church and state. The Brotherhood’s nonnegotiable demand is that they get both the pulpit and the crown. The implication then is that the Al Sa’ud are illegitimate rulers of Saudi Arabia.  

The Saudis watched in mute horror as Egypt’s Arab Spring led to the legitimization of the Muslim Brotherhood in voting booths. They could only ask whether their turn was next. A source close to the Saudis told me, “The royal family looks at the Muslim Brotherhood as hands down the most serious threat to its existence. Its Shia minority doesn’t come even close.”

You can see why the House of Saud thumbed its nose to the US and engineered a coup d'etat in Egypt to overthrow the democratically elected Muslim Brotherhood candidate Muhammad Mursi and why it has been working overtime to crush the Brotherhood.

It is them or the Brotherhood.

However, while this fear and loathing towards the Shia and Muslim Brotherhood explain the Saudi motivations, they also expose the Kingdom's vulnerabilities: the House of Saud is not in a position to fully alienate its allies:

Although Saudi Arabia spends 9.1 percent of its GDP on its military and has an active duty armed force of 200,000, the fact is it’s always depended more on alliances for its national security than it has military force. From the moment Franklin Roosevelt sat down with King Ibn Sa’ud on the deck of the USS Quincy in 1945, the United States has been a constant and vital ally for the Kingdom. Even when the United States took up positions against it, Saudi Arabia never let the relationship go.

In other words, they have an extremely well-equipped army which is barely adequate to suppress the Bahraini uprising. They need regional and global allies to ensure their security.

After the Egypt debacle, the US, cognizant of this vulnerability, worked out a carefully designed rapprochement with Iran using President Rouhani's desire to see the embargo lifted and relying on the trust and friendship between Javad Zarif and John Kerry.

It is a clever bit of play on the part of the Obama Administration.

On the one hand, the move unsettled the Iranian clergy and exposed their weaknesses. They could not stop the negotiation process because they were keenly aware that the crushing embargo would soon open the floodgates of social discontent and people would be likely to rise up against their regime.

Moreover, they knew that, in the last decade, the balance of power in the region had dramatically shifted against the Islamic Republic: Saudi Arabia and Gulf countries had the financial resources and ideological zeal to wage a war of proxy against Iran. And Iran's long-time neighbor Turkey, the only remaining regional superpower, was now headed by a mercurial Sunni Islamist with delusions of grandeur.  A shrinking economy is hardly an asset when you feel threatened.

Finally, ISIS and other Sunni terror groups occupy large swaths of Iraq and Syria and pose a very tangible and violent threat to the Hezbollah and the Shias of Iraq.

So, the mullahs had no choice but let Zarif and Rouhani work with the US. In fact, despite harsh public rhetoric, there is already a deeper collaboration between the two sides, as Iran has just joined the Great Satan in bombing raids against ISIS.

On the other hand, if a nuclear deal is signed, and despite stupid moves of the Republican Congress, I am pretty sure it will be (probably with a cliffhanger finish to make it more credible for each side's constituencies), Saudi Arabia will find itself in a very tough spot.

Because that will mean that, freed from the shackles of the embargo, Iran will move to regain its regional power status. This is something that terrifies the Sunni bloc and the House of Saud. And it should.

For one thing, Iran might proceed to re-ignite Shia uprisings in Bahrain and even Saudi Arabia. It might provide support to Iraq's Shia in the South to lure them away from what looks like a failed state destined for partitioning. And perhaps more problematically for the Sauidis, it might turn the Houthis of Yemen (adherents of a branch of Shia Islam known as Zaidiyyah), who have just surprised everyone by forcing the Yemeni government to capitulate, into a permanent thorn on the side of Saudi Arabia.

On Jan. 25, Hojatoleslam (a Shiite clerical rank just below that of ayatollah) Ali Shirazi, representative of Supreme Leader Ayatollah Ali Khamenei to the Iranian Revolutionary Guard Corps (IRGC) Quds Force, said, “Hezbollah was formed in Lebanon as a popular force like Basij (Iran’s militia). Similarly popular forces were also formed in Syria and Iraq, and today we are watching the formation of Ansarollah in Yemen.”

While this is probably boastful credit-taking on the part of the Iranian clergy (Houthis are unlikely to be like the Hezbollah or take orders from Iran), it is still quite indicative of their mindset and of the dangers for the Kingdom in its own neighborhood.

Secondly, before they engineered a coup in Egypt the royal family could count on Turkey as the most important Sunni regional power to provide a solid deterrence towards Iran.

Angering Erdogan in a bid to crush Muslim Brotherhood was very short-sighted, as Egypt cannot provide the kind of regional counterbalance that the Kingdom needs. Its economy is in shambles, its army is not very professional and most importantly, it is separated from Iran by 2,300 km.

To emphasize the growing gap between the two countries, after the Egyptian coup (just like the US), Erdogan moved closer to Tehran. During his visit in January 2014, he called Iran "his second home" and he made conciliatory announcements about regime change in Syria, which is their biggest point of disgareement. He publicly and loudly slammed the embargo against Iran.  And people close to his government helped Iran evade the embargo through a massive and illicit gold trade.

To reciprocate, in June 2014, Rouhani visited Turkey and announced that bilateral trade should increase to $30 billion in 2015 and declared that "Syria was no problem" between Turkey and Iran.

Erdogan is scheduled to travel to his "second home" in the next few weeks to establish a "Turkey-Iran High-Level Strategic Cooperation Council."

You can see the conundrum for Saudi Arabia.

The Saudis have no choice but to go after Shias and Iran, both for theological and geo-strategic reasons. They are their mortal enemies.

They also have to continue to try to destroy the Muslim Brotherhood because if the Brotherhood becomes the prominent Sunni political force in the region, it is game over for both House of Wahhab and House of Saud.

But these very same choices put them in a collision course with their two important allies. The coup in Egypt disrupted the American plans to re-arrange the Middle East and to achieve Israeli-Palestinian peace.

Since the main reason for them to want peace and stability in the region was to have a control over the distribution of oil and gas and therefore control over the energy needs of rising Asian powers, the Americans are not happy at all.

Simultaneously, the Egyptian coup was acrushing blow to Erdogan's dream of becoming the leader, if not the Caliph, of Sunni Muslims and contributed to Turkey's regional isolation. This is not going to over well with the current Islamist government.

For now, they have enough clout to force Erdogan to be careful in his statements about the Kingdom. And they are betting on the Egyptian generals as their first line of security by bankrolling the purchase of their new toys from France.

However, once the nuclear deal is signed with Iran, the House of Saud will suddenly become quite vulnerable and will have to review this strategy.

But given the structural factors that enlighten their current policies, I don't see how they can implement a change of course.

They are probably praying that Netanyahu could provide a way out of this impasse by encouraging the Republican Congress to sabotage the nuclear talks with Iran.

Talk about irony.

The Future Is Bleak For The House of Saud - Part I

Recently, the New York Times ran a front page story about how the Saudis expand their regional power while others falter.

To my contrarian eyes, this was a fairly inaccurate assessment of the current situation. I have been claiming that the House of Saud was built on a very precarious system and their cynical and pernicious symbiosis with the House of Wahhab would put them on a path of destruction in the near future.

Contrary to the New Times' rosy evaluation, with an economy solely based on oil revenues and therefore very sensitive to the vagaries of the oil markets, the aging kings and crown princes are ill-equipped to deal with the Kingdom's internal problems, like the very different aspirations of the youth, (51 percent under the age of 25), the frustration of women and the deep-seated resentment of the Shia minorities both in the Kingdom and in neighboring Bahrain.

If you add to this domestic tableau a region in serious turmoil, the overall crisis reaches a level that surpasses the crisis-management capabilities of the autocratic House of Saud and the reactionary and misogynistic House of Wahhab.

I believe that it is a brittle structure that is likely to break if it is confronted with a multifaceted challenge.

Moreover, I think that day of reckoning is approaching fast. And it will have far-reaching consequences for the Middle East.

In my opinion, the House of Saud is facing four sets of interrelated issues. This post deals with the first two.

The Succession Woes

The House of Saud has no institutionalized system of selecting monarchs. They use an arbitrary form of agnatic seniority as its method of succession, which means brothers have priority over male offspring. This has been the case since the death of the founder of the Kingdom Ibn Saud. And this is why most Saudi monarchs are frail old men.

The late King Abdullah created a body called the Allegiance Council in 2007 to somewhat institutionalize the succession process. It is composed of sons and grand sons of Ibn Saud. However, he never formally consulted it to select Crown Princes.

A few weeks ago, he passed away (incidentally, he died of lung cancer as a life-long smoker and not pneumonia) and he was succeeded by the Crown Prince Salman bin Abdulaziz.

Salman is one of the last remaining sons of Ibn Saud (and one of the Sudairi Seven).

Salman is old (79) and not in good shape, And he is said to be suffering from early stages of dementia. Since his health has been an issue for some time, Adbullah named a Deputy Crown Prince in 2014 and promoted, Prince Muqrin, the youngest son of ibn Saud, to that position.

After Muqrin, it is assumed that the new King will be selected from the next generation, that is, the grand sons of Ibn Saud.

This is one of the first issues: there are other several half brothers of Prince Muqrin, like Prince Ahmed. Ahmed is also one of the Sudairi Seven and when he was appointed Minister of Interior in June 2012 (following the death of Crown Prince Nayef) he was assumed to be next in line. But he was forced out within six months and the job went Nayef's son Prince Muhammad. Using the agnatic seniority principle, Ahmed could still make a case before the Allegiance Council to stop Muqrin's rise to power. It is not very likely but it is possible.

Assuming Muqrin moves up unchallenged, the transition to the next generation is not going to be smooth.

There are three leading candidates.

One is Abdullah's son Mutaib, who is the Minister of the National Guard, a very powerful portfolio created for him by his father Abdullah. Then, there is the Minister of Interior Muhammad bin Nayef. And finally there is Salman's son Muhammad who was appointed Minister of Defense as soon as his father became King, even though he is only 34.

My guess is that Salman will not rule for more than a couple of years. In fact, if dementia rumors are true, he might not even survive that long. After his departure, I expect quite a bit of turmoil, especially if the Allegiance Council decides to take its job seriously.

Between the Minister of the Interior, the Minister of National Guard and the Minister of Defense you have the making of a major power struggle.

There is one more actor who could influence the process from within the system: Prince Al-Waleed bin Talal. The fabulously wealthy grand son of Ibn Saud was recently voted "the most influential Arab" in the world.  His father Prince Talal bin Abdulaziz was a member of the Allegiance Council until he resigned in protest in 2011 and one of his sons has the right to claim his seat.

Until recently, no one thought that Al-Waleed would be interested in meddling in the political affairs of the royal family but lately he seems to be on a collision course with the Saudi Establishment.

Economic Problems

As you know, when the crude prices went below $60, life became very difficult of oil producers. And Saudi Arabia is no exception.

However, even before the falling oil prices Saudi Arabia did not have a healthy economy. The Kingdom gets roughly 93 percent of its revenues from oil products. These revenues are especially important because they allow the royal family to maintain social peace by generously subsidizing every aspect of Saudi life. There is no income tax and most state services are free. About 40 percent of working age Saudis do not bother to work. The public sector is the biggest employer for Saudi citizens and the salaries are significantly higher than private sector wages.

In an ordinary society, such subsidies would be questioned and perhaps removed if the revenues did not cover spending. But the ailing King Abdulah was so afraid of social unrest that he decided to increase spending despite falling oil prices.

[S]ince the start of the Arab Spring in 2011, the Saudi royal family has dramatically increased spending on the kingdom's welfare state to support the unemployed, the middle class and provide affordable housing. Salaries for the 2 million employees of the government, directly or indirectly, have increased. Funding for education and health care has gone up. The king has sought to buy off any dissent. Even in the Shiite Eastern Province spending on public programs has gone up.

Not surprisingly, this largesse led to the largest budget deficit of the Kingdom's history.

Last week, the world's biggest crude exporter announced an expansionary 2015 budget with the largest-ever deficit of $38.6 billion. 

It projected spending at $229.3 billion, a slight rise from last year's estimates, and revenues at $190.7 billion, sharply down from $228 billion projected in 2014.

Now, the Kingdom is not Venezuela. They have reserves of roughly $750 billion. But the reserve fund is handled by Saudi Arabia Monetary Agency, which invests in state bonds with an annual yield of 2.4 percent on average. This return is not enough to cover the kinds of budget deficits Saudi Arabia will have to run if it continues on the current path.

That is because, over and above its lavish domestic spending, the royal family has many foreign clients that depend on its continuous support.

The kingdom is keeping friendly fellow monarchs in Bahrain and Jordan in power with hefty subsidies. The military regime in Egypt is a very expensive ally. Pakistan is another major recipient of Saudi largesse. Yemen is the most immediate crisis. With the Houthi takeover of Sanaa, the kingdom faces a longstanding enemy now dominant on its southwest border. (...)   

One senior Saudi official told me privately that the kingdom spent $30 billion in 2014 propping up its friends — not counting the costs of the wars in Syria and Iraq where Riyadh funds friendly Sunni groups.

Enter Al-Waleed bin Talal, a.k.a. the guy who bought Apple, Citibank, Disney or News Corp stocks when they were dirt cheap to amass a $30 billion fortune.

After Abdullah announced his budget and the deficit that went with it in December, Al-Waleed wrote to the Minister of Finance a furious letter asking him to justify the high spending level and the use of the Saudi reserve funds to cover the budget deficit.

Think about it. This is the world's last absolute monarchy. You don't get to ask the King to justify his decisions. Yet, this is what he did. And used an unusually rude tone in the process.

Al-Waleed is noteworthy for another reason. His Rotana media group is the largest entertainment company in the Arab world. It owns record labels, radio stations and TV channels. Interestingly,

Rotana, largely owned by Saudi Prince Waleed bin Talal, does not follow strict moral codes in relation to the depiction of intimacy between female and male characters. Rotana and Rotana Clip, specialized music TV channels, regularly air music videos that focus on the sexuality of female singers and models. Woman singers are consistently shot in revealing clothes and flirt with the male characters in their videos. 

This is in a country where the mere launch of a TV station led to the assassination of its King:

King Faisal, in a rush to modernize his realm, created Saudi state television in the 1960s, and that bold step is widely believed to have led to his assassination in 1975. 

The Saudi ulema were so upset about Waleed's media activities that they tried to warn him through his brother Khaled bin Talal:

As part of conservative wing in Saudi royal family, Khaled said he had been forced to speak out after quiet efforts to advise his brother to mend his ways had fallen on deaf ears. Khaled, told an Arabic website that his brother's plan to introduce cinema into Saudi society was the straw that broke the camel's back. This was a reference to a Saudi film financed by Al-Waleed bin Talal, and shown in Saudi Arabia late last year despite fierce opposition from Islamist activists.

Al-Waleed does not simply offend the religious establishment of Saudi Arabia. He attacks the royal family as well.

“Fat Cats of the Desert,” a gaudy nighttime soap on a more daring channel on the Rotana network, is in its fourth season, and it portrays rich Saudis as decadent, hard-drinking, free-spending sybarites. The series opens with a disclaimer that says any resemblance to real people is a coincidence, which helps convince many viewers that the desert fat cats are stand-ins for certain members of the royal family.

To top it all, he launched an Al-Jazeera-type all news channel called Al-Arab with the promise of independent reporting and billed itself as "dedicated to free speech."

Yes, dedicated to "free speech" in Saudi Arabia. It was launched on 1 February 2015 and was shut down within hours after it broadcast an interview with a prominent Bahraini dissident.

You see what I mean when I say he is on a collision course with the Saudi Establishment.

As if all of this was not enough, in his letter to the Minister of Finance, he asked the King to turn the Saudi reserves into a Sovereign Wealth Fund (SWF) and allow him and people like him to run it in order to generate 7-8 percent annual revenues.

Given Al-Waleed's track record, it makes sense for the House of Saud to let him handle the Fund. The level of revenues he is projecting would allow them to run reasonable deficits without draining the reserves.

But that represents a major dilemma for the royal family: If they persist on the current system, they will eventually use up the country's reserves: they already withdrew $58 billion in two years. If they don't, they will no longer be fully in charge of the Kingdom's economy.

Clearly, if Al-Waleed were to invest the SWF, he would have a disproportionally larger say over fiscal matters. He could block certain expenditures like the transfer of huge sums to the House of Wahhab that enable them to export their brand of Islam. He could veto subsidies to some groups or payments to foreign countries.

More importantly, what if, after being put in charge of the SWF, Al-Waleed bin Talal were to claim his father's seat in the Allegiance Council?

Talk about a kingmaker.

For all these reasons, I believe that the Royal family will not put Waleed in charge of SWF and will try to keep him sidelined. The problem is that, with shale gas and fracking, oil prices are unlikely to rise to their previous levels for any sustained period of times.

Already "Standard and Poor's has lowered the outlook for the world's top oil exporter Saudi Arabia to negative" as they believe that the country cannot maintain its strong fiscal position (and credit rating) with sliding oil prices.

Sooner or later, this economic reality will catch up with the royal family.

Now let's turn to their ties to terrorism and their cynical role in the internecine fights within Islam.