The answer came in the form of the most fundamental law of economics, supply and demand. After months of internal debate over the best way to take advantage of the situation, the underminers came to a solution: drastically lowering global oil prices and thereby undercutting the Soviet ability to earn vital hard currency. In charging a price for its oil exports, the USSR, like any supplier, was at the mercy of the market. If the world’s major suppliers in the Middle East opted to drastically increase or decrease supply, they could alter prices. An increase in global supply would lead to an overall decrease in world prices and prove detrimental to the fragile Soviet economy.
The plan was perfect, but it contained a major flaw. Unfortunately, the Reagan administration could not quietly ask OPEC to boom supply simply to help Reagan hurt the Kremlin. The politics of the matter were too tenuous and rife with the potential for international backlash. Despite this apparent setback, the administration looked to persevere in its thinking, exploring the possibility that perhaps a certain lone, oil-rich Arab nation could be approached.
It was here that Saudi Arabia came to play a key role in Ronald Reagan’s economic warfare campaign against the USSR. Reagan possessed an excellent rapport with Saudi King Fahd, and in an innovative, gutsy, and generally remarkable covert operation, Reagan and Casey convinced Fahd and his regime to help the administration bust the Soviets economically by shifting Saudi oil flows. The Saudi regime alone controlled so much supply that it held the power to dictate prices simply by virtue of how much it pumped.
TAPPING THE SAUDIS
From the onset of their covert relationship, the Reagan team would find the Saudis infinitely easier to deal with than the Western Europeans (certainly the French) in pursuing economic warfare schemes. The operation was undertaken in the strictest silence in Washington and Riyadh. After a lot of legwork by Casey, in late 1985 the Saudis agreed to increase oil production radically—ultimately raising output from less than two million barrels a day up to nine million barrels per day.3 It was an unheard of boom, one that caused prices to plummet worldwide. In a matter of months the price plunged from $30 a barrel in the fall of 1985 to $10 in April 1986. There were even predictions it could hit $5 a barrel.4
When originally exploring the Soviet commodities cash flow, Roger Robinson calculated that every $1 rise in the per-barrel price of oil meant $500 million to $1 billion in extra hard currency for the Kremlin, an estimate affirmed by the CIA. The reverse was true for dropping prices: Every $1 drop in oil meant a hard currency loss of $500 million to $1 billion for the Soviets.5 So it came as no surprise to the Reagan administration that the massive price drop was absolutely devastating to the economy of the USSR; it destroyed Soviet hard currency earnings in 1985. Over the course of just a year, the Soviets shifted from a $700 million trade surplus with the West in 1984 to a deficit of $1.4 billion in 1985.
While those numbers were striking, they were merely the direct, calculable effect that the policy had on hard currency earnings. In addition, there was a ripple effect that had an impact which was harder to estimate, but nevertheless cost tens of billions of dollars more. Yevgenny Novikov, who served on the senior staff of the Central Committee, recalled: “The drop in oil prices was devastating, just devastating. It was a catastrophic event. Tens of billions were wiped away.” Peter Schweizer, who first broke this incident in two separate books, Victory and Reagan’s War, cites a classified May 1986 CIA study titled, “USSR: Facing the Dilemma of Hard Currency Shortages,” which assessed the damage. Concluding that the sharp drop in world oil prices had “dramatically altered” Moscow’s earnings, the report asserted that the total annual loss from the price drop was $13 billion—an enormous jolt to Soviet GDP.6
This Soviet crisis lingered into 1986, as the Saudis continued to maintain their high levels of output. Ultimately the crisis impacted not only the Soviet economy but Gorbachev’s policies as well, a point that the May 1986 CIA report acknowledged, “The decline of Moscow’s hard currency [capacity]… comes at a time when Gorbachev probably is counting on increased inputs from the West to assist his program of economic revitalization.”7 No, not probably—Gorbachev was certainly counting on such inputs. This made the Soviet crisis yet more acute, as if it could not get any worse.
Because of the earnings loss, the Kremlin was forced to cancel dozens of major industrial projects planned or underway.8 For a country accustomed to parceling out large public works projects for employment, this was a sharp blow. The “Soviet way” was to divert massive funds from the alleged reptilian private sector into government projects to provide jobs to the smiling masses flourishing in the workers’ paradise. The oil action halted this traditional Communist way of doing things.
By itself, the economic loss from the oil manipulation was crippling yet survivable, but when combined with Reagan’s other efforts, the effect was paralyzing. It was an across-the-board assault that hit the Soviet body like a series of bullets. As Novikov noted: “The Central Committee realized that they were facing a committed government in Washington. They saw activity on all fronts…. It frightened them to death.”9
OIL REVENUES: THE OLD SOVIET STANDBY
While the 1985–1986 oil shock would have caused big losses under any circumstance, what made the losses so extreme was that oil had been the chief stabilizing factor to the Soviet economy in the 1970s.10 During the 1970s, according to Richard Allen, high oil prices had increased Soviet energy revenues more than tenfold—possibly fifteenfold, according to another source. Western energy dollars were an important component to the Soviet ability to “stay in the race.”11 Gorbachev made a similar comparison in his memoirs, saying that in the 1960s and 1970s the structural problems in the Soviet economy—that is, the systemic failure of Communism—were masked by high oil and gas prices.12 In subsequent writings, Gorbachev would go even further saying that “in the final years before perestroika [our country] was able to exist only by virtue of oil and gas exports.”13 But now, without this valuable economic boom, the Soviet ship of state was sinking. The commodities that had long been the Soviets’ principal assets were drowning them.14
In addition to the immediate impact on cash flow, the oil shock also proved detrimental in other ways. Because of the high prices in the 1970s, the USSR had begun the 1980s with a solid credit rating resulting from a long record of good payments. By the mid-1980s the USSR’s trade surplus had all but evaporated as the country was hemorrhaging billions of dollars a year for lack of hard currency. From 1985 to 1986 alone, the budget deficit tripled. The Soviet bond rating on the international capital market was lousy, and foreign banks were unwilling to extend loans to the USSR.15 Catalyzing the weaknesses of the already struggling economy, the oil shock proved essential to the eventual fall of the Soviet economy. The stellar credit rating with which the USSR began the decade had disappeared by end of the 1980s, due to an exorbitant trade deficit, a significant general budget deficit, large external debts, and payment delays on imports—much of which was a by-product of the damage from the depleted oil earnings.
In the end, the U.S.–Saudi oil shock was economic warfare of the highest degree, and when coupled with the lower than expected revenues generated by the lone strand of the natural gas pipeline, the losses were astronomical. Facing this unprecedented drop in currency earnings, aggrieved Politburo members sent a strongly worded letter to King Fahd in early 1986. The letter candidly warned Saudi Arabia against pushing prices lower and proposed secret meetings in Geneva to stabilize prices. The Soviet protests were joined by an angry Libya and Iran. Iran made public threats toward the Saudis, as the loss of oil revenue threatened an end to Tehran’s planned wartime offensive against Iraq.16