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in the past half-century has powerfully entrenched the role of the US currency.

      Unlike stocks, bonds or other assets, derivatives have a peculiar characteristic. Since the value of a futures or options contract is inherently derived by reference to the price of the underlying asset or to a particular event, for every winner on a derivatives contract, there must be a loser. In contrast, investors holding a stock that goes up can all benefit from the increase in the stock's value. However, in order to go long on a derivative (in other words, to bet that its value will go up), there must be someone on the other side of the trade willing to go short (or bet that its value will go down). During the term of the contract, the price of the reference asset may fluctuate significantly. In order to protect against the default of one or other party, when the price moves against one side of the contract, the losing party is usually required to post collateral in order to provide security that they can meet their obligation. The growth of derivatives markets has, therefore, multiplied the demand for high quality assets that can be posted to meet collateral requirements.

      Further, not all investors seeking to avoid market volatility risks are able to do so using derivatives. This has spawned demand for secure and highly liquid assets that can be held as insurance against sudden and large funding needs. The largest issuer of such assets in the world is the US Treasury.

‘Risk Free’ Assets

As of the end of 2020, the total amount of US Treasury securities outstanding stood at $27.8 trillion.⁷⁴ These securities represent the cumulative amount of money raised by the US federal government to fund its spending requirements over and above what it collects in taxes. They are the largest and most liquid asset class in the world, with around one-third of the public debt owned by overseas investors.⁷⁵ Although the number seems staggeringly large, there is theoretically no risk that the US government will default on this debt. This is because all of its outstanding debt is denominated in US dollars and, since Nixon took the US off the gold standard, the US Treasury can simply print more dollars to meet its repayment obligations as they fall due. For this reason, US Treasuries are considered to be ‘risk free’ assets.

The history of the US Treasury securities market as we know it today is surprisingly short. Up until the US entered WW1, there was only around $1 billion of Treasury debt outstanding. New offers were infrequent. The last time before 1917 that Treasury securities were issued was in 1911 to help finance the construction of the Panama Canal.⁷⁶ Prior to that, the last offering had been in 1900 for the refinancing of bonds that had been issued during the Spanish-American War of 1898.⁷⁷ Treasury bonds were issued on a project finance basis and required Congressional approval for each issue. Congress would therefore supervise all the terms of each bond, including the interest rate and the maturity. It was not until 1935 when the Roosevelt Administration was engaging in consistent deficit spending to combat the Great Depression that Congress switched to regulating the total value of bonds that could be issued, rather than the specific terms of each issue. In 1939, Congress agreed to turn over decisions regarding the issuance of Treasury securities to the Secretary of the Treasury, limiting itself to specifying only the maximum debt that could be outstanding – the so-called ‘debt ceiling’.

To finance its participation in WW1, Woodrow Wilson's administration issued five ‘Liberty Loans’ totalling $21.4 billion, with maturities between four and 30 years. The government debt was gradually reduced during the 1920s and, by the time Franklin Roosevelt took office in 1933, the outstanding public debt stood at around $20 billion, or 20 percent of GDP.⁷⁸ From there, the size of the US deficit continued to grow through WW2 and peaked at 119 percent of GDP at the end of the war.⁷⁹ Each US administration since then has added to the balance of US Treasury debt outstanding. However, as America enjoyed strong economic growth, the debt as a percentage of GDP steadily declined to 24.6 percent of GDP in 1974.⁸⁰ From that point on, however, slower economic growth and rising government expenditure saw the US national debt grow at a much faster pace than the economy.

      It's not just the government that has continually spent more than it earns; American consumers have done so too. This might never have been possible without an audacious deal negotiated by former Treasury Secretary William Simon to ensure a stable source of funding from overseas.

      Born in Paterson, New Jersey in 1927, William Edward Simon was the son of an insurance executive. Handsome and athletic, he served in the US Army before attending Lafayette College in Easton, Pennsylvania, where he was a member of the Delta Kappa Epsilon fraternity. Upon graduation in 1952, he headed to Wall Street, where he eventually became the partner in charge of the Government and Municipal Bond Departments at Salomon Brothers. The chain-smoking Simon became Deputy Secretary of the Treasury in January 1973 and launched the Federal Energy Administration to address the energy crisis at the height of the Arab oil embargo. He was appointed Treasury Secretary in May 1974, after George Shultz resigned from the Nixon Administration.

In mid-1974, the economic outlook for the US was dire. The oil embargo had quadrupled oil prices and inflation soared, even as unemployment was rising. For the oil exporters, however, the sharp rise in oil prices had been a bonanza. In 1974, members of the Organisation of the Petroleum Exporting Countries (OPEC) had a balance of payments surplus of $67 billion.⁸¹ None benefited more than Saudi Arabia which, with the largest reserves of oil in the world, enjoyed a surge in its wealth. Bedouin shepherds, whose fathers and grandfathers had ridden across the desert on camel back with Ibn Saud, were suddenly driving Datsun pick-up trucks, propelling Nissan to the number one spot in vehicle sales in the country.

On an overcast morning in July 1974, the newly appointed Treasury Secretary boarded an 8am flight from Andrews Air Force Base to embark on a secret mission. The official purpose of his two-week trip was to conduct a tour of economic diplomacy across Europe and the Middle East. However, the real mission that he and President Nixon had agreed was to take place during a four-day layover in Jeddah, Saudi Arabia. His objectives were to neutralise oil as an economic weapon and to persuade King Faisal to help finance America's rising government deficits with his country's newfound oil wealth.

      On the surface, the outspoken former bond salesman seemed uniquely ill-suited for such a delicate diplomatic assignment. Just a week before his trip to Saudi Arabia, Simon had publicly called the Shah of Iran, a close US ally, a ‘nut’. Nevertheless, his earlier career had given him an appreciation of the appeal of US Treasury debt and why this would be attractive to the Saudis.

      Up until that point, Saudi Arabia had been parking its petrodollar surpluses in the Eurobond market. However, the emerging market government and corporate debt that featured prominently in that market exposed the Saudi Treasury to credit risks, and those securities were far less liquid than those issued by the US government.

      It took several months of negotiations after Simon's initial trip, but the US and Saudi Arabia finally reached a deal. The US agreed to buy oil and to provide the kingdom with military aid and equipment, while Saudi Arabia promised to invest billions of its petrodollar surpluses into US Treasuries to finance US government spending.

      At the last minute, King Faisal demanded one key final term: that the country's purchases of US Treasuries should remain strictly secret. The US had offended Arab sensibilities just a year before with its military support to Israel, so publicity around this deal might have been embarrassing to the kingdom. The bearer nature of Eurobonds allowed the country to keep its holdings secret, and it sought the same anonymity for its investments in US Treasuries. Under the arrangement agreed between the US Treasury and Saudi Arabia, the Saudis were allowed to

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