Thursday, September 16, 2010

A few days ago the U.S. and Saudi governments announced a record breaking $60 Billion dollars in future arms sales. This comes as a great relief to the Obama administration who was faced with the prospect of massive layoffs in the defense sector as the Defense Department begins to roll back its budget. While these cuts will come slowly over the next few years,the more important issue for the defense industry is the lack of big ticket defense procurements in the pipeline. Defense budgeting usually looks five to ten years into the future and from what I have seen of these budgets there is simply not enough money coming their way to maintain the American defense sector at its current size. This is however nothing new. The American defense industry has essentially existed as a welfare system since the end of the Cold War. If you were to ask Ash Carter, Under Secretary of Defense for Acquisition, Technology & Logistics, he would tell you (privately of course) that the DoD is personally paying the operating costs of several U.S. weapons factories that are not producing so much as a single bullet. In fact only one weapons plant has actually shuttered its doors since 1991.

So why is Saudi Arabia suddenly buying $60 Billion in weapons just when the U.S defense industry is showing signs of struggling? A sale perhaps? The answer is in fact two fold and has as much to do with the Kingdom's unique relationship with the United States as its does with its own internal politics.

Officially, Saudi Arabia spends around 13% of its annual GDP on defense, despite having not fought a real war since the 1930's. (Yes there was some bombing of rebels in Yemen last year but I would hardly call that a war.) Furthermore, as was demonstrated during the 1991 Gulf War, Saudi Arabia sits firmly under the protection of the U.S military's security bubble and has no real need for a high tech military and yet they are one of the top buyers of American made F-15's and Sidewinder missiles as well as the second largest purchaser of Bradley fighting vehicles in the world. While the relationship between the U.S. and Saudi Arabia is long and complicated it essentially goes like this. The U.S. built up Saudi Arabia's oil industry in the 1930's and remains its biggest customer. In exchange for Saudi Arabia keeping the supply of oil steady the U.S. government agrees to provide the Kingdom's rulers, the Al-Saud family, with complete protection from both internal and external threats. The one caveat on this relationship has always been that whenever the U.S. defense industry is suffering and a key election is approaching the Al-Saud's pitch in to buy just enough weapons to ensure that workers in key electoral areas like Washington and California are not laid off. The Clinton administration did the same thing in 1993 when Saudi Arabia agreed to buy 72 F-15's for $9 billion dollars just in time for the mid term elections.

The second reason for Saudi Arabia's willingness to buy $60 Billion in weapons it doesn't need has to do with corruption within the House of Saud. While it is certainly true that the Al-Saud family is by far the richest clan on the face of the earth, over the past decade money has gotten a little tight. Decades of largess has allowed the Al-Saud family to expand to over 20,000 members with the typical male having anywhere between 10 and 40 children each. This means that allowances have dropped down to the range of $10,000 to $15,000 a month for the average prince. While this is certainly huge by normal standards it is not enough maintain a leer jet and the general lifestyle that many Saudi royals feel is their birthright. As a result, many in the Al-Saud family have had to resort to more nefarious ways of making money. Typically this activity comes in the form of "commissions" that they receive from foreign companies in exchange for the Saudi government granting them business contracts.

How large are these commissions and how large will the commission be for this most recent deal? Lets take the Kingdom's 1993 purchase of 61 commercial aircraft from Boeing for $7 billion as a case study. Boeing was in fierce competition with France's Airbus to win this contract. In an effort to win, Boeing was advised to secure the services of Khalid bin Mahfouz, a man known as the Saudi banker to the King. His consulting contract stated that he would be entitled to a whopping 5% of the price at delivery of all the aircraft. Court documents would later show that his commission was actually more in the range of 10-12%.

Behind the scene the fix was already in well before Boeing secured the services of Mr. Mahfouz. In February of 1993, Secretary of State Warren Christopher had been sent by President Clinton to pressure King Fahd (now deceased) to make the deal exclusively with Boeing. So why hire Mr. Mahfouz at all? While the Al-Saud family technically owns all the oil under Saudi Arabia, members of the family cannot simply withdraw funds from the Arabian Oil Company's accounts. ARAMCO is supervised and audited by huge international corporations and such thievery would not go unnoticed. Instead members of the Saudi royal family must either overpay or overbuy from foreign companies in order for those companies to return a percentage of that money (usually around 10-12%) back to the Saudi royals personal accounts. So while Mr. Mahfouz pocketed a cool $700 million from his consulting job with Boeing a significant portion of that money would have had to be dispersed amongst the Saudi royals starting most likely with Crown Prince Sultan, brother to the King and head of the the Saudi Defense Ministry.

So how much money should we expect the Saudi Royal Family to pocket off this new $60 billion dollar arms purchase? If we conservatively estimate that there is about 10% graft on every deal then the Al-Saud should walk away with around $6 Billion. Will some of this money end up being given to organizations that support terrorism? History says yes, but since the Kingdom has staunchly refused to cooperate in the Treasury Department's terrorist financing investigations we will likely never know for sure. If you are interested in a more in depth explanation of how things work inside the kingdom I would highly suggest reading Sleeping with the Devil by Robert Baer from which most of the facts in this article were taken.

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