The Rise and Fall of Diamonds

by Edward Jay Epstein

  By 1977, however, the situation in Israel was almost completely out of De Beers' control. The Goldfinger organization, and other of De Beers' leading distributors in Israel, told De Beers that even if they cut back on their purchases, independent dealers and speculators would step in to take up the slack. The distributors warned the cartel that as long as the banks were willing to finance diamond purchases with artificially low interest rates, there would be no effective way of stopping Israelis from accumulating diamonds as a hedge against inflation. If it wanted to bring the diamond speculation under control, De Beers would have to clamp down on the banks.

  De Beers was not without influence in Israeli banking circles. Harry Oppenheimer sat on the board of directors of Barclays International Bank, which controlled Barclays Discount Bank in Israel. And E. J. G. Dawes, one of the managing directors of the De Beers operation in London, was on the board of directors of the Union Bank of Israel, which together with Barclays Discount Bank financed more than half of all the Israeli diamond purchases. De Beers made it clear to the Israeli bankers that it considered the present speculation to be extremely dangerous. Moreover, it warned that it was adopting a new strategy of imposing "surcharges" on diamonds, which might be abruptly withdrawn at any moment. Since these "surcharges," which would range as high as 40 percent of the value of the diamonds, were effectively a temporary price increase, they could be extremely risky to banks extending credit to diamond dealers. For example, with a 40 percent surcharge, a diamond dealer had to pay $1,400 rather than $1,000 for a small lot of diamonds; however, if the surcharge was then withdrawn, the diamonds would be worth only a thousand dollars. Through this device, De Beers, in effect, announced that it was embarking on a policy of manipulating the prices of diamonds in order to trap speculators. Under these circumstances, the Israeli banks could not afford to advance 80 percent of the purchase price, including the so-called surcharge. They therefore required additional collateral from the dealers and speculators. Further, they began, under pressure from De Beers, to raise interest rates on outstanding loans.

  Within a matter of weeks in 1977, interest rates on diamonds went up 50th percent. Moreover, instead of lending money based on what Israeli dealers paid for diamonds, the banks now would only lend money based on the official De Beers price for diamonds. If a dealer paid more than the De Beers price for diamonds-and most Israeli dealers were paying at least double the price in 1977-he would have to finance the increment from his personal funds.

  To tighten the squeeze on Israel, De Beers abruptly cut off shipments of diamonds to forty of its clients who had been selling large portions of their consignments to Israeli dealers. This dramatic reprisal made De Beers' 250 or so remaining clients aware of the risks involved in trafficking with Israel.

  As Israeli dealers found it increasingly difficult either to buy or finance diamonds, they were forced to sell diamonds from the stockpiles that they had accumulated. As Israeli diamonds poured onto the market in 1979, prices began to fall at the wholesale level. This decline led the Israeli banks to put further pressure on dealers to liquidate their stocks to repay their loans. Speculators found themselves caught between rising financing charges and lower prices, and in a state approaching panic, began selling their diamonds regardless of the price they had paid. Hundreds of Israeli dealers, unable to meet their commitments, went bankrupt in the fall of 1980 as prices continued to plunge. The banks inherited the diamonds. De Beers had won the first round in the diamond war with Israel.

  [17]

  The Russians Are Coming

  The most ominous threat to the stability of the diamond invention, however, came from the Russians. For the Soviet Union, diamonds in the postwar years were a strategic objective of the highest priority. When the Cold War began in 1947, the Soviet Union had no secure source of industrial diamonds. It was entirely dependent on the De Beers cartel for the diamond drilling stones it needed in order to explore for oil and gas, the diamond die stones it needed to produce precision parts and draw out fine wire, and the diamond abrasives it needed to grind machine tools and armaments. Without a continuous supply of these industrial diamonds, it would be impossible for it to rebuild its war-wrecked economy-or to effectively rearm its military machine. Stalin, fully realizing that his crucial supply of diamonds could be cut off at any moment by an embargo, demanded that Russian geologists and scientists develop a more dependable source of diamonds. Since no diamond mines had ever been found in the Soviet Union, there were only two possible ways of satisfying Stalin's order: either pipe mines had to be uncovered in the unexplored regions of the Soviet Union through a vast program of systematic prospecting, or industrial diamonds had to be manufactured through a laboratory procedure.

  The search for diamonds focused on the Siberian plateau in Yakutia province that lay between the Lena and Yenisei rivers, which Russian geologists concluded resembled geologically the "shield" of South Africa. Both formations had remained stable for cons of geological time, and neither had been deformed or "folded" by convolutions of the earth. Since kimberlite pipes had been found on the South African shield Russian geologists theorized that they might also exist in this Yakutian shield. The first party of diamond prospectors flew into Yakutia in late 1947. The expedition was ill-prepared for the punishing environment, however, and after suffering astounding privations on the tundra, it had to be abandoned. Moscow ordered the search to be continued, regardless of cost, and the following spring more geologists were flown into the wastelands of Yakutia. They were better equipped, with X-ray diamond detectors and other sophisticated prospecting gear, and they found a few microscopic diamond traces-but no pipe. Finally, in 1953, a young Russian geologist named Larissa Popugaieva, working in her laboratory in Leningrad, noticed that the prospecting samples from Yakutia contained an increasing percentage of tiny blood-red garnets called pyropes. Since she knew such garnets had been found in kimberlite ore formations in southern Africa, she proposed that prospectors, rather than searching for diamonds, follow the trail of the garnets. She then joined the diamond-hunting expedition in Yakutia, and intrepidly tracking the garnets, managed to find their source near the Vilyul River Basin within a matter of months. It was a volcanic pipe mine she named "Thunder Flash." Unfortunately, however, the proportion of diamonds in the ore in Thunder Flash was not high enough for feasible production. Dozens of geologists, all looking for traces of blood-red garnets, then began scrutinizing the banks of the Vilyul River for more volcanic pipes (which the Russians call trubkas). In the spring, of 1955, another young geologist, Yuri Khabardin, came across a fox's hole in a ravine with blue earth. He found that it had high diamond content, and excitedly began sending a message over his shortwave radio. It said cryptically, "I am smoking the pipe of peace." In Moscow, the prearranged code was immediately understood to mean that the geologist had discovered and tested a kimberlite pipe.

  The volcanic pipe that Khabardin discovered was called appropriately the Mirny, or Peace, pipe. The blue ground at the mouth of the pipe was slightly more than a half mile wide, and covered some seventeen acres. Compared to kimberlite pipes in southern Africa, the Mirny was not an immense pipe. (It was less than one-quarter of the size of the Premier mine in South Africa.) But Soviet planners in Moscow ordered a crash program for getting diamonds out of it.

  Before the Mirny pipe could begin producing diamonds, engineers in Siberia had to find ways of overcoming the incredibly harsh conditions at the mine site. During the seven month-long winter in Yakutia, they found that steel tools became so brittle that they broke like match sticks, oil froze into solid blocks, and rubber tires shattered like fragile crockery in the sub-zero temperatures. Moreover, when the summer came, the top layer of permafrost melted into a swamp of uncontrollable mud.

  Despite these natural impediments, engineers turned Mirny into an open-pit mine. Jet engines were used to blast holes in the permafrost, and enormous charges of dynamite were used to excavate the surface rock and loosen the underlying kimberlite ore
. The entire mine had to be covered at night to prevent the machinery from freezing.

  By 1960, huge steam shovels were loading the ore into trucks, which had to transport it some twenty miles to a separation plant (the permafrost at the site of the mine could not hold the weight of the plant). More pipes were later discovered on the very edge of the Arctic circle. To service these mines in the "pole of cold," as this region is called by the Russians, the Russians erected an entirely new city, Aikhal. According to the descriptions in Russian periodicals, Aikhal stands, like some giant centipede, on ten-foot-high steel legs. Each of these steel legs is Imbedded into the permafrost to prevent the city from sinking into a quagmire of mud during the summer thaw. Even in winter, when the temperature falls to 80 degrees below zero, giant pumps cool the air beneath the buildings to prevent the heat of the buildings from causing any melting in the permafrost. All the buildings are interconnected by elevated passageways and wrapped in a heavy shroud of translucent plastic. Aikhal is, as one journal puts it, "a completely enclosed working environment." This herculean effort had a single purpose: the production of diamonds.

  Just as diamonds began to flow out of Siberia, Russian scientists in a laboratory in Kiev reported that they had found a commercial process for synthesizing minute diamonds that could be used as abrasive grit. The process, though similar to the one that General Electric had developed in the United States, was based on Russian research in high-pressure physics.

  In the Siberian diamond mine, the gem diamonds, which had first been mined as a by-product of industrial diamonds, could now be sold abroad. In early 1962, the Soviet Union agreed to sell virtually all of its uncut gem diamonds to De Beers. Within a few years, diamond production was nearly ten million carats a year, and the Soviet Union exported some two million carats as gems. Diamonds became the leading Soviet cash export to the West. In 1968, Viktor 1. Tikhonov, the head of the Mirny Diamond Administration, said, "We call ourselves the country's foreign exchange department."

  Meanwhile, in London, De Beers' executives were mystified by the progressively larger shipments of Russian diamonds that they were receiving each year. In many ways, the Russian outpouring of diamonds involved a number of enigmas that could not be easily resolved on the basis of the available facts. First of all, the enormous production of diamonds from Mirny did not seem consistent with the relatively small size of the pipe mine. Specifically, De Beers' geologists questioned how this Siberian pipe mine could produce five times the number of diamonds that comparable South African mines produced. For example, in 1978, the Finsch mine, which went into production in South Africa at about the same time as did the Mirny mine in Siberia, produced some two million carats of diamonds. That same year Mirny produced well over ten million carats of diamonds. Moreover, the Finsch pipe covered an area more than twice the size of Mirny, and it seemed unlikely to them that Mirny was yielding more than ten times the number of diamonds per surface acre as its South African counterpart. This disparity became even more puzzling when the different mining conditions in South Africa and Siberia were taken into account. The Finsch mine, which processes some 10,000 tons a day, 365 days a year, operated in an ideal arid climate. The machinery at the Mirny mine, on the other hand, must excavate ground that Is frozen solid seven months of the year in sub-freezing blizzards. Under these conditions, it seemed difficult to accept that the Russians could be excavating the tonnage necessary to produce ten million carats from a single pipe.

  Russian geologists, when asked about this mysterious production from Mirny, initially suggested that the Siberian ore had an extraordinarily high grade of four carats a ton. This number greatly exceeded any grade of ore in the history of diamond mining in South Africa. Indeed, the Finsch mine, which had the richest grade of any De Beers mine, was yielding only about .8 carats a ton. The Russian technical journals further confused the issue by reporting that the grade of Mirny ore was not actually consistently high, and that at times it was as low as .05 carats a ton (which was inferior to any South African ore). The enigma of Mirny's overproduction, therefore, was not satisfactorily resolved.

  The constantly accelerating production from Mirny in the early 1970s was another aspect of the mystery. Diamond pipes are shaped roughly like funnels, with the ore body tapering off below the surface of the earth. This means that in pipe mines the amount of ore excavated declines at deeper depths. In South Africa, after a few years of initially high production, all the pipe mines enter a phase of gradual decline. In Mirny, however, after ten years of intensive excavations, the production of diamonds, instead of leveling off, accelerated. To be sure, part of these diamonds might have actually come from other Siberian mines, such as the Aikhal pipe and the Udachnaya pipe, which went into limited production. The sheer magnitude of the increased production, which went from io million carats in 1970 to 16 million carats in 1975, continued, however, to baffle De Beers analysts in London. Each year they predicted that Siberian shipments would decrease, but each year, despite the calculus of diminishing returns in diamond mining, the Russian consignments to London continued to increase.

  There was an equally inexplicable pattern during these years surrounding Soviet purchases of industrial diamonds in Europe from De Beers and its clients. Diamonds in a pipe occur in a wide spectrum of sizes, shapes and different qualities. Usually, a small proportion are sorted out for gems; a larger proportion of the twisted, deformed, and discolored diamonds are sorted out for drilling stones, dies, and industrial tools; and the balance is ground for abrasive grit. For the Siberian mines to produce some 3 million carats of gem quality diamonds, which were exported to the West, they would also have to produce a substantially higher quantity of drilling stones, die stones and other industrial diamonds. On the basis of Russian gem exports, De Beers analysts assumed that the Russians would also have an enormous amount of industrial diamonds to export. Instead, they found to their surprise that they were heavily increasing their imports of almost all categories of industrial diamonds except for abrasive grit (which they manufacture). Since by 1975 the Siberian mines were assumed to be producing in excess of 10 million carats of industrial-grade diamonds-- a quantity that could not possibly be entirely consumed by Russian industry, De Beers' executives wondered what had happened to the millions of missing Siberian drill and die stones. When asked about this quirk in the diamond equation, Russian geologists explained that Siberian diamonds could not be used for certain industrial purposes such as drilling and drawing out wire because they contained air bubbles that often explode under heat and pressure. In other words, Siberian diamonds were flawed for the very purpose they had originally been needed-industrial stones. This explanation raised more questions about the nature of Siberian diamonds than it answered.

  The De Beers sorters in London also noticed that the Siberian diamonds had some extraordinary aspects. For one thing, they tended to have a greenish tint to them and sharp angular edges, which differentiated them from most other consignments of diamonds in the De Beers vaults. Secondly, the diamonds were remarkably uniform both in size and shape. With very few exceptions, the entire consignment consisted of melees, or medium-grade diamonds ranging from one-tenth to seven-tenths of a carat in weight. The vast preponderance of these diamonds weighed about a quarter of a carat and fitted through a sieve opening that was one to two millimeters wide. Whereas African diamonds came to London in a multitude of shapes-round, square, oblong, flat, triangular and twisted-the Siberian diamonds tended to be mainly octahedrons with eight sharp edges. The consistent regularity of these diamonds made separating and evaluating them far easier.

  By 1976, De Beers was choking on the ceaseless flow of greenish diamonds that arrived each month in London on the Aeroflot let from Moscow. De Beers had little choice but to accept the consignments. Otherwise, the Russians would almost certainly dump these diamonds, which now amounted to some 2 million carats a year of gems, on the world market, and cause a ruinous collapse in prices. There was, however, a limit on the number of sma
ll diamonds that De Beers could absorb. The De Beers board of directors was becoming increasingly concerned with the seemingly magical capacity of the Siberian mines. They wanted to know how many more millions of carats of diamonds would be produced; and also why previous De Beers estimates of waning production in Siberia had proved so wrong.

  Before renewing its commitment to buy diamonds, De Beers asked the Russian authorities to allow a group of executives to visit the Siberian mines and make their own appraisal. The Russians agreed to the De Beers visit on the condition that Russian geologists be allowed to observe De Beers' mines in southern Africa.

  Sir Philip Oppenheimer, who had conducted most of the negotiations with the Russians in London, arrived in Moscow in the summer of 1976. He was accompanied by Barry Hawthorne, who was then De Beers' chief geologist in Kimberley, as well as a De Beers mining engineer, cost accountant and sales executive. Every night for nearly a week the Oppenheimer party was taken to the best restaurants in Moscow by various officials for caviar-laden meals. They also met during the day leading geologists, mineralogists, engineers and mine managers. Despite these thorough briefings, Sir Philip insisted on personally inspecting the mines, some four thousand miles away in Siberia.

  After some procrastination, the Soviet Diamond Administration finally organized air transportation to Yakutia for Oppenheimer and his associates. Fog delayed the flight for nearly a day, however, and by the time they had completed the arduous Journey to Mirny, they had to begin preparing for the return journey to Moscow, which had been very tightly scheduled. "We had about a twenty-minute tour of the mine," Hawthorne recalled, "and seeing any other mine in Siberia was out of the question." Even in that brief period of time, the Oppenheimer party was able to get some picture of the Siberian mining operation.