Tracing where the money goes after it leaves our pockets at the gas station should make us wiser as to what's going on.
By PINCHAS LANDAUoil barrel 88(photo credit: )
The unprecedented accumulation of wealth by oil-producing nations in the current oil boom is surely one of the most fascinating topics in today's world. This column has addressed the subject several times under the theme of "follow the money." The idea is that tracing where the money goes after it leaves our pockets at the gas station should make us wiser as to what's going on - compensation for becoming poorer when we bought the gas.
The biggest oil producers - excluding Russia, which is a different story - are in the Middle East. Given that they cannot possibly spend or invest domestically most of what they receive, the question boils down to what they do with their fantastic wealth. People who lived through, or have read about, the oil shocks of the 1970s tend to assume that the current oil boom will replicate the earlier one, so that we will see the reappearance of "recycling." This term did not then relate to sorting tin cans, plastic bottles and newspapers into separate receptacles, but rather to oil-producing countries depositing their receipts in Western banks, who then lent the money to countries which wanted to borrow large amounts. The rest of the story is indeed history: most of the big sovereign borrowers went bust - although this had been considered impossible at the time the loans were made - and the banks themselves had to be bailed out by their governments.
The salient point is that the oil producers played safe by relying on bank deposits and government bonds, rather than investing directly in financial or real assets, such as shares, property, etc. This was largely due to the conservative and play-safe approach of that generation of sheikhs and emirs. This time around, however, the story is very different because both the global economy and financial markets and the Arab decision-makers and their advisers have become much more sophisticated.
These people are now the recipients of inflows of staggering proportions. In a research note for Morgan Stanley, Serhan Cevik - who is also the investment bank's Israel analyst and well worth following on our own economy - explains why this pool of funds is becoming a critical factor in the world economy. Export earnings for "oil-rich, Middle-Eastern" countries rose from $251 billion in 2002, when oil prices were still in the doldrums, to $593b. last year and an estimated $780b. in 2006 - in all, $1.5 trillion in the past four years. As a result, the region's current account surplus has soared and this year will be equivalent to 1.3% of global GDP (total output of the whole world). The oil boom has worked as a tax on consumers and transferred the proceeds to the producers. But what are they doing with it?
They are investing heavily in infrastructure and construction in their own countries, but this represents a small part of their cash pile. The flood of money triggered a dramatic boom in the local stock exchanges - the Saudi market rose 900% between 2001 and March 2006, and Dubai by an extraordinary 1,475%. Not surprisingly, these undeveloped and poorly regulated markets underwent the boom-bubble-bust cycle, with the bust coming in the second quarter of 2006. More surprisingly, perhaps, after drops of 65% in Dubai and 50% in Saudi Arabia, there is still no sign of recovery. The locals have discovered that economic fundamentals are relevant after all, and that institutional probity, regulation and, especially, liquidity are all essential.
All of these things are available in the main global markets - and that's where the money's going, says Cevik. Oil exporting countries bought foreign assets for an amount equivalent to 2.5% of global GDP in 2005; this year, the amount will be equal to 3.8% of an increased global GDP. As he notes, "this massive liquidity injection is probably even more important than China's reserve accumulation in explaining the so-called 'conundrum' of low long-term interest rates." In other words, Arab oil money is the main force driving the boom on global markets and, by extension, the strong growth of the global economy.
This is good news, as far as it goes, because it explains why the global economy in this oil boom has performed so much better than in the low growth and high inflation ("stagflation") environment of the 1970s. However, Cevik also highlights the degree to which the oil economies have become much more closely linked to the US economy. This suggests that a slowdown in the US and the rest of the developed world will depress oil prices and cause the new recycling model to collapse. The money will stay in our pockets and we will have to spend or invest it somehow. The Dubai stock exchange might be attractive.
ljandaup@netvision.net.il
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