from Follow the Money

Do lower oil prices mean the end of the saving glut?

January 18, 2007

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That is question Justin Lahart raises in his Wall Street Journal column.

His answer is a qualified yes.  I would answer with a qualified maybe.  Or maybe with a muted yes.  

The oil exporters have shown a high propensity to save over the past few years (though that seems to have changed in 2006).  So the overall stock of global savings should fall by a bit. But only by a bit.   Some of the lost saving of oil exporters will be offset by rising saving in oil importers.   And while some oil importers don't save much (the US), others (China) do.

I am not sure whether there is a global savings glut or a global drought in non-residential investment or a bit of both.  But I am quite confident that there is a savings glut in China. Savings seems to be above 50% of China’s GDP – which is nuts.  And most of that isn’t household savings.  There is no investment droughtin China.

There is also clearly a savings glut in the oil exporting countries.  Lahart – drawing on work by Higgins, Klitgaard and Lerman of the New York Fed – notes that the oil exporters saved about ½ the surge in their oil export revenue over the past few years.   The result: the current account surplus of many oil exporters surged to over 30% of their GDP.  

Actually, as Higgins, Klitgaard and Lerman demonstrate, there was a surge in government savings in the oil exporting countries.  In almost every oil exporter, most oil revenues go to the government.  Overall national savings went up because the government opted to save rather than spend a large share of the oil revenue.  Fiscal surpluses soared.   Oil stabilization and investment funds got huge influxes of cash.    Some of those funds are managed by central banks, whose reserves soared.   Some are autonomous investment funds – the new 800 pound gorillas of the market.   A new paper by my friend Ramin Toloui of PIMCO has all the details -- or at least almost all of them.  I doubt any one has a better sense of how the oil savings surplus has been invested.

China and the oil exporters are big enough to have an impact on the global economy.  Their individual savings gluts seem to have combined to create a world with lots of spare savings – and plenty of liquidity

But if oil prices and oil revenues are falling, so should oil state savings.  Bye-bye glut. 

Not so fast.

The oil exporters seem to have gotten noticeably less frugal over time.  They were very frugal in 2004.   A bit less frugal in 2005.   And even less frugal in 2006.   Higgins, Klitgaard and Lerman and Toloui both based their projections on the IMF’s forecasts.   Fair enough.  I generally do the same thing.  But the early returns from 2006 are now in, and oil state spending increased by a bit more than initially expected – and as a result oil-related savings seems to have gone up a bit less than expected.

According to SAMBA, Saudi oil export revenues rose by $34b (2005: $157b; 2006: $191b ) but the Saudi current account surplus rose by only $8b (from $87b to $95b).  So only about ¼ of the incremental oil and gas revenue was saved in 2006.   Russia’s oil and gas revenues rose by $43b ($148.9b to $191.5b), its current account surplus rose by only $12b (from $83.3 to $95.6b).   Again, it only saved about ¼ of its incremental oil and gas revenues.

The huge scale of investment in offices and residential towers in Dubai suggests something similar – a lot of someone’s oil surplus was used to finance local property investment, not sequestered in offshore foreign assets.   Venezuela hasn’t exactly been frugal either. 

And so on.  Oil exporters were still contributing to the savings glut in 2006, but they were contributing rather less as the year went on.  2005 it wasn’t.   

But that doesn’t change Lahart’s basic argument.  Even with oil at $50, Saudi Arabia and Russia are cash rich.  They don’t need to cut back on spending or scale back their investment plans – hell, they could increase spending and still have a surplus.  They’ll just save less.  Maybe it is bye-bye glut after all.

And that no doubt will be part of the 2007 dynamics.  I expect the Saudi and Russian current account surpluses to shrink dramatically. 

But you also have to look at the oil-importers.   Europe cut back on its savings and its current account swung into a deficit when oil was high (the latest eurozone four quarter cumulative deficit is 36b euros).  But now that oil is falling and oil states are spending, Europe looks to be swinging back into surplus.  The eurozone could go from drawing on the world's saving glut to contributing to it. 

The Eurozone sells a lot of goods to the oil exporters, while the US is far better as selling financial assets to central banks and oil funds than at selling real goods to consumers in the oil states, with one notable exception: Venezuela.  While the Saudis avoid US goods and buy a ton of US assets (through London), Venezuela avoids US assets and buys a ton of US goods!

The US also cut back on its savings, leading its current account to move into an even bigger deficit when oil was high.  Some think the fall in oil prices will lead the US to save a bit more and thus bring the US current account deficit.  I disagree.  I think the US will use the savings from a lower oil bill to finance a surge in its external interest payments (more on that later), and perhaps an Iraq related surge in the fiscal deficit.   If the US reduces its need to draw on the global stock of savings in 2007, it won’t be by much.

But there is one other oil importing region.  Asia.   The Asian savings rose even as its oil import bill rose.  Its current account surplus got bigger, not smaller (and that wasn’t because it cut back on investment) as oil prices rose.   Look at Toloui's graphs

And now that oil prices are falling, I expect Asia's savings surplus will grow.  Perhaps dramatically.  China’s commodity import bill will fall.   And China's exports to the oil states (rising spending), Europe (the weak RMB) and the US (we love to consume) are all growing.   That's why China's trade surplus soared in the fourth quarter.  Lower oil prices and stronger exports.

Let's do the same calculation for China that we did for Russia and Saudi Arabia, but look at China's overall export revenue rather than its oil and gas export revenue.  In 2006, China’s non-oil exports rose by $208b in 2006.  We don't have the actual data for China's 2006 current account surplus, but based on the trade surplus, I would bet it increased by about $80b (from $160b to $240b).   But let's say it was $70 -- if only to make the math easier.  Then about 1/3 of the increase in China's export revenue was saved in 2006 -- a higher fraction than in either Saudi Arabia or Russia.

And that was with rising oil prices adding to China's import bill.   Plus China has to import parts to export finished goods.  Or it least it used to have to.   That is clearly changing. 

In 2007, China’s exports look set to rise by another $250b.  If even 1/3 – the 2006 ratio – is “saved,” China’s current account surplus would rise by $80b plus.   If the fraction that is saved goes up as oil prices go down, watch out …

So a smaller oil savings surplus could be offset by a higher Asian – and specifically a higher Chinese – savings surplus.  Right now China is saving a higher fraction of the increase in its exports than the oil exporters, and its export revenues are really growing fast …

Ramin Toloui also explored some of these dynamics.  His analysis focused on the impact of higher oil prices and higher oil state savings -- but the same basic logic works in reverse.  One of the points he makes is that Asia has a higher propensity to hold dollars than the oil exporters do in aggregate.   Russia and Norway (and to a lesser degree Iran) bring the "oil" exporters average down 

Overall, I would bet that $50 a barrel oil cuts the $500b (maybe less, given the most recent data) global oil savings surplus by 2006 a lot.   I haven't (yet) sat down and really done the math, but I bet that if you project out Saudi and Russian oil export revenues with oil at $50 and if you assume that their imports continue to rise at the same pace (or even a slower pace) than in 2006, their combined surplus would fall from $200b to less than $100b.   That is still a big surplus.  Just not as big a surplus as was the case in either 2005 or 2006.  

But rather than seeing a big fall the glut, I see more of a reallocation of the glut back toward Asia.  The rise in Asian (and European) savings probably won't be quite enough to offset the fall in the oil surplus. 

The US will still need to borrow a ton of the world’s savings – in a world that has just a bit less spare savings. 

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