from Follow the Money

Forget China, let’s talk about oil

October 4, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Not the oil price per se, but what oil producers are doing with all the coin that comes with high oil prices. 

I have rattled on and on about how China's current account surplus is on track to reach 6, 7 or even 8% of China's GDP - we should know a lot more after the September and October Chinese trade data come out.  But that ain't nothing compared to Saudi Arabia.  

Its current account surplus is forecast to be close 30% of GDP in 2005 by the IMF (other forecasts put its surplus above 30% of GDP), up from 13% in 2003 (and a deficit in 1998?).    The average surplus of a Middle Eastern oil exporter is around 20% of their GDP, perhaps 25% - that incidentally is why I am a bit skeptical of claims that the Gulf states need Western investment to fully develop their oil fields. The oil exporters save so much more than they currently invest that they could easily finance higher levels of investment without any inflow of capital from abroad.  They certainly are not short of cash of their own, and presumably they can buy the needed technology from some oil services company!  

But that is not what I am really getting at.   I am more interested in how the world's oil exporters are using their surplus cash.   As the Wall Street Journal notes in an excellent article today, the world's big savings surpluses are no longer in Asia but rather in the world's oil exporters, and they are presumably a big reason why interest rates are so low right now. 

"Oil producer so far are using most of their income to pay off debt and boost savings.  Most of that is being done through central banks and government investment agencies that pump the bulk of the money into Western stocks, bonds and other assets. .... The Saudi central banks foreign assets nearly doubled to $109.5 billion in May, from the end of 2003, when they totaled $59.5 billion. Saudi holdings of foreign securities jumped from $63.5 billion from $25.9 billion over the same period.   Some economists think the surging growth of oil producers' investments in the US has become and important factor keeping US interest rates low, similar to the effect of Chinese investment of its huge foreign-exchange reserves .... Konstanin Korishchenko, deputy governor of the central bank of Russia, which keeps about 60% of its $150 billion of reserves in US dollar-assets, says the windfalls generated by high oil prices are a "transmission mechanism" helping perpetuate low global interest rates." 

Who am I to argue with the deputy governor of Russia's central bank! 

But it is also true that it is far harder to match the rising reserves (and one expects rising dollar holdings) of oil exporting central banks with rising holdings of US Treasuries in the US data.     The oil exporters are more like China than like Japan - with Japan, the creditor data and the debtor data match up nicely.   Not so with China and the oil exporters.  Russia's total holdings of Treasuries (using the US data) are not large enough to put it among the largest foreign holders of Treasuries, and OPEC's combined holdings of Treasuries have fallen in 2005, going from $62 billion in December to $53 billion in July 2005.    And Saudi Arabia's formal reserves have fallen in 2005.  Their reserve data does not match up with the broader official holdings data reported by the journal, and the increase in various government assets reported in the 2004 balance of payments data ($32 billion) exceeds the increase in Saudi foreign exchange reserves ($5.6).   That makes it hard to formally estimate the impact oil exporters are having on US rates - lots of the purchases of US assets are laundered through London. 

No matter, even if tracking what oil exporters are doing with their funds is hard, there is little doubt that they have tons of cash, that cash is one reason why interest rates are low and low interest rates, as Ken Rogoff has noted, are a big reason why the impact of the oil shock on the US economy has been so muted, at least to date. 

Why hasn't the huge spike in oil prices cut the world to its knees, as it has on so many other occasions? Again, the answer is low interest rates. Ordinarily, a sharp rise in oil prices quickly translates into higher inflation expectations, followed by rising interest rates at all maturities. But this time, even as the US Federal Reserve keeps hiking its short-term lending rate to keep inflation in line, long-term interest rates - which are far more important - have been magically declining.

Indeed, America has been the single biggest beneficiary of this freakish low-interest-rate environment, with everyone seeming to borrow money like it is going out of style. Homeowners, backed by rising house prices, are piling up debt. The Federal government has thrown fiscal prudence out the window. The country as a whole is absorbing an astounding three-quarters of global excess savings. But, as long as interest rates remain low and growth high, Americans can laugh at predictions that their excesses are laying the seeds of ruin.  


Let's look at a few numbers - I could have used the numbers in the Wall Street Journal, which come from the IMF's data on petroleum exporters, but I opted instead to use a slightly different set of IMF numbers.  I added up the oil exports of the four main commodity exporting regions of the world - Latin America, the Middle East, Africa, and Russia and the former soviet union.  Australia and Canada belong too in some sense, but I limited myself to emerging economies.

Their oil export revenue?

$129 billion in 1998
$281 billion in 2002
And an estimated $703 billion in 2005. 

That is an increase of $422 billion between 2002 and 2005.

How much of that was spent rather than saved?  About $103 billion was spent on imports (or perhaps was offset by fall in non-oil export); the rest went into higher savings.  The combined current account surplus of these regions rose by close to $320 billion, to $370 billion.  All data from the IMF.

That is absolutely huge swing.    And there is little doubt that the oil exporters savings (current account) surplus is the prime counterpart to the United States' savings (current account) deficit. 

So has all the attention placed on Asia and Asian exchange rates been misplaced? 

Yes and no.

I certainly think more attention needs to be given to the exchange rates of many oil exporting countries, particularly those that continue to tie their currencies closely to the dollar.   The same argument that I make with China applies here too: it does not make sense for countries with large and growing current account surpluses to tie their currencies to the currency of a country with a large and growing current account deficit.

Why for example does Saudi Arabia for example peg its currency to the dollar - and why has that rate not been changed even as oil has surged and the dollar has (in broad terms) depreciated since 2002? 

But I do not think that means the attention placed on China has been misplaced.   China's non-oil current account surplus also has surged over the past few years.  China is spending far more on oil now than a few years ago, but its overall current account surplus has grown - not fallen.  That pushes the burden of adjustment onto others.    Instead of reducing emerging Asia's current account surplus, higher oil prices are driving up the deficits of regions (and countries) that already have big deficits.   That more or less means the US.

Basically, the region of the world whose economy is most dependent on imported energy has sat out - in balance of payments terms - the adjustments associated with higher oil prices. 

Look at the IMF's data on developing Asia's balance of payments (developing Asia basically consists of China, India and all the countries in between - the Asian NICs and Japan are left out).  Its oil imports are estimated to have increased from $41 billion in 2002 to $132-33 billion in 2005.  Had its non-oil current account balance stayed constant, that $90 billion increase in developing Asia's oil import bill would have turned a $72 billion surplus into a small deficit.  But developing Asia's non-oil balance did not stay constant - its non-oil surplus increased by about $130 billion (according to IMF estimates), so its overall surplus increased by about $40 billion.

That largely reflects China's surging current account surplus; countries like Thailand have swung from a surplus to a deficit. 

In broad terms, China's current account surplus this year is likely to approach $150 billion - far less than the current account surplus of the oil exporters.  But China is also likely to attract almost $150 billion in net capital inflows, unlike the oil exporters.    Some of that comes from the US and in broad terms get recycled back to the US, but if China is buying nothing but dollars, it also is turning inflows from Taiwan, Japan and even the eurozone into demand for US dollar and US securities. 

China matters.   The rest of Asia's current account surplus is shrinking, and its reserve accumulation is falling.  China's current account surplus is rising, as its reserve accumulation.    China has about $300 billion to invest in 2005; the oil exporters have a bit more than $350 billion to invest.  And one way or another, most of those funds are making it back to the USA, since the US is the only country that needs a comparable amount of financing!

A final thought.  So far, the rising surplus of oil exporter seems to have been dollar positive, as oil exporters seem to prefer to hold offshore dollars to euros.  But if they start spending a bit more and saving a bit less, I suspect that will be euro positive.  Europe has a bit more manufacturing capacity than the US these days, and European exports generally have done quite well in Russia and the Middle East.  Just a hunch though.

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