- Blog Post
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The health of the US economy - and for that matter the world economy - hinges on the sustained flow of capital from the world's emerging economies to the US.
The health of the US economy also depends on the sustained flow of oil from a subset of the world's emerging economies to the US, Europe and the manufacturing powerhouses in Asia.
Those two flows are related. As global demand for oil has worked through the overhang of spare capacity left over from the 1980s and started to push toward the system's capacity constraints, prices surged. See Dr. Hamilton. And the resulting surge in petrodollars has helped to finance the US current account deficit.
While I have been obsessively looking (without tremendous success) for signs that the global flow of capital to the US may wither, others have been far more concerned that the global flow of oil from Russia, Central Asia, parts of Africa, Venezuela and above all the Middle East to the rest of the world may wither, or at least not grow as fast as expected. And those concerns are rising ...
I have long argued that sustaining the United States' current trajectory requires a steady increase in the flow of capital from the world - and, barring the creation of a big current account surplus in Europe, an increase in the flow of capital from the emerging world. The US current account deficit is growing.
Similarly, sustaining the current pattern of Indian, Chinese, American and even European growth also requires an increased flow of oil from the oil states to the rest of the world. The US-European (ex Russia)-East Asian oil deficit is also growing.
Demand is rising on the back of a growing global economy- and barring an increase supply, oil prices will rise, putting something of a brake on the economy and bringing demand growth in line with supply growth. Markets clear. But the price at which they clear matters.
And, as Dr. Hamilton emphasizes in a typically excellent post, Nigeria, Iraq and Iran account for a solid share of the expected increase in global supply over the next few years. That creates plenty of reason to worry.
About Nigeria - a country that may have to resolve the internal tensions about the distribution of existing oil revenues before it can pump more on a sustained basis.
About Iraq. It hasn't been quite the stable source of supply some hoped for.
And about Iran, obviously. Read John Hamre, via the Nelson Report and Laura Rozen.
This isn't the place to game out how Iran would respond to an airstrike, should one materialize (via Dr. Hamilton, the Tradesports odds of a strike are now 40%). Or the impact of any interruption in the flow of crude on price. The Oil Drum has looked into that question.
But one thing is fairly clear - the only spare capacity the world has right now is in Saudi Arabia, more or less. And I think that a fair amount of the Saudi's spare capacity is for relatively heavy crude - not the sweet light stuff.
The absence of much global spare capacity raises the stakes immensely. The world could stop buying Iranian oil to punish Iran. But cutting off the flow of crude from Iran to the world hurt oil consumers, not just Iran. It has some (and I emphasize some) analogues to China cutting off the supply of financing to one of its biggest customers.
The fact that China and India both eye Iran as a potential source of future supply certainly complicates the political calculus of sanctions. An effective diplomatic coalition requires far more than just the Europeans.
The National Iranian Oil Company estimates that $70 billion is needed over the next ten years to modernize the country's dilapidated infrastructure and is counting on foreign oil companies and international capital markets to provide approximately three-quarters of those massive investments.
Apparently, Iran's own economists don't think the needed financing could be generated domestically, or from China. I am a contrarian sort. I don't see why not.
Iran ran a current account surplus in 2004 - meaning that it financed the world. It could have therefore could have invested more at home if it invested less internationally without increasing its current savings. Iran's 2004 surplus seems to have been in the $8-9 billion range, according to OPEC. No doubt its 2004 surplus was even bigger. Say $15 billion. If oil stays at $50 a barrel, it certainly seems that Iran could finance a decent chunk of the required investment itself. $15 billion over five years is $75 billion, $15 billion over ten years is $150 billion ....
More to the point, last I checked, China would have no problem financing a $70 billion investment program over ten years all by itself. That's only a bit more than what China adds to its reserves in an average quarter.
Financially, at least, as Daniel Gross has emphasized, the US is no longer the indispensable nation.
I doubt that the recent agreement between India and China not to compete over oil will amounts to much (a Chinese and Indian consortium does look to be bidding for a Russian field, but it sounds like one Chinese state oil company is joining with India's state oil company to bid against another Chinese state oil company and Malaysia's state oil company ... ).
But it does at least raise the question of how China and India intend to divide up the (oil) world between themselves, who gets to bid for the right to invest in Iran's oil and gas fields - and if they agree to share Iran, how? Not to mentino the question of how much China and India value their relationship with Iran relative to say, their relationship with the US ...
General hat tip to Brad Plummer, for rounding a host of useful links on Iran.