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How to spend $1,500b
Oil producers must find ways to transform their resource wealth into financial and real assets on a big scale.
- By Krishna Guha, Financial Times
- Published: 23:59 August 12, 2008
At today's prices the value of oil in the ground exceeds the combined value of all the world's equity and debt markets. Oil-importing nations are paying oil-exporting nations roughly $1,500 billion per annum for oil - about 2.5 per cent of global gross domestic product - by some measures the biggest income transfer in history.
These two statistics highlight the scale of the oil bonanza even after the recent retreat in prices, and its potential to influence both global economic activity and asset prices worldwide.
This presents two fundamental macroeconomic challenges. The first is to sustain global demand at levels consistent with full employment. Exporting countries tend to spend less and save more than importing countries, so a transfer of income from consumer to producer depresses global demand.
The second is to find ways to enable oil producers to transform their resource wealth into financial and real assets on a gigantic scale.
This is much more difficult than it might sound. Of course no-one knows what the long-run price will be, but at current prices the value of oil in the ground is $162,000 billion - more than the total value of all equity markets ($52,300 billion) plus all debt markets ($67,000 billion.)
Indeed, it almost equals the value of all tradeable financial assets, which the McKinsey Global Institute estimated was $167,000 billion at the end of 2006.
Challenging
Of course, some of the income generated by oil wealth will be spent rather than saved. The figures for assets do not include real estate. And the transformation of oil wealth into claims on other assets will take place over half a century or more, during which time the value of existing financial assets will rise and more will be created.
Over such a long period of time, it should be possible for global markets to absorb the petrodollar flows, but it will be challenging, given the politics. The current debate over sovereign wealth funds is the cutting edge of this problem, but it extends beyond them.
Ken Rogoff, a professor at Harvard, says much will depend on the extent to which over time oil producers start to spend more and save less of their bonanza.
"These are still relatively poor countries," he says. So far, rulers have been able to resist pressure to spend the oil windfall, but this may not be sustainable in the long run.
Most economists think oil exporters could boost consumption by revaluing their currencies, which are mostly tied to the dollar, but that the effect would be weaker for them than it would be for Asian nations with diversified economies.
Even if the savings rate declines over time in the oil-producing nations, for the forseeable future they will have huge surpluses of petrodollars to invest. These flows are likely to have a significant influence on the pattern of global economic activity. The precedents for recycling sudden increases in petrodollars are not encouraging. In the 1970s oil dollars flowed to emerging markets, primarily in Latin America, via the US banking system.
This easy money sustained emerging market growth for a while, but ended in the Latin American debt crises of the 1980s, which nearly crippled the US banks that had acted as intermediaries.
In the 2000s, petrodollars - along with reserves accumulated by mostly Asian emerging market exporters - flowed mostly into debt, keeping global interest rates low. This unleashed the US housing boom and a scramble for yield that depressed the price of credit risk to unsustainably low levels - the seeds of today's credit crisis.
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