New reserves of economic power By George Magnus Published: August 21 2006 19:42 | Last updated: August 21 2006 19:42 Financial Times
Not for the first time, the world's global and regional powers find themselves at odds over the Middle East, a part of the world that remains of significant strategic interest and the locus of potentially even more serious ethnic unrest. It is therefore remarkable that Middle Eastern oil producers, along with those of Russia, Venezuela and Nigeria - most of which have seen a deterioration in their political relationships with the US - have become the stabilising financial force in the global economy and in terms of the US dollar. Can this last? Until recently, relative stability in the global economy has been attributed mainly to China, seen by some economists as the core of a Bretton Woods II system. But if this was what global balance was about, it is a diminished force. Petrodollars will probably provide all oil exporters with a total current account surplus of about $450bn in 2006, up from $347bn in 2005 and compared with just under $150bn in 2000. Developing Asia, including China, generated an external surplus of about $155bn in 2005 and it will be little changed this year. The current account surplus of the oil producers will be about three times that of developing Asia in 2006 and close to that in 2007, assuming the oil price falls back a bit next year. There are no Asian-style mutual economic interests here, but the financial effect of these capital flows is the same. This new financial muscle is unlikely to disappear quickly. Last week, oil prices dipped briefly below $70 a barrel for the first time since late June, attributed mostly to relief following the ceasefire in Lebanon. Whatever happens, the expected global economic downswing into 2007 should be the real catalyst for a cyclical drop in oil prices. However, the supply constraints over conventional crude oil from Mexico, the Middle East and Russia are looking increasingly structural and irreversible. New highs for oil prices can be expected in the future for both geological and demand reasons, even without inevitable threats to supply. Petrodollar financial power is likely to preoccupy us for a while, for several reasons. First, considerable mystery surrounds the investment of petrodollars. The Bank for International Settlements says it cannot trace 70 per cent of the accumulated investable funds by oil producers since 1999. Reasons include the desire of those producers to remain off statistical reporting radar screens, the growth of agencies to manage petrodollars, the outsourcing of funds to offshore institutions including hedge funds and private equity, the repayment of debt and the growth in real estate and foreign direct investment. The tripling of US resident banks' liabilities to foreigners to just over $3,000bn between 2003 and 2005 - with the UK and Caribbean centres accounting for 65 per cent of the rise - is indicative of the weight of petrodollars, its penchant for obscurity and the probability that it remains mainly in US dollars. Geopolitical tensions have the potential to be disruptive to the financial interdependencies between oil exporters and the US. Second, petrodollars may accentuate a global economic downturn. The rise in oil producers' net exports in real terms between 2002 and 2006 has been about the same as it was between 1973 and 1981. As a share of global gross domestic product it is a little lower, at 1.2 per cent, compared with 1.9 per cent. However, the distribution of the oil shock has been more uneven. The US has borne the brunt of the decay in external balances. Europe's position has remained stable while Asia's has actually strengthened. Thus, global imbalances are being exacerbated by petrodollar developments to the disadvantage of the US. Moreover, because the propensity of oil producers to spend their revenues is lower and changes more slowly than the propensity of oil consumers to consume, the income transfer is not a zero-sum game. Third, oil producers should be expected to spend much faster in the future. Russia's demographics are poor with an ageing population and rising mortality but the country's oil wealth will help finance President Vladimir Putin's identified priorities: defence, security and public health. Middle Eastern and Latin oil producers' populations will grow by nearly 10m annually in the next decade, nearly twice the pace of 1970-2005. The Gulf Co-operation Council countries have a GDP of $600bn, making them the eighth largest emerging market, and have announced investment projects of about $1,000bn over the next decade. Beneficiaries should include suppliers of basic materials, commodities, energy, social infrastructure, construction and real estate development services. Finally, a more sober reflection. Transparency over petrodollars would be worthwhile but is not critical. An accentuated downturn because of differing spending propensities would be unwelcome but of limited duration. But there is a tension in the triangle that links petrodollars to population and politics. If these funds are allocated to economic development in the face of rapid population growth, they will be a positive force in the global economy. If not, they may end up in non-economically productive uses, as a catalyst for instability and ultimately in a disruptive move away from the US dollar. The writer is senior economic adviser at UBS Investment Bank ------------------- Jayson Funke Graduate School of Geography Clark University 950 Main Street Worcester, MA 01610
