Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Growth slowing, oil rising … not good

by Brad Setser
July 31, 2006

If Roubini  hasn’t done enough to convince you that the US is at risk of a slump … check out Calculated Risk.   A big fall in residential investment would put something of a dent in the US economy.

And perhaps the global economy as well.   Like Dr. Roubini, I am not convinced that Chinese growth is entirely independent of US growth.    China may be more like Mexico than many think.  Exports to the US (using US import data) account for over 10% of China’ GDP now.  Sure, lots of Chinese exports come from the reprocessing trade – importing parts for final assembly.  But Mexico does its own share of reprocessing as well.

It is enough to make me wonder whether oil should be trading at $70 plus.   Particularly with high inventories in OECD countries.   And by some accounts (notably that of Ben Dell of Bernstein Research), global spare capacity is beginning to rise.  Check out the Capital Spectator’s post on fear v. fundamentals – it is my source.

But then, well, pick up a newspaper.   The Levant doesn’t have oil.  The Gulf does.  But the big players in the Gulf have a range of interests in the Levant.  And the Gulf itself has no shortage of flash points.

Even Iraqi seems to be producing a bit more (p. 31 of the Iraq index).  Official exports may be up too, in part because unofficial exports are down.  The FT reports on Iraq’s new oil for fish policy:

(Mr Shahristani) said that the government had managed to curb smuggling by reducing subsidies – a policy initiated last year and which is expected to lift the budgetary burden on Iraq’s government, which spends several billion dollars a year to import refined products.

…. His ministry has also reduced fuel rations to Basra’s fishing fleets, who take it down the Shatt al-Arab waterway to the Gulf to sell – a policy enacted under Saddam Hussein’s government to encourage sanctions-busting smuggling. Basra fishermen freely admit that they make far more from the trade than from fishing.

“We have told them to come to another port very far from Shatt al-Arab and bring their catch of fish and market it, and then they will be supplied fuel for their next trip,” he said – an initiative that he acknowledged could be called the “oil-for-fish programme.” (hat tip, an anonymous commentator) 

Alas, even with a bit more spare capacity and a bit more production from Iraq, it is hard to argue against a big geopolitical risk premium for oil.  

That premium seems to be rising even as global growth seems poised to slow.    That is good for oil producers, but not for anyone else.

Michael Sessit’s (Bloomberg) estimate for the oil states’ current account surplus — $300b – is, incidentally, way too small.  Saudi Arabia and Russia are both individually on their way to current account surpluses in the $120b range.   $500b or more strikes me as more likely.  But in a broader sense, he is right: the oil exporters have more new cash to play with right now than Asia’s central banks.  I suspect that the oil exporters’ 06 current account surplus significantly exceed that of China, the rest of emerging Asia and Japan.


  • Posted by dryfly

    People don’t appreciate how big RE is to overall domestic demand. And it isn’t only the direct labor associated with the build or the commissions from sales & mortgage origination… it kicks way back into durables mfg & services.

    I sell parts to companies & asked an appliance manager for a forecast – response I got was ‘watch housing starts – single best predictor of our business’. I asked a small engine manufacturer the same thing… his reply ‘watch housing starts…’ exact same reply.

    Why? While replacement is a sizable business to them – almost all new homes need new appliances & lawn mowers. Same thing applies to services (insurance, lawn care, security, etc.)

    Housing dips, its going to take a bite out of a lot of industries and there is precious little anyone can do but brace.

  • Posted by Guest

    “People don’t appreciate how big RE is to overall domestic demand.”

    Which people?

  • Posted by Guest

    What’s interesting to me about the oil-for-fish story is that it acknowledges the importance of person-to-person ‘shadow’ networks engaged in the direct exchange of goods and cash.

    In his recent article for Financial Engineering news, Aaron Brown claims: “…money no longer makes the world go round, if it ever did. The dynamic economy has been organized by derivatives trading for a century and a half…”

    Perhaps in his world, but always interesting to think about how populations organize to navigate through the knock-on effects in the real economy, and how the results of their collective actions feed back up through the system.

  • Posted by Guest

    One commonality which Russia, China and Mexico may all share is very large, desperately impoverished populations. Have to wonder how so few can continue racing ahead, with so many apparently falling into reverse.

    “…home to the new wealth that is far removed from the rural poor. In the last 25 years, China has lifted about 400 million people out of poverty, according to a World Bank report, but efforts to reduce poverty have slowed significantly since the late 1990s and have declined since 2001. Millions of people still eke out a living in conditions that barely support life…”

    “…Risks of a bust are increasing, says Robert Subbaraman, senior economist for Asia at Lehman Brothers Holdings Inc. in Hong Kong. “We have raised our likelihood on the Chinese economy slowing sharply to a one-in-three chance,” he said in a July 28 interview. …Australia is similarly dependent on Chinese markets. “Taking out Australia’s second- or third-biggest buyer would cut overall export prices and volumes,” says Shane Oliver, head of investment strategy at AMP Capital Investors in Sydney. “It’s our biggest source of growth.” …”

    And I’m wondering if Stevens appointment may turn into a classic hospital pass:

    “Glenn Stevens was on Tuesday named as the next governor of the Reserve Bank of Australia, replacing Ian Macfarlane, who has overseen one of the most successful decades for the country’s economy. While the choice of Mr Stevens was expected, the timing of the announcement came as a surprise…”

  • Posted by OldVet

    Demand for barrels of oil may not be tightly coordinated with other types of demand, hence not cycle directly with other consumer spending. Oil/gas demand may well be “sticky” to the upside in comparison. I’d use global annual production of motor vehicles as a loose proxy for oil demand in future, since they run on the stuff except (in part) Brazil.

  • Posted by Guest

    Stephen Roach: After the Wealth Binge – The modern-day US economy has just gone through its most extraordinary period of wealth creation on record. First equities, then housing — over the past decade American households have added to net worth as never before. That binge is over. With the property market now cooling and equities settling in for an era of single-digit returns, wealth creation is likely to be subdued, for the foreseeable future. There can be no mistaking the profound implications of this development for the American consumer, the global economy, and world financial markets.


    A housing downturn will have obvious and important implications for US GDP growth. The direct effects are straightforward: Over the past three years, 2003-05, residential construction activity has boosted real GDP growth by about 0.5 percentage point per year. In data just released for 2Q06, the sector was estimated to have reduced annualized GDP growth by 0.4 percentage point… that means the contribution of residential construction activity could swing from +0.5% to -0.5% — imparting about a one percentage point drag on overall real GDP growth for at least the next couple of years.

    The indirect effects are likely to be of greater consequence. In this case, it’s back to the saga of the wealth-dependent American consumer… Barring a spontaneous and sustained resurgence of labor income generation — something I think is unlikely for as long as globalization and the global labor arbitrage persist — the state of the US property market could well hold the key to the consumption outlook.

  • Posted by Guest

    “… this cycle in particular has been dominated by the accelerating trend in housing prices – making consumers feel wealthier and able to borrow/spend more money than ordinarily is the case. And so it has been a particular focus of PIMCO (and the Fed as well) to concentrate on the fate of housing in order to forecast the future of the economy, inflation, and therefore the bond market. It’s not looking that good folks – housing that is. PIMCO’s on-the-ground analysts, who for nearly a year now have roamed the country with random real estate agents in search of local housing trend information, report that prices in many areas are actually declining which has significant implications for the economy, inflation, and interest rate trends. A just-released report by the National Association of Realtors confirms that nationwide the year-over-year housing price gains have virtually disappeared and seem to be heading into the red…”

  • Posted by Guest

    Lex: Norway

    Norwegians have stashed their petrodollars overseas in a State Petroleum Fund, renamed the Government Pension Fund, since 1990. This has been very successful in warding off Dutch disease, in which a surging currency suffocates other industries. Goldman Sachs found no significant relationship between oil and the krone since 2000.

    Preventing all the symptoms of Dutch disease is getting harder. Political pressures to use the fund have been growing. At $239bn the fund is now worth more than the domestic economy’s annual national income and would allow Norwegians to take a complete tax holiday for just over 2 years without cutting government spending.

  • Posted by bsetser

    Guest — I usually have a creative mind, but i am not sure how oil for fish ties to derivative trading. and how either is tied to a non-cash economy. Iraq created a classic arbitrage opportunity by selling oil domestically cheap. there were easy profits to be made by buying in iraq and selling elsewhere. this started with saddam as an incentive to bust sanctions (he couldn’t sell the oil w/o selling it cheap) and became a big part of Iraq’s economy. The debate now is about how to get some of the revenue the state effecively gave away back. derivatives also create arbitrage opportunities, but they generally don’t involve creating incentives for the physical transport of a bulky (but valuable) commodity like oil by selling it cheap …

  • Posted by Guest

    re:oil and fish

    just in the way that derivatives influence the global price of oil and how that feeds back through the system. wasn’t trying to make a direct correlation in any way.

    seems to be quite a few guests here today!

  • Posted by Charles

    A quick comparison of China and Mexico:

    Mexico City: Three square miles of capital city occupied by a 2.4 million-large sit-in protest
    Beijing: Three square miles of capital city occupied by happy Chinese (the p–sed off ones are in the countryside)

    Mexico: Flagrantly fraudulent elections, grossly misreported in the US media as leftist extremism.
    China: No real elections, grossly reported in the US media as normal.

    Mexico: Two states (Oaxaca and Chiapas) not under governmental control
    China: Isolated pockets of protest.

    Mexico: Oil exporter
    China: Oil importer

    Mexico: Close to the US, facilitating the flight of the desperately poor
    China: Far from the US, making the flight of the desperately poor impossible

    Mexico: Major trading partner, assembling components of heavy appliances, vehicles, and other consumer goods for the core US economy.
    China: Major trading partner, broad portfolio of exports, excluding vehicles.

    Mexico: Corrupt, repressive, incompetent oligarchy.
    China: Corrupt, repressive, arguably competent oligarchy.

    Guess which one I think is most likely to end up unexpectedly on the economic radar screen.

    At Mercury Rising (, we have followed Mexico closely for weeks and are wondering when the rest of the US will wake up to the catastrophe brewing south of the border.

  • Posted by STQ

    China exports mostly low-middle end goods to the US. If the economy slows, there probably won’t be too much of an impact on this market segment. I would expect a much bigger impact on mid-high end market.

    If I remember correctly, back in 2000 when the IT bubble bursted and the economy went into recession, China’s export to US was still increasing. On the other hand, due to a slowing market, the competition intensified, which drove alot of the big companies moving their production base to China.