The Economist and Goldman on oil and the dollar
I liked the lede of this week’s economist story on the Fed, the dollar and oil:
“THE spirit of St Augustine hovered over the Federal Reserve this week. “Oh Lord, let us stop cutting interest rates, but not yet”
And I liked the analysis even more – perhaps because it draws on an excellent Goldman Research paper by Jens Nordvig and Jeffrey Currie.
The Economist alludes what I think is the most important point: dollar weakness and oil strength and both are manifestations of the fact that global growth has been far stronger than US growth. Weak US growth translates into dollar weakness. Strong growth outside the US – particularly in emerging economies – translates into ongoing growth in demand for oil.
All the more so because many of the most rapidly growing economies in the world keep domestic oil prices below world market prices (this is true for the oil exporters like Russia and Saudi Arabia as well as oil importers like China), helping to keep demand growth up. Combine growing economies with stagnant supply and, well, prices have to rise to bring demand in line with supply.
The impact of strong global growth on oil – and commodities more generally – is one reason why strong growth outside the US doesn’t clearly help to reduce the overall US trade deficit. Strong growth abroad means it is easier for the US to sell more goods abroad. It also increases the price of the United States’ agricultural exports. Alas, those aren’t all that large a share of total exports anymore, in part because a lot of corn is buying converted into ethanol and burned in American SUVs. But strong growth abroad also increases the price of oil. And the US now imports a lot of oil. That means it spends a ton of money on imported oil. Way more than in the 70s in absolute terms, and even relative to world GDP.
The Goldman paper suggests that the United States’ energy inefficiency, its modest exports to the oil-exporting region and a reduced willingness on the part of the oil exporting economies to hold dollars – together with the Fed’s tendency to target core inflation while the ECB targets absolute inflation – explains why the dollar has tended to fall when oil rises. Goldman found that the negative correlation with between the dollar and oil holds even if oil is priced in euros or a basket of global currencies – i.e. a high real oil prices contribute to a weak dollar more than a weak dollar contributes to a high dollar price of oil. The Economist:
“So is the weaker dollar driving oil prices up or are high oil prices driving the dollar down? The Goldman analysts argue the latter because oil exporters import more from Europe than America and hold less of their oil revenues in dollars. A second factor lies with central banks. Because the Fed focuses on “core” inflation (which excludes food and fuel), whereas the ECB targets overall inflation, America’s central bank runs a looser policy in response to higher oil prices, thus pushing the dollar down.”
This negative correlation obviously makes monetary policy particularly difficult for those oil exporters that insist on pegging their currency to the dollar. They are effectively importing a doubly pro-cyclical policy – currency weakness together with low US rates – at a time when high real oil prices are producing a boom. No wonder inflation is now at or above 10% in almost all the big oil exporters that peg to the dollar (or even a dollar-euro basket).
Saudi Arabia just recently joined the club, if 9.6% y/y inflation is rounded up. Though I guess it is possible to argue that 10% inflation isn’t that bad, as Saudi inflation was closer to 30% back in the 70s …
I am particularly interested in one part of Goldman’s argument – the claim that oil exporters hold less of their oil revenue now in dollars. If there is one thing I would like to know even more than the dollar share of China’s reserves, it is what fraction of the overall increase in the official assets of the oil exporting economies that is going into dollars. We know that Russia is putting a lower share of its assets into dollar now than in 2005. Norway too – though the shift is more modest. Iran and Venezuela have likely moved in the same direction, though they are rather less transparent than Russia and Norway.
But we don’t know what the Gulf has been doing. And at current oil prices, the Gulf really matters.
The big Gulf sovereign funds (ADIA, KIA, QIA) seem to hold about the same share of their assets in dollars as Russia, or maybe just a bit less.
But recently the growth in the assets of the Gulf’s central banks, including the Saudi Arabian Monetary Agency (SAMA), has been faster than the growth in the assets of the Gulf’s sovereign funds. And they likely still hold most of their reserves in dollars.
That is why Rachel Ziemba and I argued that the Gulf as a whole hasn’t been able to diversify away from the dollar, even if individual institutions have.
However, our argument depends on a lot of assumptions and inferences. We don’t know for sure.
And the answer matters now more than ever.
The Saudi central bank added $40b to its foreign assets in the first quarter. If oil stays where it is now, the Saudis could add close to the $200b to their foreign assets this year. That is a lot for a country of maybe 25 million people; only a country of 1.3 billion people will do more …
Pervy - First?!
Interesting. This might suggest that those who expect the price of oil to crash if the dollar strengthens are likely to be disappointed (although they haven’t been in the last week or so).
Very interesting. BTW, is there a reason that most stats show oil but not gas prices?
It is not my field of expertise, but isn´t gas longterm more important than oil? Also, some countries as Russia have much more gas than oil reserves. If oil peak is near what about gas peak?
"…SAGIA and the Tadawul-listed company Emaar Economic City (EEC) hosted over 40 international and local media representatives on a visit to the project site here organized by General Electric Co. (GE) as part of its “Build the Middle East” tour”…GE is focusing its growth strategies in Saudi Arabia through effective public and private partnerships in high-growth areas, and is prioritizing overall social development through value-added initiatives…" http://www.arabnews.com/?page=6§ion=0&article=96937&d=1&m=6&y=2007
"…In a sign of unease among investors, the cost of insuring the emirate’s corporate debt against default has doubled since the credit crunch started last August. Some worry that Dubai could wind up in such trouble that neighbouring Abu Dhabi, the richest of the city states making up the United Arab Emirates, might have to bail it out. Dubai’s sprawling business empire spans government institutions and private companies owned directly by Sheikh Mohammed but acting as quasi-government bodies… In their quest to satisfy his ambitions, the business groups have come to rely heavily on debt - leveraging myriad commercial ventures, from domestic property developments to international acquisitions. Along the way, Dubai’s finances have become complicated and the line between ruler and government assets blurred. As one consequence, the emirate’s efforts to secure a sovereign rating for its debt have stalled… As one banker asks: "What happens if the real estate collateral turns back into dust?"…" A high debt burden risks leaving Dubai up the creek, By Simeon Kerr and Roula Khalaf, Apr 03, 2008 FT
Asian Ministers Agree to Pool $80 Billion of Reserves (Update1)
By Keiko Ujikane and Seyoon Kim
May 4 (Bloomberg) — Finance ministers from 13 Asian nations agreed to create a pool at least $80 billion in foreign- exchange reserves to be tapped by nations in case they need to protect currencies.
Contributions from Japan, China and South Korea will total 80 percent of the pool, while the 10-member Association of Southeast Asian Nations will make up the rest, the ministers said in a statement after talks in Madrid, where the Asian Development Bank is holding its annual meeting.
Asian governments are trying to avoid relying on institutions like the International Monetary Fund, which forced them to adopt harsh economic policies in return for bailouts during the financial crisis a decade ago. Pooling of foreign reserves may help prevent a repeat of the region’s turmoil.
Dollar Reserve Status Is Tale of Fading Glory: Michael R. Sesit
Commentary by Michael R. Sesit
May 2 (Bloomberg) — Reserve currency status is like your health: Abuse it, and you risk losing it.
… On the official side, developing countries have been steadily inching away from the dollar. Their foreign-exchange reserves surged to $4.9 trillion in 2007 from $1.2 trillion in 2000. Emerging-market countries accounted for 76 percent of total global reserves in 2007, up from 56 percent in 1997, according to the International Monetary Fund. Yet during that period, their dollar holdings shrank to 61 percent from 73 percent.
The euro has been the beneficiary, rising to 28 percent of developing-country reserves in the fourth quarter from 19 percent when the decade began…
Please post a comment along with a link/ (short) except to another article; explain why it is relevant in a sentence or two.
Oil is generally much more tradable than gas, which has to move thru pipelines (tho LNG changes things). I also suspect that there are plenty of folks like me who have some intuitive feel for the per barrel price of oil but no comparable feel for gas.
bsester:
Economist article:
"So is the weaker dollar driving oil prices up or are high oil prices driving the dollar down? "
Forgive my naiveness but isn’t this just a sympton of plain vanilla inflation–too many dollars chasing too few goods? And what a better source for sticky inflation,commodities–the third world has to eat and the first world needs their oil. I guess the cure will be for the Fed to eventual increase interest rates to mop up some liquity. But what if commodity prices increased dramatically so that all central banks were forced to pull a Volcker? Could the immature global economy handle higher dollar rates? The global expansion of the last decade was driven primarily by cheap money. Would multination corporations be willing to invest in emerging markets if capital costs were 8%+? I guess we shall see if it’s foundation is build on sand or rock.
I’m in favor of whatever it takes to shore up the U.S, dollar. After all,what ever happened to coordinated comradeship of Globalization ? Or is this dollar rally temporary?
Goldman found that the negative correlation with between the dollar and oil holds even if oil is priced in euros or a basket of global currencies – i.e. a high real oil prices contribute to a weak dollar more than a weak dollar contributes to a high dollar price of oil
Brad
oh boy, guess all those analyst are going to have to redo those logic chains sprouting all over the news; everyone it seems blamed part of the oil price trajectory on a weak dollar, indeed some of the commodities boom was also attributed to the same reason.BTW, this is off-topic but thought it would be courtesy to say that included a link to one of your posts (the one beginning with Borders…) on my own blog, ruminating on inflation, hope you don’t mind!
I am all in favor of people linking to this blog, so of course i don’t mind at all; give me the blog’s name and I’ll even check it out …
While really not any surprise, why wasn’t there any discussion or even mention in the Goldman Sachs paper between the US Dollar’s status as a reserve currency and the Geo-strategic US military presence in the Arab Gulf oil states. Under the guise of the perpetual `war on terror’, any attempt by OPEC member states in the Middle East or Latin America to transition to the Euro as their oil transaction currency standard has been met with either overt US military actions or covert US intelligence agency interventions. While not the sole reason for the military intervention, toppling Saddam Hussein allowed the US to control Iraqi’s huge oil reserves and redenominate Iraqi oil exports in US Dollars only. Can the US military control by force all Middle East oil-producing nations and dictate their oil export transaction currency that backs US Dollar hegemony? In the short term, the answer appears to be "yes". Since both Russia and China lack the military global projection power capabilities of the US, the Washington Consensus utilizes the military card to override the economic realities of a declining and less globally competitive US Economy. The US is unable to address the structural imbalances in economy due to massive debt manipulation, unaffordable 2001 tax cuts, collapsing industrial base, record levels of trade deficits, unsustainable credit expansion, corporate accounting abuses, near zero personal savings, record personal indebtedness, and reliance and over consumption of Middle Eastern oil.
http://www.lewrockwell.com/paul/paul303.html
"I liked the lede of this week’s economist story on the Fed, the dollar and oil:"
A fascinating account of the origins and spelling of "lede":
http://tinyurl.com/ajlmc
Under the Bernanke regime, US monetary policy helps subsidize the banking system relative to the industrial sector and labor. One feature is the Federal Reserve’s new willingness to absorb any sort of crap collateral in exchange for massive cheap loans to insolvent banking institutions. The Fed has, in effect, made itself the world’s largest financial sh!t-magnet. It has already taken in a few hundred billion in securities based on non-performing real estate loans, and has now opened the window to securities based on non-performing credit card debt, car loans, and other miscellaneous IOUs still drifting un-hedged in the banking ether.
http://jameshowardkunstler.typepad.com/clusterfuck_nation
DC:
How many times will you post and repost the same ole stuff. We know your perspecive, why not find something new to say. It is like you have these articles in folders and pull them out because, possibly, someone differs with your take on things. Well, guess what, many do, so what, your need to spam the board. Why don’t you just move on to more fruitful pastures, where you can chum with pals who support your perspectives. It might satisfy your ego. Some of us actually like a different perspective, to push our beliefs, and test our assumptions. Yours have been duly noted, and, frankly, have been commonly accepted in many circles for years now. Things have not turned out as you repeatedly have predicted. The results, not as you suppose, despite what Lou Rockwell believes. Go hang out on the CD forum, it is more suited to your control.
Brad:
Why do you allow people to cut and paste without providing commentary? Spamming runs people away from the blog.
Guest,
Is the Federal Reserve suppose to operate like the US Central Intelligence Agency keeping it monetary policy decisions in secret from the American people, or does the Federal Reserve operate exclusively as a branch of Goldman Sachs? A year ago, the Federal Reserve’s $915 billion balance sheet was almost all Treasury securities. But that number is quickly dwindling under Bernanke’s decision to accept subprime "garbage" securities from investment bank Goldman Sachs and others in exchange for liquid Treasuries. We don’t know what sort of subprime securities are on the Federal Reserve balance sheet because Bernanke refuses to disclose the classified information to the American people. So I have one request for the investment banks and the Federal Reserve. Show me your "real" balance sheets. Since my children and I will likely inherit this bailout of the securities industry, I would like to see exactly what the US taxpayers owe.
Hopefully no one on this board is naive enough to think that Bernanke does anything that the one’s who really control the FED ( the owners ) don’t want to do.
I don’t like censoring comments; that also runs people away from the blog. I hope though that various commentators will show a bit more respect for my desire to a have an on topic discussion. The discussion on my last post was quite good. The discussion on this one not so much.
DC
Write your Senator, Congressman, Bernanke, your local newspaper, every local newspaper, start a campaign, go on a hunger strike….but respect Brad and keep comments to topic which in this case is the Economists surprising hypothesis on a strange evolution in the ralationship between the USD and oil.
1) I remember posting on this blog on the trade deficit and saying that oil would begin to "crowd out" consumer goods. I didn’t get much traction then, but it’s good to see that Goldman Sachs is catching on. I would give a link to the post but RGE won’t show me the pages from the archives. Right now, over 50% of the trade deficit is due to oil.
2) Every $10 increase in the price of a barrel increases the trade deficit by $45 billion. At $200 a barrel, our trade deficit from oil alone would be $900 billion. The US is caught in a vicious cycle. The higher the price of oil goes, the higher the deficit, the lower the dollar, the higher the price of oil.
3) The only solution to the above is to import less oil. The implications of this are far-reaching since oil consumption is directly correlated with the GDP.
4) The latest BLS report shows a rapid decline in manufacturing employment. This runs counter to the prevailing economic theory that a weaker dollar helps manufacturing. Over the last year we have lost 300,000 jobs in manufacturing. Even as we need more manufacturing to offset the rise in oil prices, we are in fact doing the opposite. This needs to be addressed by the economic community.
Brad,
Interestingly, in a recent interview with Bloomberg TV, Bader Al-Sa’ad, the manager of Kuwait’s fund suggested that Kuwait had delayed its diversification away from the dollar in part because they sought to take advantage of dollar and US financial sector weakness.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aHwjxvO2RV3s&refer=home
and this is from Kuwait, a country that abandoned its peg (although the dollar still dominates its basket as far as I know)
Hillary is now saying she will "break up" OPEC. How much US debt does OPEC hold that it could dump on the market if it came to a showdown? I think Hillary has delusions of American grandeur.
Dump some, all, and make all of its holdings worthless, undermining all faith in paper currencies, and then what, sell its oil to whom, or rather how to buy the food it needs to feed the people in the desert, we have to think rationally here
Vorpal –
$ weakness tends to correspond to economic weakness. the slowdown in the us is hurting manufacturing and manufacturing employment (see autos) even as the weak dollar is helping exports and employment in the export sector (see planes, GE turbines and the like). dollar weakness in my view is preventing an even bigger slide in manufacturing employment.
I agree with your points about oil and its impact on the trade deficit.
Rachel — maybe kuwait, which still manages its currency basically against the dollar, has discovered that diversification doesn’t work, as it just pushes the dollar down and thus creates other problems for a country that still basically pegs? or kuwait’s statement could be taken at face value: to buy the euro now, you reallly have to believe the $ is about to tank, as it is already very strong. the case for diversification into asia and ems is a bit stronger — however, bader may be a bit worried about the fall in asian equities. they likely bought in at sometime close to the peak. and the bigger relative fall in asian than us stocks likely has increased the us weight in the portfolio.