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The FT joins the chorus arguing against the Gulf’s dollar peg

by Brad Setser
July 8, 2008

The FT’s leader concisely summarizes the arguments against the Gulf’s peg to the dollar.

“The UAE either keeps its currency pegged to the dollar, in which case too many dirhams will chase too few goods, and prices will inevitably rise; or else revalue the dirham so each one is worth more dollars.

Both options achieve the same end result but inflation has greater drawbacks. First, it is slow, whereas revaluation is instant. Second, once started, inflation is hard to stop because workers demand higher wages to compensate. Third, there is a risk of asset price bubbles in the Gulf nations because high inflation means that real interest rates are too low. Fourth, inflation hurts the poor (who do not have direct access to oil revenues), and so harms political stability.

There is also a specific problem with pegging to the dollar. Gulf currencies have actually had to depreciate against the euro in order to follow the dollar, the exact opposite of what they need, and a shift that will cause even more inflation.”

Alan Greenspan has suggested that the Gulf should allow their currencies to float. It would be hard, though, for the UAE and Qatar and Kuwait to float if Saudi Arabia remains pegged — especially if they aspire to form a monetary union. If the Saudis floated, the rest of the Gulf could peg to the riyal, but that also seems like a remote possibility.

The FT suggests that the GCC shift to a basket peg. The risk of shifting to a basket peg now though is that it locks in the Gulf’s depreciation against the euro. If the dollar were to rebound against the euro, a basket peg would imply that the Gulf’s currency would need to depreciate against the dollar to avoid appreciating against the euro by too much — no matter what happens to the price of oil. That doesn’t make much sense. A basket peg protects against further dollar depreciation, but it doesn’t address the core problem: the Gulf, like China, needs to appreciate against the ensemble of its trading partners.

The FT suggests addressing this by combining a revaluation with a basket peg. It then goes one step further and suggests that the Gulf should consider including oil in their basket.

“The Gulf needs to peg to something. A first step (after revaluation) would be to peg to a basket of currencies that included the euro and the yen. A bolder step would be to include the price of oil in that basket, so that currencies would appreciate when oil is strong, and depreciate when it is weak. That would make for smoother adjustments than double-digit inflation.”

I agree. Very much so. Jeff Frankel has argued that commodity exporters should peg to the price of their main commodity export; pegging to a basket that includes the price of their main export “waters” down a pure commodity peg. This makes sure that oil-exporters currencies appreciate when the price of their export appreciates, and depreciates when the price of their main export depreciates — without having the currencies of commodity exporters move by quite as much as the commodity prices.

It certainly beats a world where the oil-exporters’ currencies depreciate when they are rolling in cash from near record high prices.

The Saudis, according to the Bank of New York, are still not keen to change. Neil Mellor suggests that the Saudis have $800 billion in foreign assets (he calls this their “currency reserve equivalent”; it is a sum more than twice the size of SAMA’s visible foreign assets), and presumably most of them are in dollars. Mellor hints that the Saudis are once again pushing Paulson to take steps to push the dollar up in order to make the Saudis dollar peg a bit easier to sustain:

“we would not be surprised if Saudi Arabia were to bring further pressure to bear upon the US (we recall the recent Sunday Times report of Treasury Secretary Paulson’s visit to the Gulf in late May) to come up with a viable plan to reverse the USD’s six-and-a-half year old decline.”

But it isn’t clear what Paulson really can do. He cannot force the Fed to raise interest rates. The Fed is independent. US domestic conditions are far from robust.

He could offer to bailout any bank or broker-dealer that couldn’t survive a Fed tightening campaign, but it isn’t clear that Congress would go along. Nor is it clear that this would change the Fed’s policy.

Paulson could offer to increase the fiscal deficit even more, on the grounds that this would stimulate aggregate demand and tend to put upward pressure on interest rates. Higher rates in turn might push the dollar up. Think of the first part of the 1980s. But the US fiscal deficit is already large. Such a policy works against efforts to reduce the size of the US external deficit. And there is a growing sense that the world’s overall macroeconomic policy is too loose, given constraints on the expansion of commodity supplies.

Finally, the US could intervene directly in the foreign exchange market. But Paulson probably doesn’t want to do this in a big way. And if the Fed is on hold when other central banks are raising rates, it isn’t clear that token intervention would be all that effective. The US isn’t going to turn into China and start intervening to the tune of 20% of US GDP.

The US and the Gulf are in very different stages of their respective economic cycles. So long as that is the case, linking their currencies together create difficulties. Rather than trying to make the peg work, I would argue that both sides would be better off sketching out an orderly transition to a new regime.

36 Comments

  • Posted by Rien Huizer

    The difference between midland, TX and Doha, Qatar both effectively using the USD as unit of account & store of value, is that the oil economy of Midland sits in a sea of USD domestic economy, with high factor mobility. I am not so sure it matters for Abu Dhabi, but it might for Qatar, probably does for Saudi and Kuwait, and certainly does for Bahrain, Dubai and of course places like Russia and Algeria. Still, switching to another currency to follow, does not do much to the exchange rate between imported goods (in the case of Abu Dhabi etc also large amounts of locally spent man-hours) and oil. It looks a bit like an accounting trick to me, for the Abu Dhabis of this world. But it is different for countries with little oil and highly diversified economies. There domestic inflationary feedback could produce very harmful effects. So thre may well be legitimate conflict about this within de GCC. Probably the balance between tribal interests as perceived by tle rulers and their minders and what it would take to keep the three imported workforces (Yemeni, highly settled in Saudi, Palestinians/Egyptians, not as settled but not sojourners either, in de emirates and Kuwait, and Indians, Pakistani, Phillippino/as everywhere, basiclly sojourners) more or less happy, away from mischief. Not a problem to be approached in purely economics terms.
    But for the bigger countries like Algeria, Egypt, Iran, Russia etc, it does not make too much sense. Probably Russia should look bit at what Canada and Australia are doing.

    Incidentally, what about the UK seeking an alternative for a freely floating GBP?

  • Posted by anon

    off-topic, fyi:

    http://www.newyorkfed.org/research/current_issues/ci14-4.pdf

    “While the heightened exposure of the current account to movements in financial yields can be expected to create greater current account volatility, Hellerstein and Tille do not see grounds for concern. “The question is not whether U.S. international transactions have become more volatile,” they remark, “but rather how they are linked to overall U.S. income, as measured by GDP.” The authors show that although the yield differential between U.S. international assets and liabilities is volatile, it is negatively correlated with U.S. growth. As a result, the United States earns a higher return on its assets than it pays on its liabilities during downturns in the economy.
    Noting that this “insurance benefit” from financial globalization has strengthened over the last ten years, the authors conclude, “The greater volatility of the current account going forward does not imply lower economic welfare. To the contrary, it is the channel through which business cycle risk is shared across countries.”

  • Posted by bsetser

    Rien — Russia should emulate Canada or Australia. Both have let their currencies appreciate and are avoiding inflationary real adjustment. Russia now has a highly inflationary dollar/ euro peg — which means that, barring any revaluations against the peg, it is depreciating against the currency of its main trading partner (the eurozone) ’cause the $ has a heavy weight in its basket.

    I also tend to think that the inflationary dynamic of the adjustment in the uAE/ Kuwait and Qatar poses enormous problems, as it is generating a very positive feedback loop where all policy levers have turned wildly expansionary at the same time. Negative real interest rates distort the economies of wealth sheikdoms too. A common gulf peg to a basket that includes oil risks causing problems for a place like Oman, which might appreciate more than is warranted as it is dragged up by the rest of the region’s oil. But i would push back against the notion that this is just “accounting” for tribal sheikdoms; there are some important effects even in places like the UAE. the guest workers get upset if their salaries don’t rise with the price level …

    I’ll take a look at the latest from Tille. He has rather consistently argued that large deficits aren’t a problem, so the article above strikes me as in line with most of his recent work. But i should read it before saying more.

  • Posted by RebelEconomist

    “to come up with a viable plan to reverse the USD’s six-and-a-half year old decline….the US could intervene directly in the foreign exchange market”

    How exactly? The US hardly has any currency reserves……should have listened to RebelEconomist!

  • Posted by Dave Chiang

    Latest from Economist Henry Liu at Asia Times,
    http://www.atimes.com/

    About 50% of US consumption is imported at a cost of $1 billion a day, or $365 billion a year. Oil and gas import is the single largest component in the US trade deficit, not imports from Japan or China. The United States consumed in 2007 about 22 million barrels of oil each day, about 25% of world consumption of 87 million barrels. China consumes 7.3 million barrels per day. Yet daily world production is only about 85 million barrels, leaving a deficit of 2 million barrels which are being made up from inventory. This fact is the fundamental reason why oil prices have risen.

    War-making is a gluttonous oil consumer. With high oil prices, America’s wars will carry a higher price, which will either lead to a higher federal budget deficit, or lower social spending, or both. This translates into rising dollar interest rates, which is structurally recessionary for the globalized economy operating under US dollar hegemony. But while war is relentlessly inflationary, war spending is an economic stimulant, at least as long as collateral damage from war occurs only on foreign soil. War profits are always good for business, and the need for soldiers reduces unemployment. Fighting for oil faces little popular opposition at home, even though for the United States the need for oil is not a credible justification for war. The fact of the matter is that the US already controls most of the world’s oil without war, by virtue of oil being denominated in dollars that the US can print at will with little penalty. Petro-war is launched to protect dollar hegemony which requires oil to be denominated in dollars, not physical access to oil.

    The only trouble is that $100 oil takes money from the pocket of consumers and delivers it to the oil producers (not just Arabs), who then reinvest it in Wall Street. The net result is a transfer of wealth from the “working families” of the world to the capitalists the world over.

  • Posted by Rien Huizer

    Hey, David,

    You must be a Chinese trapped on an american space ship..Like to do economics puzzles or just to be homesick?

    Cheer up, the Olympics are just few days away and you -mot probably- will not have to sail (?) a 470 along the shores of Qingdao. Always knew the local beer was frothy, but Green?

  • Posted by Dave Chiang

    Hey Rien Huizer, the West has no shame in attempting to steal the oil resources of the Iraqi people and other developing nations.
    http://www.atimes.com/atimes/Middle_East/JG09Ak02.html
    Since the taking of Baghdad in April 2003, the name of the game has been facilitating relationships between Iraq and US-based and allied Western energy firms when it came to what Bush used to delicately call Iraq’s “patrimony” of “natural resources”.

    The Pentagon-petroleum partnership

    Another connection, long ignored in the mainstream media, the Bush administration, the Department of Defense (DoD), and Big Oil is the overt Pentagon connection. The DoD is, as national security expert Noah Shachtman notes, “the world’s largest energy consumer”. And, when it comes to Pentagon gas-guzzling, its post-9/11 wars and occupations, especially in Iraq, have been a boon. While the Bush administration has been working overtime to clear the path for Big Oil’s return to Iraq, the Pentagon has been paying out staggering amounts of US taxpayer dollars to the very oil majors now negotiating with Iraq’s Ministry of Oil.

    The Bush administration has been facilitating ties between the Iraqi government and foreign oil companies for years, and the same companies now likely to nab a no-bid toehold in Iraq’s oilfields are intimately tied in to the Pentagon to the tune of billions of dollars annually. It’s worth noting that most of these firms have also been closely connected to Vice President Dick Cheney from the early days of the Bush administration. In fact, executives from Exxon Mobil, Shell, and BP met behind closed doors with Cheney’s energy task force in 2001, when the administration was pounding out its energy policies, according to a White House document obtained by the Washington Post.

  • Posted by glory

    it’s been discussed before, but i think it’s pretty obvious that the pegs are being maintained because of (geo)politics rather than economics – only when local political (in)stability overwhelms geopolitical security arrangements (say more frequent and intense inflation riots) will pegs fall away or, alternatively, if ever something comes along that’s better to ‘peg’ to:

    “…maybe the world could live without a single reserve currency. Currencies could compete against each other, and gold, and other commodities. This is an age of computers; I’m not sure why there would have to be one standard of value, particularly, when the standard of value varies so much…”

  • Posted by Twofish

    One thing that makes the Gulf States very different from China is that there is not much in the way of a local economy so I’m not sure that having an independent monetary policy is such a necessity.

    Something would be interesting is to just go up to the people in charge of Saudi monetary policy and ask them why they are pegging.

  • Posted by Twofish

    The fact that Bush and Cheney are tied in with big oil is a very unsurprising fact. The trouble with “exposing” that fact is that quite honestly, most people know, most people don’t care, and it doesn’t mean very much.

    You can’t pin the Iraq War on big oil. Big oil would have made much more money if Hussein stayed in power, and would have probably much preferred a soft policy in Iraq and lifting of sanctions against Iraq.

  • Posted by Dave Chiang

    Twofish, Western Big oil would not have made much more money if Hussein stayed in power. Saddam Hussein denominated Iraqi oil exports from the US Dollar into Euros. Saddam signed exclusive energy development contracts with Russia and China that have been abrogated by the US military. From the Washington Post,
    http://www.washingtonpost.com/wp-dyn/content/article/2005/07/12/AR2005071201546_pf.html

    Through cultivation of Saddam Hussein’s government, China sought to develop some of Iraq’s more promising reserves. Beijing advocated lifting the United Nations sanctions that prevented investment in Iraq’s oil patch and limited sales of its production. Then the United States went to war in Iraq in 2003, wiping out China’s stakes.

    “Iraq changed the government’s thinking,” said Pan Rui, an international relations expert at Fudan University in Shanghai. “The Middle East is China’s largest source of oil. America is now pursuing a grand strategy, the pursuit of American hegemony in the Middle East. Saudi Arabia is the number one oil producer, and Iraq is number two [in terms of reserves]. Now, the United States has direct influence in both countries.”

    The war and its aftermath have reshaped China’s basic conception of the geopolitics of oil and added urgency to its mission to lessen dependence on Middle East supplies. It has reinforced China’s fears that it is locked in a zero-sum contest for energy with the world’s lone superpower, prompting Beijing to intensify its search for new sources, international relations and energy experts say.

  • Posted by Dave Chiang

    US military occupation of Iraq destroyed China’s $1.3 billion investment contract
    http://www.washingtonpost.com/wp-dyn/content/article/2005/07/12/AR2005071201546_pf.html

    “Most immediately, it destroyed China’s hopes of developing large assets in Iraq. China had been waiting for the end of sanctions to begin work on the Al-Ahdab field in central Iraq, under a $1.3 billion contract signed in 1997 by its largest state-owned firm, China National Petroleum Corp. The field’s production potential has been estimated at 90,000 barrels a day. China was also pursuing rights to a far bigger prize — the Halfayah field, which could produce 300,000 barrels a day. Together, those two fields might have delivered quantities equivalent to 13 percent of China’s current domestic production.”

  • Posted by Twofish

    DC: Saddam Hussein denominated Iraqi oil exports from the US Dollar into Euros.

    Exxon-Mobil can and does make money from Euros.

    DC: Saddam signed exclusive energy development contracts with Russia and China that have been abrogated by the US military.

    And he signed those agreements because he couldn’t sign the agreements with US companies. Exxon-Mobil can and does enter into cooperative agreements with Gazprom and PetroChina, and Halliburton makes a lot of money providing oil services to Chinese and Russian companies.

    DC: The war and its aftermath have reshaped China’s basic conception of the geopolitics of oil and added urgency to its mission to lessen dependence on Middle East supplies.

    The problem is that any supplies outside of the Central Asia is subject to being cut off by the US military and any Central Asian sources are subject to being cut off by the Russians.

    DC: Most immediately, it destroyed China’s hopes of developing large assets in Iraq.

    And in developing those fields they would have used American oil service companies and then resold the oil to American refineries and retailers.

  • Posted by prefer anon

    To bsetser – is the Gulf caught ina catch 22 now where even fi they pump less oil it will drive the price up, therefore leaving revenues high, therefore requiring the same level of petrodollar recycling?

    Hey Dave, maybe you can use up to date stats on oil consumption…

    “The U.S. Energy Information Administration revised downward U.S. April oil demand by 863,000 barrels per day (bpd) to 19.77 million bpd — 3.9 percent below year-ago levels. The revision, which showed April demand was the lowest for the month since April 2002, came even before gasoline prices surged to new records in June.”

    You can go back to your robotic posting now.

  • Posted by Twofish

    It seems fairly irrational to think that the US would spend $1 trillion for a war so that oil companies could make several tens of billions more money. If pure profit was the motive, then it would have made much more sense for the US to just write a check for $200 billion to the oil companies.

    Also, oil companies have been responsible for a lot of evil and nasty things. Had big oil gotten their way in Iraq then they would have signed the standard “pay off corrupt dictator so that he can ruthlessly exploit and pillage his own people” contract and looked the other way as Hussein financed a nuclear bomb and wiped out the Kurds. That’s pretty standard throughout the world, but most people don’t care as long as they get their SUV’s running.

    That’s also why I think that people are fooling themselves when you think that people will rise up in horror when they find out that Bush and Cheney are in league with big oil. Anyone who fills up a gas tank is in league with big oil, and whatever corruption and evil Bush and Cheney are involved in with regard to energy policy is only part of the corruption and evil that pretty much everyone in the developed world is involved in.

  • Posted by Dave Chiang

    Twofish, Frat boy Bush was duped by the Neo-cons into believing that Iraqi could be turned into a “land of milk and honey”, also fat oil profits. Deputy Defense Secretary Paul Wolfowitz on official record stated that, “Iraqi oil profits would fully finance US military operations”. Even after 1 million dead Iraqi civilians and other war crimes, the Bush Adminstration still remains clueless about the fiasco. VP Dick Cheney was asked about an exit plan from Iraq; his response was there isn’t one because we never intend to leave Iraq with the world’s second largest oil reserves.

    And Halliburton doesn’t make a lot of money providing oil services to Chinese and Russian companies in Iran. It’s really alot of hot air BS about free-market economics when China Sinopec and PetroChina were forced out of Iraqi oil fields literally at the point of gun of the US military occupation. Neo-colonialism as practiced in Iraq is exploitation. Period.

  • Posted by bsetser

    Glory — politics is certainly a big part of the reason why the Gulf has remained pegged to the dollar. Rumor is that the US government put pressure on the saudis to maintain the dollar peg in December. This explanation only goes so far tho — Kuwait cooperates with the US strategically like no other, and it moved away from the dollar. And presumably the US cares far more about the price of oil than about the Gulf’s peg to the dollar, and at various points in time the Saudis have preferred to take steps to push up oil prices (spring 07) even though the US wanted the opposite. The Saudis don’t do something just b/c the US asks. That leads me to suspect that they have their own reasons for maintaining the peg (including higher $ exposure than the rest of the Gulf, or simply a much more conservative central bank governor). I really don’t know the full story.

    I agree tho that the breaking point will come when domestic inflation creates a real threat to the political stability of the big gulf coutnries. Saudi matters here, b/c they have a much larger local population (relative to the oil) and some parts of that population haven’t benefited from the oil boom all that much and are getting squeezed by higher prices.

  • Posted by RealThink

    Brad, a fact that must be taken into account when studying this topic is that GCC revenues come from the extraction of a finite, non-renewable resource.

    Catham House has just produced a paper on this issue that you may find interesting.

    Resource Depletion, Dependence and Development: Can Theory Help?
    Paul Stevens and John V Mitchell, July 2008
    http://www.chathamhouse.org.uk/publications/papers/view/-/id/638/

  • Posted by not_everything_is_america's_fault

    DC: “US military occupation of Iraq destroyed China’s $1.3 billion investment contract”

    Every reader of Brad’s blog knows (excellent blog Brad) this must be a drop in the bucket to the amout China loses on its Foreign Currency reserves..

    DC: “The only trouble is that $100 oil takes money from the pocket of consumers and delivers it to the oil producers (not just Arabs), who then reinvest it in Wall Street. The net result is a transfer of wealth from the “working families” of the world to the capitalists the world over.”

    Right…the same way Chinese consumers (who are much poorer than American consumers) are paying American consumers..you know the it is always the poor who are the suckers…

  • Posted by RealThink

    Interestingly, if currencies of Gulf countries got linked to oil, they would become the hardest currencies in the world, and speculative international financial funds would probably try to get parked in them. Therefore Gulf countries would add a Capital Account surplus to their already huge Current Account surplus, which would make revaluation pressure even stronger and their currencies even more desirable. We have a positive loop here with an almost infinite revaluation potential.

  • Posted by bsetser

    real think — at some point, yes. but if the basket peg was known and credible, any big inflows would just pile up as reserves — the peg itself wouldn’t break. so betting on the gcc currency becomes an indirect bet on oil. but presumably if you like oil, you would rather be long “all oil” than a basket that includes oil. A free float might induce such a feedback loop, tho at some point the valuation would reach the point where gulf investors would move funds out b/c they concluded their currency was overvalued.

    as far as oil being a finite resource, tis true. and norway manages its oil that way — they are replacing a resource below ground with one above the ground. but i don’t think it makes sense for all countries to manage their resource revenue that way — especially countries with lots of oil and few people. if the entire oil revenue stream was used to buy financial assets of the oil importers, they collectively would need to run a major current account deficit. and in practice, this would mean truely enormous sums under the control of five gulf families and the group that now runs russia. that also would worry me a bit — it sounds like an oligarchy on a global scale.

    some of the thinking about oil when was at $20 and cost $15 to produce in a lot of places may need to be reevaluated a bit if the long-term price of oil is much higher and their are enormous scarcity rents.

  • Posted by RealThink

    Bad link above to your June 27 post.

  • Posted by Dave Chiang

    After bashing Arabs, the Chinese soon to become the #1 threat to the US Elites at the Neo-con CFR :-) LOL

    China’s economy to become world’s biggest in 2035: study
    WASHINGTON, July 8 (AFP) Jul 08, 2008
    http://www.sinodaily.com/2006/080708200445.jjdmhfw1.html

    China’s economy will overtake that of the United States by 2035 and be twice its size by midcentury, a study released Tuesday by a US research organization concluded.

    The report by economist Albert Keidel of the Carnegie Endowment for International Peace said China’s rapid growth is driven by domestic demand more than exports, and will sustain high single-digit growth rates well into the 21st century.

  • Posted by Dave Chiang

    From Bloomberg, G8 led by US blames Chinese for rising food prices. Who is really more overweight, Americans or Chinese?

    http://www.bloomberg.com/apps/news?pid=20601089&sid=aC4GE7shfWdg&refer=china

    Industrial world criticism extended to moves by developing nations to halt the export of some foods, stockpiling domestic supplies in the face of soaring prices for basic commodities. The G-8′s criticism of food policies drew a rebuke from President Hu Jintao of China, the world’s fastest-growing major economy, with an expansion of 10.6 percent in the first quarter from a year earlier.

  • Posted by Dave Chiang

    From Bloomberg, G8 led by US blames Chinese for rising food prices. Who is really more overweight, Americans or Chinese?

    http://www.bloomberg.com/apps/news?pid=20601089&sid=aC4GE7shfWdg&refer=china

    Industrial world criticism extended to moves by developing nations to halt the export of some foods, stockpiling domestic supplies in the face of soaring prices for basic commodities. The G-8’s criticism of food policies drew a rebuke from President Hu Jintao of China, the world’s fastest-growing major economy, with an expansion of 10.6 percent in the first quarter from a year earlier.

    “Big developing countries” aren’t responsible for food price increases, Hu said in Sapporo. “This is not a responsible attitude.”

  • Posted by Twofish

    It’s not clear to me why Saudi’s want to keep the Saudi peg, but it is even more unclear to me the reasons why the US seems to want the Saudis Arabia to keep the Saudi peg. The closest thing that I can figure is that you don’t have the element of trade protectionism, and that that the US is much more comfortable being financed by Saudi Arabia than by China. For all its oil, Saudi Arabia is just not going to be a geopolitical competitor to the United States so Saudi money is considered “safer” than Chinese money.

    One thing I do find it amusing is when Westerners trying to convince Chinese or Saudi officials to do something for their own domestic interests. Presumably both Chinese and Saudi officials are rational and intelligent people, and also it is likely that they are much more in touch with domestic conditions that someone in Washington. If they believed that it was in their domestic interest to do something they would have done it already.

  • Posted by Twofish

    bsetser: in practice, this would mean truely enormous sums under the control of five gulf families and the group that now runs russia. that also would worry me a bit — it sounds like an oligarchy on a global scale.

    It would only turn into an oligarchy if the US, China, and India were to suddenly disappear, but I don’t see that happening. However, more likely having lots of power in the hands of five gulf families and the group that runs the Kremlin would lead to a much more even distribution of power than the current situation, and that doesn’t strike me as a bad thing. One thing that is the case with the Saudis and the Russians is that if their power is based on money, they have a strong interest not to fundamentally challenge the world economic and political system and to oppose those that will.

    One major test of a “power elite” is how it handles new entrants, and it always seems to better when possible to invite the new folks into the country club than to keep them on the outside where they end up scheming to overthrow the system.

  • Posted by Twofish

    To put things in perspective.

    The total oil revenues of Saudi Arabia in 2008 is about $200 billion. The total revenues of Walmart is about $300 billion. Saudi Arabia’s sovereign wealth fund has about $900 billion under management. Bank of America has about $1.7 trillion.

    There are going to be some new faces in the board room, but I wouldn’t worry about them taking over just yet.

  • Posted by justwondering

    The fact of the matter is that the US already controls most of the world’s oil without war, by virtue of oil being denominated in dollars that the US can print at will with little penalty.

    You call a doubling of the USD price of oil in just the last year “little penalty”?

    Oil is denominated in all convertible currencies simultaneously, just like any other commodity.

  • Posted by bsetser

    2fish –

    a) there is a plausible argument that the saudis aren’t changing b.c. of US pressure, so this isn’t entirely a question of telling others what is in their own interest.

    b) I do think it would be in china’s interest to let their currency move, and that chinese policy has been captured by special interests that benefit from low rates and the peg. but your points here resonate a bit (LArry summers incidentally made a similar argument at the PEterson institute conference, namely that it is hard for a nation that isn’t growing to tell a nation that is growing at 10% what is in its interest). I would put more emphasis on China’s global obligations as a member of the international community, particularly now that is is a huge exporter (second biggest goods exporter in the world after germany — and germany’s total is pumped up by intra-EU trade). And if China doesn’t find that compelling, other countries could eventually conclude that it isn’t in their interest to keep their markets open to a country that subsidizes its exports as a core part of its growth strategy, as the costs of remaining open might exceed the benefits. The fact that net exports contributed more to china’s growth in q1 than to us growth in q1 when china is booming and the us is stalled is stunning. a lot of the framing about it being in China’s interest was meant to create space for china to move without caving to us pressure, but well, that strategy seems to have reached its limit, as many now have the reaction that china is far better placed to determine its interest than the US.

    c) Saudi Arabia doesn’t have a SWF. SAMA (the central bank) manages about $400b, with some of it supposedly in equities. but it is still more a cB with some risk assets portfolio than a SWF portfolio. The Saudis are thought to have $800-900b in total, but how exactly the remainder is managed is a bit of secret.

    d) the boA comparison isn’t quite right, in my view — the Saudis are managing a foreign portfolio not a domestic portfolio. the BoA (or another US bank) doesn’t generate $200b in net demand for foreign assets. they keep matched books. the Saudi funds are “earned” money not borrowed money — they aren’t leveraged. by putting their cash in say a PE firm they can gear up and they (or their fund managers) can control much more.

    the first point about d) applies with even more force to China. China’s $800b increase in its gov’s foreign assets has a much bigger impact on global flows than any private financial firm. and i rather suspect china’s combined extenral portfolio (CIC+SAFE+state banks) is going to be close to $3 trillion by the end of the year, which is WAY more than the external portfolio of any private financial institution. So from a balance of payments point of view, the assets under management of private firms matters way way less than the increase in the stocks of the foreign governments now adding to their portfolios at the fastest pace.

  • Posted by RebelEconomist

    More iconic than the Rockefeller Center:
    http://www.bloomberg.com/apps/news?pid=20601087&sid=aGA0howz2xDo&refer=home

    The US should raise gasoline tax urgently.

  • Posted by anon

    “Japanese investors spent $78 billion on U.S. properties between the late 1980s and 1995. Many of these transactions, including Mitsubishi Estate’s 1989 purchase of Manhattan’s Rockefeller Center for $895 million, came just before a U.S. recession sent real estate values plummeting. As a result, the Japanese investors lost an estimated 50 percent to 80 percent of their money during the period.”

  • Posted by bsetser

    History may rhyme, but it doesn’t always repeat. The widespread assumption now is that any big foreigner buying US real estate will get taken to the cleaners. Maybe, maybe not. the US shouldn’t bank on selling assets that fall by 50% to finance its external deficit …

    tho if you think about it, that is what it has done to any european investor who bought $ five years ago.

    More importantly, in terms of “oil”, it takes way less oil for Abu Dhabi to buy the Chrylser building than it used to …

  • Posted by RealThink

    A simple yet realistic enough model can show why depegging their currencies from the USD is not enough for oil exporters. Let’s assume that GCC countries achieve monetary union Eurozone-style, with the Gulfo (GLF) as their common currency. Let’s assume that the Current Account surplus of the Gulfozone is always half their oil exports, implying that as the oil price goes up they spend more abroad. We now consider two possible monetary regimes for the Gulfozone and see what happens per each TWO oil barrels exported as the price of an oil barrel (b) goes from USD 100 to 150 to 200.

    Current regime: 1 GLF = 1 USD

    1 b = 100 USD; Gulfozone accumulates 100 USD of reserves and prints 100 GLF
    1 b = 150 USD; Gulfozone accumulates 150 USD of reserves and prints 150 GLF
    1 b = 200 USD; Gulfozone accumulates 200 USD of reserves and prints 200 GLF

    Gulf oil standard: 100 GLF = 1 b

    1 b = 100 USD; Gulfozone accumulates 100 USD of reserves and prints 100 GLF
    1 b = 150 USD; Gulfozone accumulates 150 USD of reserves and prints 100 GLF
    1 b = 200 USD; Gulfozone accumulates 200 USD of reserves and prints 100 GLF

    Clearly, pegging the GLF to the oil price prevents the acceleration in the internal inflation rate that the current exchange rate regime is causing, but does not prevent the acceleration in the accumulation of USD reserves. Therefore in both monetary regimes Gulf countries are trading their only resource coming from a finite, exhaustible endowment for printed paper worth less and less. This case is completely different from that of factory countries like China, which by revaluating their currencies would render their exports less competitive and eventually bring their CA surplus to zero. That does not happen with oil exports, as oil has no viable substitute and its demand is highly inelastic and moreover has enormous growth potential (unless the Chinese can be convinced that driving cars and SUVs is for losers and that they should keep biking). Therefore, as long as a country can pay for oil with printed paper, it will print as much paper as needed while that paper is accepted as payment.

    This problem (for the oil exporters) cannot be solved by switching oil trade to other fiat currencies such as EUR or JPY, because if the problem arises from the fact that the US is getting a free lunch (by having its currency used as the international trade and reserve currency), the solution cannot possibly be just taking that privilege away from the US and granting it to another oil importer like the Eurozone or Japan. The solution can only be that NOBODY gets a free lunch (gold used as international trade and reserve currency) or that Gulf countries themselves start getting a free lunch (GLF used as international trade and reserve currency). The only way to prevent this outcome is to guarantee that the printed paper used today will not be worth less and less, which requires that the USD be pegged (within some reasonable band) to the oil price. This would be equivalent to the person having the free lunch privilege committing to restraining his food intake as necessary so that, in a scenario of constrained food supply, the others can eat too.

    Under this hypothetical regime, if the oil price tended to rise too much the US (biggest world oil consumer) would lower its demand as a result of tighter monetary policy. If on the other hand the oil price tended to drop too much, oil exporters could help support it by lowering their production. Needless to say, this regime would delight both Peak Oilers and Global Warmers.

  • Posted by Twofish

    bsetser: I would put more emphasis on China’s global obligations as a member of the international community.

    There are a number of problems with this approach. The first is that it’s not clear what China’s global obligations are in this situation. You can point to various documents, but China’s response would be “so what, it’s nothing that we signed.”

    Also, nations generally abide by global norms even when it is in their short term interest not do to so, when they are binding enough so that there may be other circumstances in which it is in their interest to do so. You lose one case before WTO, you might win another.

    With regard to capital flows, there’s no reason for China to believe that if it becomes a “good citizen” that those norms could be used by China against the United States or the EU at some later time. In fact, the evidence suggests the opposite in that both the US and EU will ignore norms on capital flows when it is in their interest to do so.

    Part of the problem is the possible governance structures regarding capital flows (namely the IMF) have very little Chinese participation, and so there is no reason for China to care what those institutions think.

    Also “international norms” means more than what Europe and the US think.

    bsetser: if China doesn’t find that compelling, other countries could eventually conclude that it isn’t in their interest to keep their markets open to a country that subsidizes its exports as a core part of its growth strategy, as the costs of remaining open might exceed the benefits.

    That doesn’t sound like much of a negotiating position. If you don’t do X, then maybe possibly we might get upset in a year, and then do something like write a resolution.

    Since there are lots of groups that benefit from a trade deficit, and would scream at any restrictions to it. Part of the problem is to overhaul the trade system would take years, and the process would quickly get hijacked by non-trade related issues.

    One reality here is that if China say, “no we just don’t want to break the peg” there isn’t that much the US can do quickly about it.

  • Posted by Pallj

    Interesting that we are finally seeing some signs that oil price might be levelling out. Has it peaked? Will it continue to fall?

    Might do, provided there aren’t any fresh armed conflicts just around the corner. Like Iran…

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