Tracking Petrodollars (page 3 of 3)

The deposits by OPEC countries were primarily US dominated and were largely due to the increase in US interest rates.

This increase in deposits with the BIS does not take away from the diversification in investment paths compared to the 1970s and early 1980s. First, more money is remaining within the wider region, both in the oilexporting countries themselves and their neighbours; this is especially the case with smaller investors. This is evident by the large increase in the regional stock market indices and in property prices witnessed throughout the region over the last few years. Second, investors are looking more towards the east, with increased investment in China, India and other Asian countries. This includes joint ventures to increase refining capacity, portfolio investments and real estate.

Third, there has been a strong flow of petrodollars into private equity overseas, for example, the Dubai International Capital's USD 1.2bn purchase of a 2% stake in DaimlerChrysler and USD 1.5bn purchase of Madame Tussauds, the British wax museum. Other examples include Dubai's buying P&O and Mubadala Development Company, an investment company of the government of Abu Dhabi, purchase of a 5% stake in Italian carmaker Ferrari. Private equity investment has also increased from wealthy individuals.

Finally, and importantly, for the global economy, the petrodollars are being directed towards US Treasury bonds. However, this has mostly been through indirect channels (Europe and Asia); US Treasury data indicates that OPEC holding of bonds fell in 2005. Instead, investments are being booked through intermediary bases in Europe or offshore financial centres. Private bankers have also indicated greater investments levels are being directed towards hedge funds. In addition, Europe and Asia's exports to oil-exporting countries have risen at a faster pace than the US's, limiting the effect of the high oil price on their trade balance with the region. Export earnings are then invested into US paper. Petrodollars channeled through Europe and Asia could be funding up to 20% of the US's current account deficit.

The recycling of petrodollars through bonds has had a very different effect on the world economy than the bank-mediated recycling of the previous booms. The investment of petrodollars in US paper, alongside similar investments from Asia, has helped to keep US long-term interest rates low, even as the Fed has been increasing short-term rates. The low long-term interest rates have contributed to bolstering consumer spending, softening the impact of the high oil prices. (In addition, it is also important to note, that real oil prices are not currently as high in real terms as compared to the late 1970s and early 1980s. Therefore the negative impact on the global economy of the high oil price has been less.)

Reducing global imbalances remains a key area of concern for international agencies, such as the IMF, along with the US Treasury. These organisations have urged that the Middle Eastern oil exporting countries take a number of measures to help in reducing the imbalance. This includes, for countries with higher absorption capacities, to increase spending in areas that will benefit their long-term development, whilst avoiding wasteful spending. The US Treasury has also called on oil-exporting countries to increase investment in production and refining capacity, in order to reduce tightness in global supply.

However, the region will be limited in the short-term in its ability to help reduce the US's current account deficit via reducing oil prices. The majority of countries are already pumping oil at capacity and the high price is to a large part down to a political risk premium, rather than market fundamentals. In addition, the medium-term investment plans will increase demand for good and services from industrialised countries. However, even as the Middle East increases spending, the majority of the imports will still originate from Asia and Europe. An appreciation of Asian currencies is required against the US dollar to make US imports more competitive. Other measures needed to reduce the US's current account deficit included steps to encourage saving in the US and increase demand in Europe and Japan.