Title shamelessly stolen from Chris Cook, who’s applied the term to the IEA’s “easing” of tight oil markets by releasing reserves.
What we refer to though is the direct depression of bond yields, via the sheer weight of petrodollars (for example Saudi Arabia’s gigantic foreign assets) recycled into buying those bonds.
Let’s say the petrodollars keep multiplying, starting with $70bn of ‘asset purchases’ per month.
This was the number (and rationale) bandied about by Goldman’s analysts on Monday in a note which looked at the petrodollar implications of long-term high oil prices. This is the main bit:
The asset market implications of higher oil prices alongside higher petrodollar saving flows are bounded by two offsetting considerations. On the one hand, higher oil prices obviously represent a headwind for domestic demand in the US and Europe. Indeed, higher oil prices top our list of reasons for the recent slowing of US economic growth. On the other hand, we estimate that the $70/barrel rise in Brent crude prices over the past two years has caused petrodollar saving flows to rise from roughly $10bn to $70bn per month, thus adding roughly $700bn of asset demand to global capital markets. In a world where developed market borrowing demand is expected to remain high, this is not necessarily a bad thing.
If you’re thinking that (apart from that desperate need to sell sovereign debt) this all sounds very 2006, you would be right. Goldman think this was the last time petrodollar flows reached $70bn/month, apart from the summer 2008 run-up in oil. (Er, potentially a counter-indicator for oil prices then?)
The thing is though, Goldman’s view really trades on the idea that the global savings glut piled into fixed income before the crisis (i.e. money had to go into assets somewhere, preferably things bearing yield, leading markets onward to a credit bubble) and that this glut will perforce return in strength on the oil price. Well, we dunno. There was a great BIS paper a while back arguing that the problem before the financial crisis was never excess savings or current account surpluses at all. (Although recycling oil receipts is much more influential on current accounts than foreign exchange reserve accumulation, they said, nor did the paper’s authors deny that US long-term yields had been reduced in some way by official buying.)
In fact, the BIS argued, the issue was and is “excess elasticity”. No giant wall of savings, just lots of overstretched balance sheets and extended low interest rates on the other side, enabling credit to be created.
There is actually a ghost of the excess elasticity argument in this second point by Goldman, though note how they imply that it will eventually repress Treasury yields anyway:
As for “round two” of the surge in petrodollar savings, it is difficult to say whether the effects are likely to be greater or smaller this time. We see offsetting arguments. On the one hand, global savings flows have already begun to reallocate away from fixed income and away from the developed market economies – the US in particular. In this sense, the demand for plain vanilla credit instruments is likely to be less heated this time around. On the other hand, we strongly suspect that due to the experience of the recent crisis, financial markets in developed economies will prove highly resistant to the lure of “easy credit.” New and tighter regulatory oversight, bank capital standards, and risk management processes will all effectively work to reduce the developed market supply of credit instruments and securities available to global investors. Paradoxically, this will increase the scarcity value of plain vanilla credit products, which should push their prices higher…
Petrodollars, meet Basel III, meet collateralised lending, meet the great age of financial repression, maybe.
We think we prefer Chris Cook’s definition…
Related links:
The central oil bank of Saudi Arabia – FT Alphaville
Beware the special US Treasury market – FT Alphaville
It’s not a liquidity crisis, it’s an energy crisis stupid - FT Alphaville