Why Henry Paulson should have gone to the Middle East not China
THAT two-thirds of the world’s oil comes from troubled emerging economies is worrying enough. Less noticed, and more alarming, is the growing financial clout of places like the Middle East, Russia and Venezuela as a result of sustained high oil prices and their build-up of foreign assets.
With America fixated on China, this matter is not widely discussed. A visit by Henry Paulson, America’s treasury secretary, and a high-ranking team of policymakers to Beijing on December 14th to urge China to shrink its current-account surplus of around $200 billion this year is a symptom of the excessive attention paid to China’s surplus and the supposedly undervalued yuan in the debate about global imbalances.
China’s surplus is dwarfed by those of oil-exporting emerging economies, which are expected to total $500 billion, over half of it in the Middle East (see article). Relative to their economies, the oil producers’ external surpluses look even bigger: Saudi Arabia, the UAE and Kuwait have an average surplus of around 30% of GDP, making China’s 8% seem almost modest. These surpluses are having a huge impact on international capital flows; and they may, unless the right policy prescriptions are applied, undermine efforts to unwind global imbalances in an orderly way.
The surge in oil revenues over the past four years is perhaps the biggest windfall ever enjoyed by a group of countries. In real terms, the oil exporters’ current-account surplus is more than twice as big as it was at its peak in the 1970s’ oil-price shocks. According to the IMF, the cumulative surpluses of oil exporters could amount to $1.7 trillion in the five years to 2007, swamping China’s likely stash of $700 billion.
Previous periods of expensive oil and bumper surpluses did not last long, but this one may prove more durable. Although prices have recently dipped, most analysts expect the tightness of oil supplies to keep the average price close to $60 a barrel—three times the average level in the 1990s. Oil exporters are also spending a smaller share of their windfalls on imports than in past booms and instead saving more. As oil prices stabilise and imports pick up, current-account surpluses will shrink, but remain unusually large.
The petrodollar explosion has two main consequences. First, it is one of the principal causes of the liquidity that is stirring up frothy financial markets. Middle Eastern money is much harder to track than Chinese capital, because a large chunk of foreign assets are held not as official reserves but in secretive government investment funds. Moreover, whereas China buys American treasury securities direct from American brokers or dealers, Middle Eastern purchases of bonds are typically channelled through intermediaries in London, hiding their true ownership. Oil surpluses are also flooding into equities, hedge funds, private equity and property. In the 1970s petrodollars were deposited in western banks, which lent too many of them to developing countries and thus sowed the seeds of Latin America’s debt crisis. Today, given the complexity of modern capital markets, the flood of money may be storing up different sorts of trouble.
Second, Middle Eastern countries, just like China, have been preventing the global economy from rebalancing itself. But whereas China is at last moving slowly towards a more flexible exchange-rate, the currencies of Saudi Arabia, Kuwait, the UAE and most other Gulf economies are still firmly pegged to the dollar—and are possibly more undervalued than the yuan, given the huge gains in their terms of trade.
Dragged down by the dollar
The dollar peg means that, as the price of oil has soared, those currencies’ real trade-weighted exchange rates have, perversely, fallen. This is pushing up inflation and stoking asset-price and credit bubbles in their domestic economies. Pegging those currencies to the weak dollar also dampens demand for imports in their economies, and thus hinders the rebalancing of global current accounts. Higher levels of both imports and government spending by the oil-producing countries would help unwind the imbalances that endanger the world’s economic stability.
Nor will the Middle Easterners’ attachment to the dollar keep it stable. The government investment funds that manage much of the oil money are not subject to the constraints on holding liquid assets that China’s central bank is. Their risk-and-return profile is closer to that of private investors. Thus, if the dollar looks likely to continue its slide, oil exporters are more likely to diversify out of dollars than China is.
American voters have got it in for China at the moment. All manner of economic ills are attributed to the place. That, no doubt, is why Mr Paulson is going there. But although his trip may pay political dividends, if he wants to improve America’s economic prospects, he should cut short the China visit and drop in on the Middle East on his way home.
