February 24, 2008

Time to follow the money

Posted in International Economy · 13 comments ·
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The people who benefit from the spike in the price of oil are the ones who are really in charge of the world economy.

When you fill up your car, do you ever wonder where all this cash goes? Ten years ago oil was trading at close to $12 a barrel; today it is just under $100 a barrel this week. So who is benefiting?

And, more importantly, what are they doing with all their new cash? Obviously, much of it ends up in the hands of the oil producer after all the others take their cut, particularly the taxman.

Since September 11, 2001, and particularly since the occupation of Afghanistan and Iraq, the price of oil has increased sharply from $23, hovering around $80 a barrel for much of the past year. In the past week it recorded above $100, before falling back slightly on Friday. The main winners are the Arab oil producers, who benefit from a huge windfall as millions of western drivers hand over cash to the sheikhs. You might say that this is Osama’s handiwork.

The best way to gauge just how much of your cash has ended up in the Gulf as a result of Bin Laden’s oil boom is to look at the foreign reserves of the region. The IMF calculates that the balance of payments of the Gulf went from a $30 billion surplus on the eve of September 11, to $212 billion last year. The crucial oil-trade balance has rocketed from $159 billion to $451 billion. This is your cash, and the cash of every western punter and company that depends on oil for their daily existence.

But because the Gulf states are small places, they can’t absorb all this cash, and the money has to go somewhere. It can’t all be spent in the Gulf. Also, given that the atmosphere in the US is one of overt suspicion and barely-concealed hostility towards Arabs – especially Saudis – the recycled cash is not going back to buy Manhattan penthouses for Arab playboys.

Not surprisingly, many Arabs have taken the hint and moved themselves and their money back home, with the result being huge price rises and rampant speculation in property in the Gulf, leading to the extraordinary rise of Dubai out of the desert. This new metropolis is sucking in workers from Bangladesh and Pakistan, hookers from Russia and money from investors reading the property ads.

However, the Gulf states have fairly modest economies. Because of this, the bulk of the petro-cash, as happened in the 1970s, has gone back out into the global economy, looking for a profitable home.

(In the 1970s, recycled petro-dollars fuelled the Third World debt crisis, as Arab cash was lent to Third World countries. The 1970s saw a commodity price boom and lenders thought that revenue from commodities would be enough to pay back the loans. Commodity prices fell in the early 1980s and so too did the Third World’s ability to pay back the loans, ushering in what was known as the Third World debt crisis.)

All this recycled cash has had the effect of keeping world interest rates lower than they otherwise would be. As well as having old Germans to thank for our lower interest rates, Ireland has to acknowledge Bin Laden’s role in the liquidity bonanza of the past few years. His attack on the Twin Towers, triggering the invasion of Iraq, has ensured that a wave of oil money from the Gulf is washing over us. However, something much bigger is happening. The peak in the oil price has also been mirrored by peaks in other commodity prices, particularly (though not exclusively) metal prices.

For example, this week saw all-time highs in wheat, corn and soybean prices. Most economists are suggesting that these rises in commodity prices are just the simple reaction to huge demand from China and India. But can this explain everything? While the demand from Asia might explain the direction of commodity prices, it doesn’t explain the extent of the price increases.

To understand this, we’ve got to go back to the idea that the global financial market is one large recycling mechanism that (legally) launders cash consistently. I am writing this article from London where, in the past few months, many former colleagues in the banking game have jumped ship from large investment banks to private equity firms and sovereign wealth funds. Much of the money in these funds is coming from the Gulf: the proceeds of millions of us who fill up our cars’ petrol tanks every day.

These funds are now engaged in rampant speculation all around the globe, driven mainly by the greed of their newly-hired staff. This process is creating a wall of new money that gushes into the asset of choice, driving up prices and, ultimately, creating a false market.

This used to be known as ‘hot money’ in the old days. In the 1970s and 1980s, hot money was speculative cash that typically poured into a country to take advantage of interest rate anomalies. So if Irish interest rates were higher than German ones, we might see lots of cash coming in to short-term deposits in the Irish market.

Back then, the Irish Central Bank would intervene in the market, buying up this new cash so as not to let interest rates and or the exchange rate move too far in response to the new liquidity. As a result, the peaks and troughs associated with hot money were smoothed.

Now, we have a superannuated version of old hot money. The new sovereign wealth funds constitute ‘mega-hot money’ (a term coined in the wonderful Dines Newsletter – possibly the best financial newsletter around.) This mega hot money is sloshing around the globe looking for a home. In the past year, this cash has rushed out of global property and the dollar into other assets.

Commodities are the main beneficiaries, and commodity-producing countries, such as Australia and Canada, have benefited enormously. But the downside is that there is no ‘global central bank’ for these assets to smooth out the subsequent price gyrations.

So we are left with a financial system that is almost guaranteed to generate the sort of massive price spikes and troughs we’ve witnessed in the past few years. None of this fazes my mates working for these new funds because, after all, if they make money they are paid enormous bonuses, and if they lose money, they are fired and paid off! Either way, they’re quids in.

With Masters of the Universe like these running the global show, and an endless supply of our recycled cash gushing out of the Gulf, is it any wonder that financial markets are volatile?


  1. John Q. Public

    A lot of the recently made money in the gulf is staying put to build hotels, houses and apartments. In Dubai for example, the infrastructure is being developed to cater for a lot of expats including paddies by the plane load. The arabs feel that they have to invest in their future for when the oil runs out. They have had all their eggs in one basket (oil) for too long now and need to diversify.
    There is a lot of suspicion regarding sovereign funds at the moment but the arabs probably won’t do anything to scare investors away or tourists for that matter. People always get suspicious when huge sums of money accumulate but let’s just stay calm. At least we can see what they are spending the money on unlike Saddam Hussein. Remember that episode? some of us thought he was up to no good. Well he was,but not in the way some of us thought.WMD remember?
    We should be more bothered about how America spends it’s cash at home and abroad; buying huge amounts of Chinese produce(making them wealthy-a big worry too), war costs in Iraq and so on. America’s spending spree and interference has caused more volatility worldwide than most other events. Their investment in Ireland for example can only be taken with a pinch of salt from now on as they can always pull out and leave hundreds of workers high and dry each time. The yanks are also in enormous debt and have their own credit crises and so on. They are more of a destabalising force worldwide than oil-rich countries. Afterall America caused Bin Laden’s mob to get angry in the first place. Markets go up and down anyway so maybe we should give muslim countries a break in that regard unless they threaten us.

  2. Paul Boyle

    While I generally enjoy your articles, your latest, prompted me to write a response. I feel that most people, yourself included, appear to be ill-informed about the reality which is happening in the oil and other commodities markets now. The astonishing rise in prices for basic commodities are simply being ‘hand waveringly’ dismissed as a result of speculators, China or some other excuse, whereas the reality is frighteningly different.

    If there is an increasing demand for a product while at the same time there is decreasing supply of that product, then elementary economics tells use that one can expect the price for the product to increase significantly. This is the exact situation in which the world finds itself in regards to oil and other commodities. Crude oil production has fallen year on year for the last three years, while at the same time demand is increasing. Average global oil production has decreased from its peak three years ago of 74.3 million barrels a day, by approximately half a million barrels since then. The actual numbers are freely available from the International Energy Agency, (IEA). This is the real reason why oil prices are increasing so much; it has nothing what so ever to do with Osama Bin Laden and 9/11, it is simply elementary economics: falling supply and rising demand = higher prices. Global oil production is falling and it will continue to fall in the future with drastic consequences. It will not be long before $100 oil will appear cheep.

    You mentioned the increasing price that has occurred for wheat and speculate as to the causes. The fact is that global supplies for wheat are now at their lowest level since records began being kept, 50 years ago. We are now in the very real situation, whereby if there is a bad spring or summer there will simply not be enough grain in the world to get us through next winter if we continue to eat as much bread as we do today. The thought of which should be terrifying to anyone; a global shortage of bread! This is a situation which has been building now for years. For each of the last seven years, the world has consumed more food than it has produced; again simple economics is driving the price increases, supply has simply not kept up with demand which has resulted in greater prices.

    Much, but not all, of this price inflation in wheat and other foods stuffs can be explained directly by the oil situation. For generations now, farming has been a miserable business to be in. It is difficult to make a profit or even make a decent living being a farmer. Over the last decade or so, governments around the world have put in place large subsidies for farmers to develop crops for things such as ethanol and bio-diesel. Farmers, being intelligent people, responded to these subsidies and began converting part of their land to develop crops to be turned into oil rather than food. They can make more money that way. This has resulted in lower food production world wide, with the result that stored supplies are being consumed to make up the difference. This is one example of how changes in oil production are affecting everything else. We are sacrificing food production in an attempt to maintain oil production.

    Oil is a finite resource, the supply of which will eventually peak and decline indefinitely; this is an indisputable fact. It will happen. It is not a case of economics, but one of Geology. There are many who believe that this point has already occurred and production has started to decline, of which I am one. There are others who believe that the recent drop in production is simply a blip, and the peak in oil production has not occurred yet; even the most optimistic of them claim that it will happen in the not too distant future, a date of sometime after 2020 being given. But no one disputes the fact that it will happen.

    I firmly believe that we are entering the most uncertain period in history. While this may sound dramatic, I would say that on the contrary is impossible to overstate the change which is coming, a change which has already started and is being caused by declining oil production.

    The global economy is completely dependent on cheep transport and communications. We are completely dependent on oil for transport. Approximately 95% of all transport is powered by oil products. Ireland is the perfect example, very little of what is consumed in Ireland is actually produced in Ireland anymore. Apart from the Dart and Luas, all other transport in this country is powered by oil based products. Everything is being shipped around the world to our shops, consuming oil in the process. We then drive to and from the shops to get our products and to work, consuming vast quantities of oil in the process.

    What happens when oil is at $200 a barrel, $500 or $1000? What happens when petrol costs €5. €10. or €20 a litter? This is the consequence of a falling supply and increasing demand for a product; the price goes up. Will it still be possible to transport all our products and goods around the world with such high prices? Will we still be able to afford such long commutes to work every day? I am unable to predict what the answer to these questions will be. But I do know we are in for a profound economic and social change in the not too distant future, all of which will be caused by what we are now seeing in the commodity markets.

  3. John Q. Public

    These reasons were given over three years ago and no mention of Bin Laden. http://news.bbc.co.uk/1/hi/business/3708951.stm

  4. AndrewGMooney

    Osam-Economics? Osama’s plan is doing very well. Now all it needs is Obama to bring some kind of weird theological, geometrical, numerological synchronicity to ‘Fortuna’s Wheel’ and: Game on! The Rapture!

    Osama said in 2004(!) that an ‘ethical’ price for ‘Saudi’ Islamic Black Gold was above $200 per barrel. We’re getting there…

    http://www.nationalreview.com/robbins/robbins200406020835.asp

    He also prophesied/ ‘wet-dreamed’ that ‘The American Dream’ would be destroyed by an incompetent charlatan of a ‘President’ who would over-reach himself by launching an Iraq bridge-2-far assault on two fronts: Instead of nailing The Real Enemy in his cave in Tora-Bora:

    http://www.csmonitor.com/2002/0304/p01s03-wosc.html

    We’re getting there. I was born on September 11th 1960. In 2001, I remember ’blowing out the candles’ clutching my young daughter and thinking: Something will never be the same again. I felt, even if I didn’t have the ‘chutzpah’ to state it, exactly the same sentiments / presentiments as Stockhausen:

    http://www.youtube.com/watch?v=0ZpCV3IFkS4

    Oh, and if you’re not ‘bonkers’ about Art like me, don’t bother even clicking the link. It won’t make sense. I’ve said it before (on this site!):

    ‘Economics is the Slave of Culture: Culture is the Slave of Ethics.’

    Makes a nice T-Shirt slogan, back and front, methinks. Much better than ’I’m A Porn Star’: Which seems very popular with teenage girls at local bus stops in Worcetershire.
    Why are ‘Western drivers / consumers / drones’, in their Chelsea Tractors (what’s the argot for D4?) fuelling their own destruction in a ‘bonfire of vanities’ every time they fill up their silly Viagra / Breast Implant ‘status symbols’?
    Listen, lads and lasses: You don’t impress me one bit. Every bit of designer -label – trash – accoutrement means ‘zero’ when you’re butt naked: Either you’ve got the goodies or you haven’t. Grow up.

    “Some Slaves Are Very Well Paid“. Carry on riding round the M25 / M50 whilst you put your lip-gloss on / scream at your P.A / check on the Czech nanny / have a crafty wank to Britney on your IPod: I’m not impressed. You’re all prison bitches. Unlike me.

    I feel for you. I was once there, at the ‘Bus-Stop‘. But now I’m a ..Sister…I‘m a ….Bbrother…..I’m all over this town….

    I ‘Got A Life’: Real Life. And all I need is ‘Sound Money’ and ‘The Rule of Law’ – everything else is an irrelevant bonus. No-one, other than DMcW checking my I.P address, knows whether I’m scribbling this missive from a council estate in Birmingham or from a cul-de-sac of luxurious pointlessness in the Arabian Sea.

    http://www.theworld.ae/

    Must go now, that’s Becks at the door, again!…..

    DMcW: You mention ‘metals’, but you’re forgetting that old Spandau Ballet opus: GOLD!

    http://www.financialsense.com/fsu/editorials/schiff/2006/0506.html

    Any smug Fc-Uk/Feckr ‘calculating paper gains’ on some semi in Solihull or Tallaght needs to re-calculate against the ‘Ascendency Of Inca Gold‘.

    I was, in a ‘Piers The Ploughman’ sense: Wandering Ye Olde Malvern Hills at dawn, when I met two ‘farmers’. After a convoluted discussion about petrochemical agribusiness versus preserving the ‘idyll’ of Mittle-England from the ‘Horrors of Modernity‘, they, astonishingly, echoed DMcW’s tales of Paddies in Leominster.

    But with the added twist of those savvy English Shire Gentlemen who sold up to Paddy – and have used their windfall profits to allow ‘Farmer Giles of Ledbury’ to move to ……Poland!

    When I threw up my hands in incomprehension about ‘The Language Issue’: I was told in no uncertain terms that speaking English in rural Poland is a fast-track to endless shagging and kudos for the average ‘useless’ English ‘farmer’. No need for that ‘Thai Brides’ catalogue anymore.

    Here, in the Fc-uk-up U.K: We don’t have the oil to sustain our current strategic food dependence. We’ve squandered our coal reserves in an orgy of ‘Thatcherite -Reverse – Class – War – 80’s – Madness’:

    If we’d not been intoxicated with The Enemy Scargill, the ‘Political Class’ drinking café au lait with Andrew Marr would have anticipated ‘carbon-capture coal burn technologies’ which would have ensured the strategic safety of Eng-Eire-land for a 1000 years.

    David, you say:

    “we’ve got to go back to the idea that the global financial market is one large recycling mechanism that (legally) launders cash consistently”

    We’re going to fall out! What are the biggest ‘industries’ in Economic Terms on the planet?
    Drugs ? Prostitution ? Pornography ?
    ‘Legal’ arms sales ?
    ‘Legal’ trade in ‘commodities’: From ‘blood diamonds’ to ‘indentured servants’: Whether racehorses, Filipino maids in Riyadh, or Irish Botox/Viagra to underpin the ‘Western Fashion / Sex / Military Industrial Complex? Legal trade in debt/misery/destruction by Vulture / Hedge Funds?

    I’m taking bets from all readers of this site as to the likely odds of Intel moving from Eire to Poland within 5 years. What comes after ‘The Knowledge Economy’ ?

    I owe nothing. I can skin a rabbit. I know which berries and leaves aren’t poisonous. Ray Mears is in the garden right now creating a ‘bothy’. The neighbours are complaining, but they always do, when they’re not ripping out the latest ’unfashionable’ UPVC windows for ’authentic’ Victoriana Sash-Trash or ’impressing’ me with a new ’deck’…. even if they‘re not playing with a full one.

    “Embodied Energy Discrepancies!“ I shriek as I open another crate of ale, but they just look…..confused. It’s not like Ray and I are running a full-on suburban brothel / dog – Fight-Club like all the other losers. Actually, we’re very Norton/ Pitt. We’re ‘prepared’. Are you?

    Finally, thank you all for your prayers for Eduardo. The news is comforting after the horrors of St Andrews yesterday. Please continue to light those candles……

    “I’m awoken by a…Handbrake turn outside,
    I knew lads who died, that sound chills me inside still.
    Howth Junction could take you away
    And in the hayfields we’d squander the day
    And from the corner of Holywell road.
    See the sunset over Saint Donaghs…..”

    Damo, your round…..

  5. Darren Kelly

    Paul,

    There is merit in much of your argument, but there’s an air of panic (or possibly despondency) in the tone of your comment that I feel is not warranted.

    Certainly we shall reach peak oil. As you say; geology dictates as much. But new sources will come on stream as oil prices rise. There will be a lag as the capital investment for extraction is significant (Canadian oil sands, for example) and investors will need assurances that oil will not drop back below $50 anytime soon. So while geology makes peek-oil a certainty, it also tells us that we’re not going to run-out of petrol any time soon. Supply can rise to meet demand (all be it at a higher price).

    When we talk about the price of oil we really mean the price of energy. Oil has been convenient but we are an ingenious lot, and the energy sources are there to be exploited. As oil becomes expensive we will use it more efficiently and gradually transfer to other forms of energy.
    The basic thesis is that; as the cost of energy rises, new technologies will become available to dampen that scale of that rise by increasing supply and reducing demand (through efficiencies and by providing alternatives). Yes, energy will be more expensive. Yes, that will have a general inflationary impact. Yes, we will see some changes in how we structure our cities, lives and consumption patterns as a result. But it’s really not the end of the world.

    As for this being the most uncertain time in history; the present is always the most uncertain time, all other times in history are only certain because they have already happened. Such statements about the present always put me in mind of Dickens; “…the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only”. My own noisy opinion is that this is the best of times (so far) and that the tide of history suggests that increasingly better times shall come.

  6. Garry

    I agree with Paul on the need for economists to start looking at things from different perspectives. Have ye forgotten the stuff ye learned in 1′st year science? look at the problem from an energy perspective….

    Without doubt, our financhial system creates volatility in commodity prices — its gambling on a huge scale and seems to run on sentiment/superstition as much as data.

    That said, volatility often hides an overall trend in prices, there has been a definite trend this past 5 years.

    So we have the laws of economics, when demand goes up, people will adapt, new technologies will come on stream which will increase supply, the market will find its own level….

    But wheres theres a conflict, the laws of physics will always trump the “laws of economics”. And there is a conflict….

    Food (wheat/potatoes/rice/meat etc) is the output from agriculture. Agriculture has to obey the first law of thermodynamics (the one that says theres no free lunch in terms of energy). There are huge energy inputs needed to produce the food in the form of powering machinery, fertilizer, heating, processing… all provided by oil.
    Combined with cheap oil, the sun provides the extra (free to us) energy needed to make the whole effort worthwhile, so the net result is producing some more energy than we put in. So theres a very rational explaination for the surge in food prices. the cost of the inputs (oil) has gone up…

    Yes new oil supplies are coming on stream but globally we have long since past the peak in terms of oil discovery…. we are burning far more oil every day than we discover…. this is an early warning sign…. for all practical purposes we are at peak oil… (it may already be here or else its less than 20 years away)

    That said, its not all doom and gloom…. We already have new technologies to lessen the impact of declining oil and gas reserves…. nuclear and renewables (wind and wave in particular)… These technologies have a significant ramp up time, it would take years to commission a nuclear reactor.

    So we have a few choices, sit and wait for someone else to invent new technology to solve our problems, invest in nuclear and carefully chosen renewables, or ignore the warning signs. Increasing better times are not guaranteed, decisions either taken or put off today will affect tomorrow.

  7. VincentH

    The issue with food is short term, as there is vast spare capacity. Even in Europe where it seems that every square inch is being farmed, the CAP has shown us that we are able to ramp up production.
    While metals, now at a higher price, will correct when the Nature of the companies kicks in, the slightly more difficult areas will be exploited. And the penny weight per ton will drop relative to the ton excavated.
    Oil is a different matter, and is vastly more important to use it for product rather than transport. But as long as the middle east has the oil then there will be a wealth transfer to them. It is when there is little more in those states/estates, oil-wise, the shite will hit the fan. As they will have huge populations and nothing to feed them on. It will make famine in Africa seem like the grumblings before your evening meal.

  8. Ed

    Paul Doyle. Doesn’t the low value of the dollar have some bearing on the present price of oil? What about Oil Shale reserves – the U.S. is said to have 200 years supply just sitting there .

  9. o

    Check out Jim “God” Rogers Irish interview on Bloomberg.com. Anyone got an idea when this Irish interview took place?

    http://www.bloomberg.com (Audio)

  10. Philip

    Developed 1st World – Listen Up – Malthus – here we come. Too many idiots with money and in high places running around the place. The principle of the Ricardo safety net of tech development to save the day will be seriously hampered by an over-contented and smug society. This is not Osama’s doing…it’s just plain greed at a global level and we are just too plain stupid to get around it.

  11. Philip

    Even if oil was in plentiful supply (which it aint!), arable land and water is not and we simply cannot afford to warm up the planet anymore. Dubai and all these crazy western/ euro style properties in the desert will be non-viable in 20 years merely for technical reasons. High rise ghost-towns in 60C heat. French wine farmers are buying large tracts of land in South of England becasue they figure that’s where the next big vineyards will be..Too hot in Spain and South of France. This is just a sample of mega demographic shifts which seem only 1 or 2 decades away…and all without a war…is humanity that clever?

  12. John Q. Public

    Have a listen to Chomsky on this: http://www.youtube.com/watch?v=RdYwAXZh0ME

  13. FreedomFighter

    AndrewGMooney – In Ireland we call them “Terenure tractors”. Terenure is not in Dublin 4, but it is in a neighbouring postal district in South East Dublin, where people are pretty status obsessed. [Read Ross O'Carroll Kelly's Guide to South (East) Dublin, for more hilarity]. And of course the term Terenure tractor is sounds poetic, based on common letters and sounds.

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