Thursday, December 14, 2006

THINGS THAT MIGHT SAVE US (No.1 in an occasional series): PETRODOLLARS

Oil


Let’s not beat about the proverbial President George W.....our beloved team is in serious trouble. However in light of the rumoured $450m bid for Liverpool FC by Dubai International Capital, it’s clear there might just be a way out for Charlton…..we need to start praying for higher oil prices.

Although the price of oil has fallen in price in recent weeks, one would have had to have been a bicycle-riding hermit not to have noticed it creeping up steadily over recent years. Unlike previous cycles however, the ‘pain’ which oil consumers should be bearing seems to be conspicuous by its absence……UK house prices are rising again, global equities are rocketing, and growth is strong.

In its starkest terms, this is how the maths works: Global oil production is approximately 80 million barrels per day. Crude oil currently sells for approximately $62 per barrel. Hence given that Russia and Saudi Arabia alone account for approximately 19 million barrels of production per day, then the $20 increase in the price per barrel since the start of 2005 alone roughly translates into a windfall wealth transfer from oil importers to the Russians and Saudis of $48,000billion ($48trillion).

The implications of this extraordinary transfer of wealth are complex. In very simple terms, the importing nations have chosen to keep their exchange rates artificially low for now (in order to encourage export-led growth and employment), and to do so have been forced to recycle their oil wealth back into foreign currency-denominated assets. This has also helped reduce the risk of so-called Dutch disease which occurs when the powerful effect of natural resource exports on a nation's exchange rate overpowers the rest of the export sector, and destroys the manufacturing base. Initially the recycling was undertaken via financial assets such as government bonds and hedge funds, but now the ‘petrodollar’ nations are diversifying into potentially safer Western ‘hard assets’ from football clubs to hotel chains, and from ports, to steel companies.

Surely I can’t have been alone in walking through Mayfair recently, admiring the wealth and thinking, something doesn't feel right? Is it a coincidence that Chelsea's current owner, Liverpool’s suitor and West Ham’s previous fancier are all oilmen? Even Icelanders benefit from higher oil prices (relatively at least) thanks to their abundance of (free) geothermal power. And the mysterious set of circumstances are not helped by the relatively anonymous, yet enormously powerful, state-run investment offices which hold such power over markets.

Back in the 1970s, the pain of OPEC-induced higher oil prices was clear. Inflation was rampant, rubbish was left uncollected, and the British worker was forced to work a 3-day week. Eventually the obviously negative impact of higher oil prices must outweigh the beneficial effects of all the above recycling, but for now we should stop bemoaning higher petrol prices because if nothing else it's making house prices go up.

Why have times changed? The impact of higher oil prices upon oil consumers/importers tends to manifest itself through higher prices of not merely oil, but also any goods for which oil is an input (the UK became a net oil importer again in August 2004). In this sense it tends to act like an additional and involuntary tax, and hence is undesirable particularly if it feeds through into general inflation (thus reducing the purchasing power of money).

However the 1970s and the current decade are vastly different. Back then, trade union power was omnipotent and any perceived increase in the overall cost of living (eg. via petrol prices) was rapidly translated into wage demands and soon inflation. If you were a unionised worker then you felt as if you had been recompensed (but you hadn’t been because the general inflation you helped to set in train affected you also). Likewise, the non-unionised workers, pensioners and frankly everybody else were particularly screwed, feeling the pain of the increased cost of living but without the bargaining power to do much about it. Whilst the 1970s are remembered fondly for the flared trousers and disco music, the economy had little to be nostalgic about because in short, its non-inflationary growth rate fell substantially thanks to oil.

The current decade is very different however. A disproportionate amount of the benefits of the post-2003 global economic boom have been distributed to capital (ie. profits) rather than labour. The FTSE has risen handsomely since 2003 whilst average incomes have barely grown at all. If you read the Daily Mail constantly bemoaning the fate of the British middle classes, then this theme might resonate especially strongly.

A substantial reason for this has been the incredible increase in the skilled and semi-skilled global labour supply, thanks to the exceptional growth rates currently being experienced in developing countries, particularly China. And of course coincidentally, China’s government is pursuing the exact same economic policies as the oil importing nations ie. keeping its exchange rate down via the recycling of foreign currency flows. This has resulted in its foreign currency reserves alone booming to $1trillion.

In short therefore, thanks to the coincidence of disinflation effects from China, and oil exporters' desire to recycle their windfall, the UK (and other Western oil-importing nations) have seemingly benefitted from higher oil prices, rather than suffered from them despite the obvious paradox.

Thus so long as this mutually beneficial set of circumstances prevails, then Charlton might just have a route to safety through an oil-driven takeover particularly if completed before January's transfer window. Whether or not we’d welcome it is another story, but desperate times call for desperate solutions.

Indeed January might just be our only likely takeover window, because this handy state of affairs might well be transitory. One of the unfortunate side-effects of the current ‘petrodollar’ recycling approach is that eventually their domestic economies might demand a little TLC. Keeping the exchange rate artificially low reduces the ability of locals to become the global consumers many of them wish to be.

Likewise, the dire state of the infrastructure in Russia and much of the Middle East might eventually become a better source of funds than the English Premiership. Indeed, the Saudi royal family might be particularly sensitive about the simmering tensions amongst the impoverished masses. It seems that the Dubai leaders at least have finally ‘got it’ judging from its incredible transformation during the past decade away from dependence on oil revenues.

Moreover ‘petrodollar recycling’ requires an enormous influx of ‘liquidity’ (ie. money) back into their domestic economies (because local currency has to be printed to re-purchase foreign currency). If not ‘sterilised’ and soaked up (via the simultaneous issuance of government bonds), this process leads inevitably to domestic inflation, asset bubbles and misallocation of resources (have you tried buying a property in Moscow recently?). These countries will also be aware of the risk of holding such a preponderance of reserves/assets in a single foreign currency (most obviously dollars, but also sterling/euro) that any attempt to diversify causes the very currency revaluation they would want to avoid.

Eventually the world will rebalance and the more enlightened oil importers will reduce their recycling, allow their exchange rate to rise, invest domestically, improve the relative position of their people, and leave everyone from English footballers to property owners in Aspen wondering what just happened.

So go on Mr Murray, give it a try. The international code for Russia is +7, and for Saudi Arabia it’s +966.

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COMING SOON: THINGS THAT MIGHT SAVE US (No. 2 in an occasional series): MY NEWSAGENT'S BLACK CAT


2 Comments:

At 7:11 AM, Anonymous Anonymous said...

Add +971 Emirates Area code to that. A great many players other than the Beckhams can be seen lounging around Dubai, Manchester United has a football school there and everybody has at least one mate who has a relative living there. Maybe we need to get back some of the money UK holiday makers spend there.

 
At 9:12 AM, Anonymous Dublin Addick said...

This is the most thoughtful Charlton related article that I've ever read.....

Don't forget that for the moment the Celtic tiger still roars, how about +353 1 for Dublin, there are still so many unspent Euros to invest, it's not just Russians and Saudis with more money than sense (see Celtic, Man U, Sunderland etc.)

 

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