Oil prices & Oil exporting countries are the major cause of high liquidity & leverage in global economy. Once liquidity overstretched then it creates asset bubble and, crash of financial market. We have seen the same in the last recession when oil price reached its highest level of $ 147.
What is the future of oil prices and how it is going to impact/shape global economy?
As I mentioned oil exporting countries plays a very important role in global capital flow. If oil prices rise then we see huge amount capital flow in global financial market. Apart from this lot depends upon these countries domestic investment strategy. In the past they have invested quite less as compare to emerging countries like China, India & Russia etc. If they increase investment domestically then we see less flow in global market which reduces liquidity globally and makes market to stabilize.
As per the survey conducted by top Consulting firm, exports of crude oil will earn Gulf Cooperation Council (GCC)/Petrodollar countries $5 trillion to $9 trillion from 2007 to 2020.
The GCC foreign-investment choices influence interest rates, liquidity, and financial markets around the world. And the domestic investments affect the region’s urban development, economic diversification, and ability to create jobs. Fortunately for the citizens of the GCC states and global policy makers, there will probably be enough petrodollars to satisfy both sets of needs.
Now the question arises how much of this capital will be deployed domestically by GCC countries?
Since 1993, GCC investment rates have averaged 20 percent of GDP, on par with European and US levels but almost one-quarter lower than the average investment rate of Brazil, China, India, and Russia combined. Petrodollars not invested locally will spill over into global capital markets. If oil lingers at around $100 a barrel and domestic investment stays at 20% level as mentioned above, the GCC would send $5.1 trillion in new funds into world markets and boosting these states’ total foreign wealth to $10.5 trillion by 2020. Domestic-investment rates as high as 28% combined with $70-a-barrel oil, would generate around $2.5 trillion of new funds for GCC investors to deploy in global capital markets until 2020. Only a major decline in oil prices-to less than $30 a barrel,-combined with high levels of domestic investment would make it difficult for the GCC to continue pumping significant liquidity into global capital markets which seems unlikely situation.
As oil prices continue to set new records, investors outside Europe and the United States are increasingly shaping trends in financial markets. Petrodollar investors have a newfound influence, and the more than tripling of oil prices since 2002 makes them the largest and fastest-growing component of a broad shift in global economic markets-a shift that also includes Asian central banks, private-equity firms, and hedge funds. High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting nations, which in 2006 became the world’s largest source of net global capital flows, surpassing Asia for the first time since the 1970s. A majority of these revenues have been recycled into global financial markets, making petrodollar investors increasingly powerful players.
Fueling liquidity—and creates asset bubble
Since 2002, oil prices have tripled, and much of the incremental increase has ended up in the investment funds and private portfolios of investors in oil-exporting countries. Most of the money is then recycled on global financial markets, whose liquidity is therefore rising.
In fixed-income markets, this added liquidity has significantly lowered interest rates. Estimated total foreign net purchases of US bonds have brought down long-term rates by about 130 basis points. Twenty-one of them can be attributed to purchases by the central banks of oil-exporting countries, and impact as large as that of the capital flows from financial hubs such as the Cayman Islands, Luxembourg, Switzerland, and the United Kingdom, though less than half the impact of Asia’s central banks on US interest rates. Petrodollars have added liquidity to international equity markets as well.
The story is different in global real-estate markets. According to research by the Economist Intelligence Unit, real-estate values in developed countries have increased by $30 trillion since 2000, reaching $70 trillion in 2005 and far outstripping GDP growth over the same period. This rise reflects not only the preference of petrodollar investors for global real estate but also the home-equity loans and larger mortgages that low interest rates and risk spreads have made possible.
Indeed, petrodollars have helped increase global leverage in many forms. Low interest rates and credit spreads have enabled the rise of hedge funds and the private-equity boom. Although low rates and spreads have created ample liquidity for consumer credit in the United Kingdom, the United States, and many other countries, a reassessed appetite for risk could burst this global credit bubble, causing pain to lenders and borrowers alike. In mid-2007 problems in the US sub-prime-mortgage market sparked a re-pricing of credit risk and a credit crunch.
Despite the many beneficial effects of petrodollars in increasing global liquidity and spurring the growth of various financial-asset classes throughout the world, the rise of investors in oil-exporting countries has created concerns.
One worry is that the huge size of petrodollar sovereign wealth funds, coupled with their relatively high appetite for risk, could make global capital markets more volatile. The limited transparency of these funds amplifies the anxiety. Research, however, finds that their investment portfolios are widely diversified not only across asset classes and regions but also through a number of intermediaries and investors. Diversification reduces the risk that the funds could make financial markets more volatile. Moreover, petrodollar investors have a track record of sensitivity about the broader market impact of large flows and use derivatives and intermediaries to lessen it. ADIA, for instance, reportedly invests 70 percent of its funds through external asset managers—intermediaries who know they must move slowly in markets to avoid adverse price adjustments. Direct petrodollar investors tend to adopt a relatively low profile.
A second concern has also attracted growing attention among financial-market regulators in Europe and the United States; the prospect that sovereign wealth funds could use their growing financial heft for political or other non-economic motives. The rise of large government investors in financial markets is a new phenomenon-and one at odds with the shrinking role of state ownership in real economies. Given the limited transparency and enormous size of these investors, some observers question the motivations underlying their investment strategies. How will state investors behave as public shareholders or owners of companies in foreign markets? Will they seek to maximize value creation and long-term growth, or will their investments reflect the political objectives of their governments and the interests of businesses in their home countries? Financial markets require the free flow of information to function efficiently. The presence of huge, opaque players with non-economic motives could distort the pricing signals that other investors need. A growing number of economists and policy makers in Europe and the United States now support the creation of disclosure standards for government investors.
Final concern the long-term economic impact of higher oil prices. In the 1970s their rise sparked inflation in the major oil-consuming economies and sent global banks on a petrodollar-fueled lending spree in Latin America. Both developments inflicted significant economic pain on the countries involved. Today higher oil prices have been a boon for global financial markets, but, paradoxically, inflation hasn’t risen very much. Can higher oil prices really be good for the world economy? As we have seen, petrodollars are creating inflationary pressures in markets for illiquid investments, such as real estate, art, and companies. If the pressures move beyond those markets, the potential asset price bubbles could burst. So far the world economy has accommodated higher oil prices without a notable rise in inflation or a economic slowdown, but this may change in the future.
High oil prices will create more revenue for GCC countries and if domestic investment of these countries will not increase appropriately then more money will be available in global financial market which may cause high liquidity & emergence of more private equity & hedge fund players that increases global financial leverage and may create asset bubble & crash of financial market.