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Energy Prices, Business Cycles, and Financial Crises the Argument for Cycle Attenuation

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Business and Financial Cycles Post-Bretton-Woods Problems

Energy Prices, Business Cycles, and Financial Crises

The Argument for Cycle Attenuation

Mahmoud A. El-Gamal & Amy M. Jaffe

Rice University & Baker Institute for Public Policy

October 2008

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Financial Crises and Energy Prices

The Role of Recycled Petrodollars

Frequency and Causes of Crises

Globalizations Past and Present

Reckless Lending Era 1850s–1870s: Major currency and banking crises Gold Standard Era 1880–1913: Some currency and banking crises

Between Wars 1919–1939: Numerous currency and banking crises Bretton Woods 1945–1971: Many currency crises but no banking crises Dollar Era 1973–present: Numerous currency & many banking crises

Trade surpluses, Reckless Lending, and Recent Crises 1980–present:

1980s Scandinavia & Latin America: Reckless lending fueled bubbles

that collapsed with oil prices, leading to currency and banking crises
1990s Japan, Asia: Supporting the Dollar and reckless lending fueled bubbles, which burst with tightened monetary policy, banking crisis

2000s Contagion + record U.S. debt pose substantial global-systemic risk

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Financial Crises and Energy Prices

The Role of Recycled Petrodollars

Coincidence of High Oil Prices with Financial Crises

Crises Severest 1850s-70s (before gold standard), and 1970s– (after Bretton Woods)

120 100
80 60 40 20
0

  • 1860
  • 1880
  • 1900
  • 1920
  • 1940
  • 1960
  • 1980
  • 2000

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Financial Crises and Energy Prices

The Role of Recycled Petrodollars

Asian Savings Glut and The Return of Recycled Petrodollars

Contagion + Petrodollar Flows Have Contributed Substantially to Bubbles & Inflation

x 1011
2.5

2
1.5
China

Kuwait
1

0.5
0
+
Saudi Arabia

−0.5
−1

  • 1975
  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Financial Crises and Energy Prices

The Role of Recycled Petrodollars

Cyclical Petrodollar Recycling and Financial Crises

Feedback mechanism during booms

growth (lag) ⇒ oil price ↑ ⇒ Petrodollar flow ↑ ⇒ interest rates ↓ ⇒ growth

Hubris (80’s: countries do n ’ t go bankrupt; 00’s: house prices do n ’ t fall !)

Petrodollars ↑ ⇒ interest rates ↓ , asset prices ↑ ⇒ leverage ↑ ⇒ asset prices ↑

Eventually (Minsky moment; Ponzi finance)

high cost ⇒ slowdown ⇒ bad loans ⇒ Crisis, interest rates ↑ ⇒ recession

Feedback mechanism during busts

recession ⇒ oil price ↓ ⇒ Petrodollar flow ↓ ⇒ interest rates ↑ ⇒ recession

Low cost of production + monetary and fiscal policies (lag) ⇒ economic growth + geopolitical strife (lag) ⇒ oil price ↑

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems
Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

Lag in Oil-Price Responses, Lag in Capacity Development

Declining Real Oil Prices Precede Jumps

1000
900 800 700 600 500 400 300 200 100
0
140 120 100 80
Gold Prices
(left axis)

60 40 20
Crude oil prices
(right axis)

0

  • 1970
  • 1975
  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005
  • 2010

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems
Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

The Absence of Automatic Exchange-Rate Cycle Attenuation

Trade Deficits, Debts, Debased Dollars, and Oil

x 104
70

60 50 40 30 20 10
0
876
Crude oil price
(left axis)
5

U.S. trade deficit
(right axis)
4

3210−1

  • 1970
  • 1975
  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

Self-Perpetuating Cycle, Magnified during Financial Crises

Amy’s Presentation Will Cover Current Decline in Demand

76
World GDP growth
5

4321

  • 0
  • World

Energy Use growth

−1

−2

  • 1970
  • 1975
  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

China’s Dependent Business Cycle

The Dangerous Mirages of “Economic Miracles”

18 16 14 12 10
8
China GDP growth

642
China
Energy−demand growth
0−2

  • 1970
  • 1975
  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

Beginning of the End for the Dollar Era?

Compare to British Pound A Century Ago

  • x
  • 106

110 100 90

4.5
4

U.S. Nominal Effective Exchange Rate

3.5
3
Total Reserves All Countries
2.5
2

80
Percentage of Official Reserves in US $

1.5
1

70

Reserves held by Oil!Exporting Countries

60

0.5
01940

50

  • 1950
  • 1960
  • 1970
  • 1980
  • 1990
  • 2000
  • 2010

  • 1994
  • 1996
  • 1998
  • 2000
  • 2002
  • 2004
  • 2006
  • 2008

Total Official Reserves (millions of SDRs)
Percentage of Official Reserves in U.S.$

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

Inevitable Cycle, Amplitude Ramifications

Ramifications for Middle-East

Upswing amplifiers: Cheap-money driven bubbles and financial crises Amplification catalyst: Amnesia/hubris: “This time is different” Downswing amplifiers: Socioeconomic & geopolitical costs

350 300 250 200 150 100 50

45,000 40,000 35,000 30,000 25,000 20,000 15,000
U.S.
Saudi Arabia

01975

  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005
  • 2010

  • 1980
  • 1985
  • 1990
  • 1995
  • 2000
  • 2005
  • 2010

Saudi vs. U.S. Real Per-Capita GDP

Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008

Real Per-Capita Egyptian Worker Remittances

Energy Prices, Business Cycles, and Financial Crises

Business and Financial Cycles

Post-Bretton-Woods Problems

Source of The Dollar-Era Crisis

The Cycle Continues: Need for Attenuation

The Need for Counter-Cyclical SWF Investments

Avoiding Extreme Fluctuations through Cycle Attenuation

Paradox 1: Middle-East Sovereign Wealth Funds invest pro-cyclically
(data collected by Chhaochharia and Laeven, 2008)
Focus on private equity deals in Middle East Focus on oil & gas (ADIA), financials (KIA), utilities (QIA) U.S. exposure too much (KIA) or too little (ADIA)

Paradox 2: Banking crisis flight to safety led to Dollar appreciation!

Attenuate: Invest in fuel-production capacity during recessions Diversify: Invest in alternative energy, green technology, etc. Balance: America & Middle East need to consume less and invest more, Asia needs to consume more and save less

  • Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008
  • Energy Prices, Business Cycles, and Financial Crises

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