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 Financial Crises and Energy Prices Post-Bretton-Woods Problems 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 Financial Crises and Energy Prices Post-Bretton-Woods Problems 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 Brent Oil Price in 2006 Dollars 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 Financial Crises and Energy Prices Post-Bretton-Woods Problems 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 + Saudi Arabia
0.5
0
−0.5 Capital & Financial Accounts net Outflows (U.S.$, IMF BOP)
−1 1975 1980 1985 1990 1995 2000 2005
Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Financial Crises and Energy Prices Post-Bretton-Woods Problems The Role of Recycled Petrodollars Cyclical Petrodollar Recycling and Financial Crises
Feedback mechanism during booms growth (lag) ⇒ oil price ↑ ⇒ Petrodollar flow ↑ ⇒ interest rates ↓ ⇒ growth
Hubris (80’s: countries don’t go bankrupt; 00’s: house prices don’t fall !) Petrodollars ↑ ⇒ interest rates ↓ , asset prices ↑ ⇒ leverage ↑ ⇒ asset prices ↑
Eventually (Minsky moment; Ponzi finance) high cost ⇒ slowdown ⇒ bad loans ⇒ Crisis, interest rates ↑ ⇒ recession
Feedback mechanism during busts recession ⇒ oil price ↓ ⇒ Petrodollar flow ↓ ⇒ interest rates ↑ ⇒ recession
Low cost of production + monetary and fiscal policies (lag) ⇒ economic growth + geopolitical strife (lag) ⇒ oil price ↑
Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation Lag in Oil-Price Responses, Lag in Capacity Development Declining Real Oil Prices Precede Jumps
1000 140
900 120 800
Gold Prices 100 700 (left axis)
600 80
500
60 400 Gold Price ($US/T.Ounce) Crude Oil Price ($US/BBL) 300 40
200
Crude oil prices 20 100 (right axis)
0 0 1970 1975 1980 1985 1990 1995 2000 2005 2010
Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation The Absence of Automatic Exchange-Rate Cycle Attenuation Trade Deficits, Debts, Debased Dollars, and Oil
4 x 10 70 8
7 60
6 Crude oil price 50 (left axis) 5 U.S. trade deficit 40 (right axis) 4
30 3
2 20 Dubai Crude Price ($US/BBL) 1 US trade deficit ($million USD)
10 0
0 −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 Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation Self-Perpetuating Cycle, Magnified during Financial Crises Amy’s Presentation Will Cover Current Decline in Demand
7
6
World 5 GDP growth
4
3
2
1
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 Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation China’s Dependent Business Cycle The Dangerous Mirages of “Economic Miracles”
18
China 16 GDP growth
14
12
10
8
6
4
2
China 0 Energy−demand growth
−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 Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation Beginning of the End for the Dollar Era? Compare to British Pound A Century Ago
x 106 4.5 110
U.S. Nominal 4 Effective Exchange Rate 100
3.5
3 90
2.5 Total Reserves All Countries 80 Percentage of Official Reserves in US $ 2 Reserves (millions of SDRs) 1.5 70
1
Reserves held by 60 Oil!Exporting Countries 0.5
0 50 1940 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 Source of The Dollar-Era Crisis Post-Bretton-Woods Problems 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
45,000 350
300 40,000
U.S. 250
35,000
200
30,000
150
25,000
Per Capita GDP PPP constant 2005 Dollrs Saudi Arabia 100
20,000 50
15,000 0 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010
Saudi vs. U.S. Real Per-Capita GDP Real Per-Capita Egyptian Worker Remittances
Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Source of The Dollar-Era Crisis Post-Bretton-Woods Problems 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