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. JaVe Rice University & Baker Institute for Public Policy October 2008 Mahmoud A. El-Gamal & Amy M. JaVe – 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. JaVe – 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. JaVe – 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.$, IMF BOP) −1 1975 1980 1985 1990 1995 2000 2005 Mahmoud A. El-Gamal & Amy M. JaVe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Financial Crises and Energy Prices Post-Bretton-Woods Problems The Role of Recycled Petrodollars Cyclical Petrodollar Recycling and Financial Crises Feedback mechanism during booms growth (lag) ) oil price " ) Petrodollar flow " ) interest rates # ) growth Hubris (80’s: countries don’t go bankrupt; 00’s: house prices don’t fall !) Petrodollars " ) interest rates # ; asset prices " ) leverage " ) asset prices " Eventually (Minsky moment; Ponzi finance) high cost ) slowdown ) bad loans ) Crisis, interest rates " ) recession Feedback mechanism during busts recession ) oil price # ) Petrodollar flow # ) interest rates " ) recession Low cost of production + monetary and fiscal policies (lag) ) economic growth + geopolitical strife (lag) ) oil price " Mahmoud A. El-Gamal & Amy M. JaVe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation Lag in Oil-Price Responses, Lag in Capacity Development Declining Real Oil Prices Precede Jumps 1000 140 900 120 800 Gold Prices 100 700 (left axis) 600 80 500 60 400 Gold Price ($US/T.Ounce) Crude Oil Price ($US/BBL) 300 40 200 Crude oil prices 20 100 (right axis) 0 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 Mahmoud A. El-Gamal & Amy M. JaVe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises Business and Financial Cycles Source of The Dollar-Era Crisis Post-Bretton-Woods Problems The Cycle Continues: Need for Attenuation The Absence of Automatic Exchange-Rate Cycle Attenuation Trade Deficits, Debts, Debased Dollars, and Oil 4 x 10 70 8 7 60 6 Crude oil price 50 (left axis) 5 U.S. trade deficit 40 (right axis) 4 30 3 2 20 Dubai Crude Price ($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. JaVe – 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. JaVe – 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. JaVe – 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 OYcial Reserves (millions of SDRs) Percentage of OYcial Reserves in U.S.$ Mahmoud A. El-Gamal & Amy M. JaVe – 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 diVerent” 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. JaVe – 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. JaVe – London, October 27, 2008 Energy Prices, Business Cycles, and Financial Crises.