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

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 <ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 <ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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<ul style="display: flex;"><li style="flex:1">1860 </li><li style="flex:1">1880 </li><li style="flex:1">1900 </li><li style="flex:1">1920 </li><li style="flex:1">1940 </li><li style="flex:1">1960 </li><li style="flex:1">1980 </li><li style="flex:1">2000 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 10.5 0 + Saudi Arabia −0.5 −1 <ul style="display: flex;"><li style="flex:1">1975 </li><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 ↑ <ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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<ul style="display: flex;"><li style="flex:1">1970 </li><li style="flex:1">1975 </li><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li><li style="flex:1">2010 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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) 5U.S. trade deficit (right axis) 43210−1 <ul style="display: flex;"><li style="flex:1">1970 </li><li style="flex:1">1975 </li><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 54321<ul style="display: flex;"><li style="flex:1">0</li><li style="flex:1">World </li></ul>Energy Use growth −1 −2 <ul style="display: flex;"><li style="flex:1">1970 </li><li style="flex:1">1975 </li><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 <ul style="display: flex;"><li style="flex:1">1970 </li><li style="flex:1">1975 </li><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li></ul><ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 <ul style="display: flex;"><li style="flex:1">x</li><li style="flex:1">106 </li></ul>110 100 90 4.5 4U.S. Nominal Effective Exchange Rate 3.5 3 Total Reserves All Countries 2.5 280 Percentage of Official Reserves in US $ 1.5 170 Reserves held by Oil!Exporting Countries 60 0.5 01940 50 <ul style="display: flex;"><li style="flex:1">1950 </li><li style="flex:1">1960 </li><li style="flex:1">1970 </li><li style="flex:1">1980 </li><li style="flex:1">1990 </li><li style="flex:1">2000 </li><li style="flex:1">2010 </li></ul><ul style="display: flex;"><li style="flex:1">1994 </li><li style="flex:1">1996 </li><li style="flex:1">1998 </li><li style="flex:1">2000 </li><li style="flex:1">2002 </li><li style="flex:1">2004 </li><li style="flex:1">2006 </li><li style="flex:1">2008 </li></ul>Total Official Reserves (millions of SDRs) Percentage of Official Reserves in U.S.$ <ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>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 <ul style="display: flex;"><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li><li style="flex:1">2010 </li></ul><ul style="display: flex;"><li style="flex:1">1980 </li><li style="flex:1">1985 </li><li style="flex:1">1990 </li><li style="flex:1">1995 </li><li style="flex:1">2000 </li><li style="flex:1">2005 </li><li style="flex:1">2010 </li></ul>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 <ul style="display: flex;"><li style="flex:1">Mahmoud A. El-Gamal & Amy M. Jaffe – London, October 27, 2008 </li><li style="flex:1">Energy Prices, Business Cycles, and Financial Crises </li></ul>

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

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