Wednesday, June 07, 2006

Outsourcing Saving

As the price of oil sustains record highs in the neighborhood of $70 per barrel, American consumers are beginning to experience what Europeans have felt for years. The price of a gallon of petrol in America has recently spiked to an average high of about $3 and shows few signs of a letdown. American consumers and investors certainly have a bellyache over the higher cost of fuel, but the recent oil spike may in fact be a boon for the U.S. economy over the long run, and oil exporting countries should be applauded rather than cursed for the recent spike.
It is no coincidence that as the price of oil has jumped, the American current account has accelerated its free-fall and the Middle-Eastern current accounts have loosened their belts. The International Monetary Fund calculates Saudi Arabia’s 2005 current account surplus at over $100 billion, a stunning 30% of GDP. Relative to the size of its economy, the Saudi current account surplus is enormous, as it dwarfs China’s which stands at only 6% of GDP. The Saudi Arabians are simply saving too much with little opportunity to invest their windfall. While the Saudi and other oil exporting countries’ current accounts surpluses have grown, the U.S. current account deficit has fallen to record lows, amounting to nearly 7% of GDP. This growing deficit reflects the strength of the American economy relative to foreign markets as private firms and governments choose to offer their savings on global capital markets to the United States, which enables the Americans to run a current account deficit.
The growing American trade deficit has been accompanied by a curious flattening of the yield curve, as long-term yields have failed to keep pace with the Federal Reserve’s tightening and rates have remained at 25 year lows. This rate convergence phenomenon is likely the result of the recent increase in oil prices from $30 to over $75 per barrel since 2003. The Fed has increased the Funds rate sixteen times since 2004, yet the yield on the 10-Year Bond has failed to budge significantly. On average, the interest rate on the 10-Year Treasury has exceeded the Fed Funds Rate by 90 basis points for the last half-century, however in the past year, the yield curve has been generally flat and at times slightly inverted. Oil exporting countries such as Saudi Arabia generally have a higher marginal propensity to save than the United States. Because of this, this transfer of income from American consumers at the pump to oil exporters has increased the amount of global savings, driving interest rates to historic lows and making the world awash with credit.
High oil prices in the past have been the source of supply shocks, aggravating inflation and reducing output, however, this effect does not seem to hold as strongly today, as many goods are less intensive in petroleum inputs, and inflation has remained rather tame so far. While oil exporters are often portrayed as villainous greed-mongers, American consumers and investors should actually be thanking them. As consumers and businesses are forced to pay ever-higher fuel prices at the pump, they are essentially outsourcing the role of saving for the nation’s capital accumulation. Because Middle Eastern oil exporters have a significantly higher marginal propensity to save, the transfer of income from the U.S. to oil exporters increases the quantity of saving abroad, which is in turn recycled back into the United States through international capital markets. The increase in savings has driven down interest rates, providing access to low-interest mortgages, increased the quantity of investment in the United States, and offered a tremendous opportunity for the Federal government to issue cheap long-term debt with the 30 Year Bond. In effect, the United States has offshored the task of saving for long-term capital accumulation to today’s net exporting countries.