Thursday, June 25, 2015

Interesting perspective on oil

Liberty Street Economics - falling oil prices and global saving. Basically, first year macro suggests falling oil prices will result in higher interest rates. Quote:
The rise in oil prices from near $30 per barrel in 2000 to around $110 per barrel in mid-2014 was a dramatic reallocation of global income to oil producers. So what did oil producers do with this bounty? Trade data show that they spent about half of the increase in total export revenues on imports and the other half to buy foreign assets. The drop in oil prices will unwind this process. Oil-importing countries will gain from lower oil bills, but they will also see a decline in their exports to oil-producing countries and in purchases of their assets by investors in these countries. Indeed, one can make the case that the drop in oil prices, by itself, is putting upward pressure on interest rates as income shifts away from countries that have had a relatively high propensity to save.
Basically, S = I + NCO. A country that earns a lot of money from oil exports ends up with a lot of S (savings), which has to (apparently it's an accounting identity) go into I (domestic investment) and NCO (net capital outflow, which is the purchase of foreign assets, which can include USTs).

What's neat to me is I think I just stumbled across a good reason to dump my old Jim Rogers theory of investment cycles in favour of this one:

1) A commodity bull market will increase NCO of high saver countries, which thus suppresses the world interest rate, and thus provides a boost to EM economies.

2) When the commodity bull market ends and commodity prices collapse, NCO drops, which makes the world interest rate rise, which then strangles EM economies.

Looking at that, I guess it has to be much more complex than what I just wrote. But I guess I'll be learning more about that in 3rd year.

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