Wednesday, March 14, 2007

. Ramin Toloui. "Petrodollars, Asset Prices, and the Global Financial", PIMCO Bonds

PIMCO's Ramin Toloui dissects the dynamics of petro-dollar flows and their impact on global financial markets. Since 2001, oil exporters have poured about $1 trillion into world financial markets. Accordingly, a clear understanding of how these flows operate has become a key element in the outlook for global liquidity, financial markets, and the so-called New Bretton Woods arrangement. Here's a brief overview of Tolouis's main points:

- Governments of oil-producing countries have become the largest source of global savings, having surpassed Asia in 2005. They added $500bn to global financial markets in 2006 alone;

- While their combined current account surplus amounted to only 1/5th of the US current account deficit in 2001, it now represents as much as 2/3ds of the world's largest economy's external deficit;

- Savings from oil producing countries are highly concentrated; only three countries make up the lion's share of petro-dollar flows: Russia, Saudi Arabia and Norway;

- The bulk of petro-dollar savings takes the form of central bank reserves: nearly 80% of the their cumulative surpluses from 2002-2005 were used to build up central bank reserves. The "explosion" is such that even with oil prices at $50/barrel, these countries would channel as much as $300bn into global markets annualy;

- There is evidence to support the view that central bank reserves are being diversified away from the US Treasury market, into bank deposits and / or into other currencies, notably the euro. For example, Russia's reserves are growing, but its holdings of Treasuries remain flat.

- Middle East accounts tend to diversify much more aggressively than their Asian counterparts. This may lead to sustained levels of M&A activity, ongoing downward pressure on credit spreads, and less investment flows into the US Treasury market. This last point, in turn, raises doubts over the sustainability of the New Bretton Woods system.

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