Time to follow the money

The people who benefit from the spike in the price of oil are the ones who are really in charge of the world economy.

When you fill up your car, do you ever wonder where all this cash goes? Ten years ago oil was trading at close to $12 a barrel; today it is just under $100 a barrel this week. So who is benefiting?

And, more importantly, what are they doing with all their new cash? Obviously, much of it ends up in the hands of the oil producer after all the others take their cut, particularly the taxman.

Since September 11, 2001, and particularly since the occupation of Afghanistan and Iraq, the price of oil has increased sharply from $23, hovering around $80 a barrel for much of the past year. In the past week it recorded above $100, before falling back slightly on Friday. The main winners are the Arab oil producers, who benefit from a huge windfall as millions of western drivers hand over cash to the sheikhs. You might say that this is Osama’s handiwork.

The best way to gauge just how much of your cash has ended up in the Gulf as a result of Bin Laden’s oil boom is to look at the foreign reserves of the region. The IMF calculates that the balance of payments of the Gulf went from a $30 billion surplus on the eve of September 11, to $212 billion last year. The crucial oil-trade balance has rocketed from $159 billion to $451 billion. This is your cash, and the cash of every western punter and company that depends on oil for their daily existence.

But because the Gulf states are small places, they can’t absorb all this cash, and the money has to go somewhere. It can’t all be spent in the Gulf. Also, given that the atmosphere in the US is one of overt suspicion and barely-concealed hostility towards Arabs – especially Saudis – the recycled cash is not going back to buy Manhattan penthouses for Arab playboys.

Not surprisingly, many Arabs have taken the hint and moved themselves and their money back home, with the result being huge price rises and rampant speculation in property in the Gulf, leading to the extraordinary rise of Dubai out of the desert. This new metropolis is sucking in workers from Bangladesh and Pakistan, hookers from Russia and money from investors reading the property ads.

However, the Gulf states have fairly modest economies. Because of this, the bulk of the petro-cash, as happened in the 1970s, has gone back out into the global economy, looking for a profitable home.

(In the 1970s, recycled petro-dollars fuelled the Third World debt crisis, as Arab cash was lent to Third World countries. The 1970s saw a commodity price boom and lenders thought that revenue from commodities would be enough to pay back the loans. Commodity prices fell in the early 1980s and so too did the Third World’s ability to pay back the loans, ushering in what was known as the Third World debt crisis.)

All this recycled cash has had the effect of keeping world interest rates lower than they otherwise would be. As well as having old Germans to thank for our lower interest rates, Ireland has to acknowledge Bin Laden’s role in the liquidity bonanza of the past few years. His attack on the Twin Towers, triggering the invasion of Iraq, has ensured that a wave of oil money from the Gulf is washing over us. However, something much bigger is happening. The peak in the oil price has also been mirrored by peaks in other commodity prices, particularly (though not exclusively) metal prices.

For example, this week saw all-time highs in wheat, corn and soybean prices. Most economists are suggesting that these rises in commodity prices are just the simple reaction to huge demand from China and India. But can this explain everything? While the demand from Asia might explain the direction of commodity prices, it doesn’t explain the extent of the price increases.

To understand this, we’ve got to go back to the idea that the global financial market is one large recycling mechanism that (legally) launders cash consistently. I am writing this article from London where, in the past few months, many former colleagues in the banking game have jumped ship from large investment banks to private equity firms and sovereign wealth funds. Much of the money in these funds is coming from the Gulf: the proceeds of millions of us who fill up our cars’ petrol tanks every day.

These funds are now engaged in rampant speculation all around the globe, driven mainly by the greed of their newly-hired staff. This process is creating a wall of new money that gushes into the asset of choice, driving up prices and, ultimately, creating a false market.

This used to be known as ‘hot money’ in the old days. In the 1970s and 1980s, hot money was speculative cash that typically poured into a country to take advantage of interest rate anomalies. So if Irish interest rates were higher than German ones, we might see lots of cash coming in to short-term deposits in the Irish market.

Back then, the Irish Central Bank would intervene in the market, buying up this new cash so as not to let interest rates and or the exchange rate move too far in response to the new liquidity. As a result, the peaks and troughs associated with hot money were smoothed.

Now, we have a superannuated version of old hot money. The new sovereign wealth funds constitute ‘mega-hot money’ (a term coined in the wonderful Dines Newsletter – possibly the best financial newsletter around.) This mega hot money is sloshing around the globe looking for a home. In the past year, this cash has rushed out of global property and the dollar into other assets.

Commodities are the main beneficiaries, and commodity-producing countries, such as Australia and Canada, have benefited enormously. But the downside is that there is no ‘global central bank’ for these assets to smooth out the subsequent price gyrations.

So we are left with a financial system that is almost guaranteed to generate the sort of massive price spikes and troughs we’ve witnessed in the past few years. None of this fazes my mates working for these new funds because, after all, if they make money they are paid enormous bonuses, and if they lose money, they are fired and paid off! Either way, they’re quids in.

With Masters of the Universe like these running the global show, and an endless supply of our recycled cash gushing out of the Gulf, is it any wonder that financial markets are volatile?