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Petrodollars Pose no Risk to the Global Economy

Investors outside the EU and the US are increasingly shaping trends in global financial markets. With the tripling of oil prices since 2002, petrodollar investors in particular have increasing influence and are in fact the fastest growing component of a broad shift in global financial markets – a shift that also includes Asian central banks, private-equity firms, and hedge funds. McKinsey estimates that with an oil price of $50 per barrel, the yearly influx of petrodollars would amount to $387 billion, which equates to more than $1 billion a day. This flood of oil money of course brings new dynamics to the international finance markets, but at the same time there are growing fears that this could have a negative impact. However, according to a McKinsey analysis, these fears are largely ungrounded.

Inflationary Pressure
Added liquidity from petrodollars has significantly lowered interest rates. Purchases by the central banks of oil-exporting countries now have the same impact as capital flows from financial centres such as the Cayman Islands, Luxembourg, Switzerland and the UK.

Some observers worry that this new liquidity could have an inflationary effect and fuel bubbles. Although petrodollar capitalization has risen rapidly since the 2000 stock market decline, McKinsey notes that this demand has also emerged at home as a result of cheap credit.

Instability
One key concern is the immense size of petrodollar sovereign wealth funds, and their high appetite for risk – this could lead to instability in global capital markets. However McKinsey research finds that petrodollar investment portfolios are not only spread across various assets and regions, but are also managed via a number of intermediaries. Furthermore, petrodollar investors have a track record of recognizing the broader impact of large investment flows.

Political Interference
A second concern is the limited transparency of these funds. This is attracting more and more attention from financial regulators in Europe and the US, who worry that funds could be used for political or other non-economic motives. Fortunately most sovereign wealth funds invest at least part of their assets through external managers.

McKinsey suggests that European and US regulators should ensure their policy decisions are based on fact – sovereign wealth funds typically hold a diversified portfolio of assets in public debt and equity securities rather than large stakes in foreign companies. However, sovereign wealth funds could help themselves a great deal by being more transparent, which would allow well-managed funds to stand out.

The long term impact of high oil prices must also be taken into account. In the 1970’s their rise caused inflation in major oil-consuming economies. However, this time round increased oil prices have benefited financial markets while paradoxically inflation has not risen that much. The question is, how long will this continue?

This summary was prepared by Cosmo Macfarlane of the Atlantic Community editorial team from “The New Role of Oil Wealth in the World Economy” by Diana Farrell and Susan Lund, and published here in the McKinsey Quarterly.

Related material from the Atlantic Community:

• Jakob von Weizsäcker and Nicolas Véron: Valuable Capital
• Thomas Straubhaar: The $100 Barrel is a Blessing
• McKinsey: Emerging Global Finance Giants: The New Power Brokers