GCC ‘petrodollar tsunami’
Matein Khalid talks about the impact of oil revenues surplus on the international financial markets

The political firestorm over DP World’s acquisition of a British maritime services firm with US port management contracts and the increasing allocation of GCC Central Bank reserves to Euros and gold suggest that Arab petrodollars have once again become a seismic force in the global financial markets for the first time since the OPEC shocks of the 1970’s.

The IMF estimates that the GCC will generate $300 billion in current account surpluses, making the Gulf as significant a supplier of credit to the Euro markets as the exporter tiger companies of the Pacific Rim. In essence, GCC petrodollars are as mission critical to the financing of the American deficit as the central banks of China and Japan, Uncle Sam’s two Asian mega-creditors.

Without Kuwait’s KIO, Abu Dhabi’s ADIA, and Saudi Arabia’s SAMA, there is no way the US Treasury bond auctions could offer its paper IOUs without a quantum increase in interest rates. These low T-bond interest rates, in turn, jump-started the US and global economies after the trauma of 9/11 and the collapse of the Silicon Valley tech bubble. Without petrodollars reserves, the zero savings economy of the US would have been mired in recession after 2001 and vulnerable to a worldwide run on the dollar, as happened in the twilight of Bretton Woods in the early 1970’s, or after the Plaza Accords in 1985.

No Wholesale Abandonment
Contrary to media hype, there has been no wholesale abandonment of the American  financial markets by the GCC sovereign, bank and private investors. GCC currency regimes are all pegged to the Dollar; GCC central bank and sovereign investment agencies are overwhelmingly invested in dollar bank deposits and bonds; crude oil and natural gas are invoiced and settled in dollars; the  bulk of the Gulf’s private wealth invested offshore, estimated by the IMF as $1.5 trillion, is denominated in Dollars.

Investment logic — not emotions or politics — guides the decision-making process in the boardrooms of the Gulf’s smart money gnomes. Sure, perceived, expropriation risk and the Patriot Act triggered Saudi private wealth withdrawals from US banks and Wall Street but the funds were re-invested in Eurodollar and Singapore’s Asia dollar deposits. The petrodollar tsunami from the Gulf is a major reason why the US, a nation with a zero savings rate, that is now the largest borrower in the history of finance, still commands geo-political top banana status just because the Dollar is the world’s international reserve currency of the last resort.

Gulf Conservatism
Despite the vast infrastructure, property and stock market boom in the GCC, the Gulf’s petrodollar bonanza since 2003 is largely invested in Dollars. This is because the major oil exporting countries in the GCC have extremely conservative oil price projections in their budget process. Hence, 70-80 per cent of their petrodollar windfall is invested in global capital markets. Like Norway and Singapore, the Gulf has sophisticated investment agencies — ADIA, KIA, Dubai Investment Capital — that recycle petrodollars into the world stock, bond and property markets.

In fact, KIO was at one time a major shareholder in British Petroleum, as the UAE is in Daimler Chrysler, Ferrari and Doncasters now. Bahraini investment bank Investcorp also recycled private Arab petrodollars into the biggest trophy leveraged buyout and acquisition deals on Wall Street, including Tiffany’s, Gucci and Saks Fifth Avenue.

Gulf petrodollars also seeded some of the world’s leading money managers and commodities funds, including Man’s flagship AHL (the largest “black box” futures fund in the world) and the futures legends Paul Tudor Jones, Louis Bacon and John Henry, Saudi Prince Waleed bin Talal bailed out Citicorp in 1991 and invested in such historic deals as Eurodisney, Canary Wharf Four Seasons, Netscape, AOL and Motorola.

Lender of Last Resort
The Middle East has been a factor in the foreign exchange market ever since the 1970s. Kuwait, for instance, helped H. M. Treasury avert Sterling devaluations several times by switching from Dollars to Sterling during moments of monetary panic in London.

While oil is priced in Dollars, only two-thirds of Gulf’s offshore reserves are invested in the US currency. This means that the Sterling and Euro are buttressed by the GCC petrodollar tsunami.

Moreover, unlike the Asian central banks, Gulf petrodollars are not passive actors in the foreign exchange market. Indeed KIO (Kuwait Investment London Office) acts sometimes like a profit maximizing global hedge fund, and not like passive Asian or European central banks, content to earn money market returns. So the greater the scale of petrodollars in the currency bazaars, the greater the volatility in the foreign exchange market. It is also no coincidence that the great bull markets in gold and silver, traditional Arab hedges against inflation and geo-political kismet, came alive just as oil price tripled to $60 in 2004. The correlation between gold and oil, as in the 1970s, lies in the mystique of the Arab petrodollar.

Gulf central banks cannot respond to asset bubble in the regional share and property markets because of their currency pegs. The result? Negative real interest rates, rampant stock market speculation, huge inflation and the inevitable binge in bank borrowings! The meteoric boom and bust in the GCC markets were also a result of a loose monetary policy and overheated economy.

The financial markets in the Gulf are still embryonic, so any fall will be exaggerated in scale as liquidity disappears when it is needed most. Chaos theory is all too relevant in Gulf finance.

Matein Khalid is a renowned investment banker based in Dubai. His regular monthly column will focus on the economic happenings in the Gulf Cooperation Council member countries and their impact on the global finance.