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Dollar on an oily
slope
By Jephraim P Gundzik
The unabated rise of international oil
prices and depreciation of the dollar will push
economic growth in the US down to about 2.5% in
2005, but will have little impact on economic
growth in the European Union, where growth is
expected to accelerate modestly. Stronger economic
fundamentals in the EU will support the continued
impressive economic growth in non-Japan Asia.
In cumulative terms, global oil demand
increased by 12% between 1999 and 2004. Cumulative
global oil supply increased by only 8.6% during
the same period. Between 1999 and 2001,
OPEC-engineered oil production cuts reduced global
oil supplies relative to demand. Beginning in
2002, the "war on terror" also began to hamper
global oil supplies.
The "war on terror"
has contributed to destabilization in Syria,
Yemen, Nigeria, Indonesia and Colombia, preventing
foreign investment in oil production. As a result,
oil production has declined in all of these
countries since 2002. More broadly, the "war on
terror" has significantly influenced the
depreciation of the dollar in the past two years.
The dollar's depreciation has also contained the
growth of oil production.
The imports of
most oil-exporting countries are dominated by
Europe. Though the dollar price of oil has
increased substantially in the past two years, the
trade-weighted increase in the price of oil has
been muted for oil producers in Europe, Africa and
the Middle East. Because of this, the dollar's
depreciation against the euro has also contained
investment in oil production in many countries.
The "war on terror" has crippled US
foreign relations with key oil producing
countries, including Russia and Venezuela.
Deteriorating relations with Washington have
encouraged these countries to contain oil
production growth in order to push international
oil prices higher. The "war on terror" has made
investment in oil production unusually
unresponsive to sharply higher international oil
prices.
With the "war on terror" unlikely
to abate, the growth of global oil supply will
slow in 2005. Oil production in Europe, Latin
America, Africa and Asia will decline, partially
offsetting production increases in the former
Soviet Union. Periodic instability-related supply
shocks will also contain the growth of oil supply.
Global oil demand growth will not slow as
quickly as oil supply growth. Like investment in
oil production, global oil demand growth has been
very unresponsive to rapidly increasing
international oil prices in the past two years.
The dollar's depreciation has played a significant
role in this by offsetting the rising dollar price
of oil in Europe and Asia. In addition, large and
rapidly growing oil-consuming countries such as
China and India subsidize oil prices.
The
continued depreciation of the dollar in 2005 will
prevent a significant decline in oil demand
growth. International oil prices could easily
reach $75 per barrel. This will push inflation and
interest rates in the US significantly higher,
slowing economic growth in 2005.
US
slowdown and the dollar
Slowing economic
growth and the increasing cost of the "war on
terror" will push the US budget deficit, including
state government deficits, to about 6% of gross
domestic product (GDP). This will also weigh
heavily on the dollar in 2005. With all indicators
pointing toward further dollar depreciation,
foreign central banks may become more inclined to
rebalance their foreign exchange reserves in favor
of the euro.
The rebalancing of reserves
could swiftly snowball if Russia decides
to redenominate its oil and gas exports
to Europe from dollars into euros. Both the
EU and Russia are interested in such a redenomination.
This change would force Europe's central banks
to reduce their dollar reserves. It could
also encourage the Organization of Petroleum Exporting
Countries (OPEC) to redenominate its oil exports
into euros.
The redenomination of oil
would allow the traditional relationship between
oil prices and oil supply and demand to reassert
itself. The redenomination of oil into euros would
force the dollar to devalue by 30-50%. It would
also force foreign central banks, which hold about
$1.5 trillion of US Treasury securities, to
liquidate a portion of their holdings, pushing US
interest rates much higher.
America's
loss is Europe's gain
The dollar's
depreciation against the euro will continue to
insulate Europe from rising international oil
prices in 2005, preventing a significant increase
of inflation. As a result, economic growth in the
EU is expected to accelerate mildly. This will
allow economic growth rates in the US and Europe
to converge for the first time in many years.
Convergence in economic growth rates will
be accompanied by lower European inflation
vis-a-vis the US. In addition, the EU's current
account surplus will be about $75 billion in 2005.
This will compare to a current account deficit of
about $600 billion in the US. Europe's economic
fundamentals will be much stronger than America's
in 2005. This will further fuel the dollar's
depreciation as investors, including American
ones, reallocate assets away from the US stock and
bond markets in favor of European stock and bond
markets.
Non-Japan Asia: Slow but
bright
Slowing US economic growth will
reduce export growth in several Asian countries,
including China. However, private consumption and
investment growth is unlikely to slow in China.
China's government can and will reopen the
country's credit taps if economic growth slows
below 7% on the back of weaker exports to the US.
In addition to continued strong economic
growth in China in 2005, slightly stronger
economic growth in Europe will help to contain
economic weakness in non-Japan Asia. India, in
particular, is expected to benefit from expanding
exports to the EU. Other Asian countries will also
be able to replace exports lost to the US with
exports gained to the EU.
Only a mild
economic slowdown is likely to occur in non-Japan
Asia in 2005. Like Europe, the currencies of most
Asian countries will continue to appreciate
against the dollar, insulating the region from
rising oil prices and higher inflation. With the
dollar expected to depreciate against most
currencies in the world, the dollar's role as a
reserve currency will be tested in 2005.
Jephraim P Gundzik is
president of
Condor Advisers, Inc, which provides investment risk
analysis on emerging markets to individuals and
institutions globally. Please visit
www.condoradvisers.com for further
information. |
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