September 28, 2012 7:01 am
The Fed, quantitative easing and oil prices
Is the ultra-lax monetary policy of US Federal Reserve behind high oil prices?
The Yes camp argues that low interest rates – and recently QE, followed by QE2 and “QE Infinity” – depress the value of the dollar, pushing up oil prices.
The No camp says the link through the exchange rate is flawed as the oil market has seen high prices irrespective of the dollar’s strength. Both sides, nonetheless, agree that lower interest rates spur economic growth, and thus, oil demand.
But there is a third argument.
I recently sat down with a senior official from a medium-sized Opec country, with decades of experience in the oil market, who offered an interesting point of view about the role of the Fed in setting oil prices. He explained that his country already has significant foreign exchange reserves, mostly invested in low yielding US Treasuries, and current oil prices were high enough to both meet budgetary needs and further inflate the reserves.
“I know the US and the Europeans would like us to increase production,” he told me. “But what is the point? We would earn more money; money we do not need. And US interest rates are so low that we earn nothing from our extra production. It is better for us to keep production unchanged and keep the money underground.”
In short, the opportunity cost of not producing oil has fallen dramatically. Thus, policy makers feel little pressure to increase production to lower oil prices.
According to the US Treasury, crude oil exporters – a proxy for Opec countries – hold a record $268bn in the country’s bonds, up from roughly $100bn in 2007 and just below $50bn in 2000, before the spectacular rise in oil prices of the last decade started.
The big increase in holdings in US debt has come in spite of declining interest rates. Benchmark 10-year Treasuries yielded between 4 and 6.5 per cent from early 2000 until late 2007. But since the start of the global financial crisis in mid-2008, it has steadily fallen, recently yielding less than 1.5 per cent.
Of course, the problem could be resolved with a better allocation. Patrick Artus, an economist at Natixis, recently argued in a paper that “the low return of foreign exchange reserves” for countries such as China, Japan or the members of the Opec oil cartel, should “encourage central banks to diversify the assets that make up their foreign exchange reserves into corporate securities and other currencies”.
United Arab Emirates, Qatar and Kuwait have partially resolved the problem recycling their extra holdings through sovereign wealth funds with wider investment mandates. But others, including Saudi Arabia and Algeria, still manage the bulk of their reserves through their central banks, largely investing in Treasuries.
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The Commodities Note is a daily online commentary on the industry from the Financial Times
Copyright The Financial Times Limited 2012.
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