Hamish McRae:
Published: 25 October 2007
Bahrain: Even brief visits give you a feeling for changes of mood. And the mood yesterday at a conference for investment advisers, not just from Bahrain but from all over the Gulf, was that they should be looking at as diversified a portfolio as possible, and particularly should be thinking about investment in Asia.
This is important because, of course, the United States has been relying on savings from the oil producers in the Middle East, along with Asian savings, to offset its current account deficit. One of the reasons why the dollar has been so weak in recent days has been the sense that the commitment of the international community to the US and to dollar assets has weakened. The US current account deficit has actually begun to narrow through the earlier part of this year, yet the dollar has become progressively weaker. Meanwhile, continuing rapid growth in China and the rest of the newly developing world has sustained demand for oil, pushing the price up and further boosting the balances of the oil exporters.
To put this into context have a look at the two graphs, which come from the latest World Economic Outlook, produced by the International Monetary Fund. As you can see in the first graph, the US current account deficit is more than 1.5 per cent of world GDP; yes, that is world GDP, not US GDP. On the other side of the balance sheet, the surplus of the oil producers is more than 1 per cent of world GDP. Thanks to the high oil price that surplus is at a sweet spot. It has shot up suddenly and the IMF thinks it will come down, at least as a share of world GDP. Elsewhere in the report the IMF predicts that the oil price will come slowly down, so it follows that if the present price levels are maintained it may be understating the size of the oil exporters' surpluses.
In the other graph you can see what these flows are doing to the stock of foreign assets. The net asset position of the US gets worse and worse not just in absolute numbers but as a percentage of world GDP, while the surpluses of the oil producers and to an even greater extent, the emerging Asian economies (actually, mostly China) keep on growing.
Now whenever you see a graph like that you have to ask whether it is credible. Is it really likely that the rest of the world will allow the US to accumulate net debts equivalent to 12 per cent of world GDP? Would the US itself be prepared to see itself become so indebted, particularly since so much of the debts will be to China and the Middle East? Surely not.
But if you don't believe this will happen you have to ask what sequence of evens might stop it. I happen to think that the US current account may correct rather more swiftly than the IMF expects. I also suspect that the investment community in China and the Middle East may seek to diversify their portfolios more swiftly, too. If the second happens faster than the first, the dollar becomes vulnerable. It does not need foreign investors to stop investing in dollar assets for the dollar to fall; it just needs them to build up dollar assets rather more slowly.
Pause for a moment. The US will remain a relatively attractive place for international investment funds for the foreseeable future. It is a huge and transparent market and at some level, dollar assets will always be attractive. So that is not going to change.
What is interesting, though, is the extent to which Middle Eastern investors are now interested in alternative assets classes. These include property, residential as well as commercial, various forms of infrastructure, and resources. The drying up of liquidity for venture capital and private equity investments, which seen from London or New York is a problem, from the perspective of the Gulf is an opportunity. The tighter the money markets, the more expensive it is to borrow, the greater the opportunities for Middle Eastern investors who are generating huge amounts of cash. That 1 per cent plus of world GDP has to find a home somewhere. India appears a particular beneficiary, more indeed than the rest of Asia. The point was made to me by a Qatari banker that India had many attractions for Gulf investors. It was close. There were strong cultural and personal links. And India needed investment in infrastructure as it had lagged behind China in that regard. It was a natural fit.
That must be right. We are also going to see much more Gulf money in Britain and Europe. You can see what has been happening to the euro as a result of this rebalancing of the flow of investment between dollar and euro assets, but Britain will also remain attractive because it remains extremely open to international investment.
That leads to what seems to me to be the biggest issue of all: how open will the US remain to foreign investors?
There is one particular area of current concern, which is the extent to which the so-called sovereign investment funds – funds accumulated by countries rather than private investors – are allowed to invest freely. The US in particular is concerned about such investment, particularly since some of the countries concerned are regarded as hostile to American interests.
There are quite legitimate reasons for concern. Foreign governments not only can mobilise funds on a huge scale; they can also have different objectives from private sector investors. But restrictions on sovereign funds can scare off private investors, too, particularly if they appear to be applied in a capricious manner. I don't think people in the US have any idea of the long-term damage done by the blocking last year by Congress of the bid for P&O by Dubai Ports, on the grounds that the former controlled a number of ports on the US East Coast.
From Dubai's perspective, these were not particularly important assets and they were duly excluded from the sale. But learning that you were not welcome by people you had assumed were your friends was a salutary experience for investors throughout the region.
The result will not be that Middle East investors shun the US. Rather it will be that investment in the US will carry a handicap. The US has the advantage of the size of its market and the general predictability of its legal system. These have enabled it to offer lower returns to international investors than would otherwise be the case. Now it is fairly clear that some of that advantage will be offset by this sense that foreign investment may be unwelcome. So the US will have to offer higher returns to attract international savings. A lot of the dollar's decline this year, in the face of an improving trade position, may be the result of this handicap. That will force a faster adjustment on the US than would otherwise be the case.
This may be no bad thing. It is not reasonable that the world's richest country should rely on the savings of other poorer countries to maintain its lifestyle. The decline in the dollar may force countries that have linked their currency to it to cut loose. That is gradually happening in China and it is a big issue, by the way, in the Gulf. But you don't want adjustment to be too sudden. It is in no one's interest that the dollar should fall in an uncontrolled way – and that danger will remain until the US becomes less reliant on savers in the rest of the world, including the Middle East.
This is important because, of course, the United States has been relying on savings from the oil producers in the Middle East, along with Asian savings, to offset its current account deficit. One of the reasons why the dollar has been so weak in recent days has been the sense that the commitment of the international community to the US and to dollar assets has weakened. The US current account deficit has actually begun to narrow through the earlier part of this year, yet the dollar has become progressively weaker. Meanwhile, continuing rapid growth in China and the rest of the newly developing world has sustained demand for oil, pushing the price up and further boosting the balances of the oil exporters.
To put this into context have a look at the two graphs, which come from the latest World Economic Outlook, produced by the International Monetary Fund. As you can see in the first graph, the US current account deficit is more than 1.5 per cent of world GDP; yes, that is world GDP, not US GDP. On the other side of the balance sheet, the surplus of the oil producers is more than 1 per cent of world GDP. Thanks to the high oil price that surplus is at a sweet spot. It has shot up suddenly and the IMF thinks it will come down, at least as a share of world GDP. Elsewhere in the report the IMF predicts that the oil price will come slowly down, so it follows that if the present price levels are maintained it may be understating the size of the oil exporters' surpluses.
In the other graph you can see what these flows are doing to the stock of foreign assets. The net asset position of the US gets worse and worse not just in absolute numbers but as a percentage of world GDP, while the surpluses of the oil producers and to an even greater extent, the emerging Asian economies (actually, mostly China) keep on growing.
Now whenever you see a graph like that you have to ask whether it is credible. Is it really likely that the rest of the world will allow the US to accumulate net debts equivalent to 12 per cent of world GDP? Would the US itself be prepared to see itself become so indebted, particularly since so much of the debts will be to China and the Middle East? Surely not.
But if you don't believe this will happen you have to ask what sequence of evens might stop it. I happen to think that the US current account may correct rather more swiftly than the IMF expects. I also suspect that the investment community in China and the Middle East may seek to diversify their portfolios more swiftly, too. If the second happens faster than the first, the dollar becomes vulnerable. It does not need foreign investors to stop investing in dollar assets for the dollar to fall; it just needs them to build up dollar assets rather more slowly.
Pause for a moment. The US will remain a relatively attractive place for international investment funds for the foreseeable future. It is a huge and transparent market and at some level, dollar assets will always be attractive. So that is not going to change.
What is interesting, though, is the extent to which Middle Eastern investors are now interested in alternative assets classes. These include property, residential as well as commercial, various forms of infrastructure, and resources. The drying up of liquidity for venture capital and private equity investments, which seen from London or New York is a problem, from the perspective of the Gulf is an opportunity. The tighter the money markets, the more expensive it is to borrow, the greater the opportunities for Middle Eastern investors who are generating huge amounts of cash. That 1 per cent plus of world GDP has to find a home somewhere. India appears a particular beneficiary, more indeed than the rest of Asia. The point was made to me by a Qatari banker that India had many attractions for Gulf investors. It was close. There were strong cultural and personal links. And India needed investment in infrastructure as it had lagged behind China in that regard. It was a natural fit.
That must be right. We are also going to see much more Gulf money in Britain and Europe. You can see what has been happening to the euro as a result of this rebalancing of the flow of investment between dollar and euro assets, but Britain will also remain attractive because it remains extremely open to international investment.
That leads to what seems to me to be the biggest issue of all: how open will the US remain to foreign investors?
There is one particular area of current concern, which is the extent to which the so-called sovereign investment funds – funds accumulated by countries rather than private investors – are allowed to invest freely. The US in particular is concerned about such investment, particularly since some of the countries concerned are regarded as hostile to American interests.
There are quite legitimate reasons for concern. Foreign governments not only can mobilise funds on a huge scale; they can also have different objectives from private sector investors. But restrictions on sovereign funds can scare off private investors, too, particularly if they appear to be applied in a capricious manner. I don't think people in the US have any idea of the long-term damage done by the blocking last year by Congress of the bid for P&O by Dubai Ports, on the grounds that the former controlled a number of ports on the US East Coast.
From Dubai's perspective, these were not particularly important assets and they were duly excluded from the sale. But learning that you were not welcome by people you had assumed were your friends was a salutary experience for investors throughout the region.
The result will not be that Middle East investors shun the US. Rather it will be that investment in the US will carry a handicap. The US has the advantage of the size of its market and the general predictability of its legal system. These have enabled it to offer lower returns to international investors than would otherwise be the case. Now it is fairly clear that some of that advantage will be offset by this sense that foreign investment may be unwelcome. So the US will have to offer higher returns to attract international savings. A lot of the dollar's decline this year, in the face of an improving trade position, may be the result of this handicap. That will force a faster adjustment on the US than would otherwise be the case.
This may be no bad thing. It is not reasonable that the world's richest country should rely on the savings of other poorer countries to maintain its lifestyle. The decline in the dollar may force countries that have linked their currency to it to cut loose. That is gradually happening in China and it is a big issue, by the way, in the Gulf. But you don't want adjustment to be too sudden. It is in no one's interest that the dollar should fall in an uncontrolled way – and that danger will remain until the US becomes less reliant on savers in the rest of the world, including the Middle East.
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