The Oil BubbleAndy XieMarch 04, 2005Asia/Pacific: Oil Is a Bubble Andy Xie (Hong Kong) The impact of high oil prices on China’s economy and on profit margins in general is a key risk in the current global boom. If current oil prices persist, the windfall for oil exporters may exceed the total earnings of S&P 500 companies, and China will have to pay 2% of GDP more in 2005 than last year for oil imports. China is a low-income economy and cannot sustain its rapid growth at current oil prices, in my view. Although current oil prices are still half as high as their peak during the oil shock in the late 1970s, China’s per capita income is less than one-tenth of that among the OECD economies at that time. The global property bubble has covered up the impact of high oil prices so far. Anglo-Saxon consumers have leveraged their rising property values to overcome sluggish income growth and high oil prices, thus sustaining consumption growth. Chinese investors expect massive profits from property inventory in a rising market and are willing to absorb the higher materials costs as a result. Oil is a bubble because the strong demand reflects the global liquidity bubble. At the same time, financial investors have poured into this commodity. When the demand-supply balance is tight in a strong global economy, demand from financial investors can push up prices rapidly. Hence, even though financial investors lose some money for carrying a commodity without yield, the price increase in the short term can still make the trade very profitable. Without the demand from financial investors, the current oil price could be US$15/barrel lower, in my view. The oil and property bubbles are aspects of the global liquidity bubble that has arisen from the combination of a low US Federal funds rate and the willingness of Asian central banks to accumulate foreign exchange reserves. The property bubble is the primary manifestation of this liquidity. The oil bubble is a secondary aspect. Oil, however, could destabilize the equilibrium through its contractionary redistributing effects. |