Saved by the greenback tsunami

Historically, global recession has followed when the price of oil crosses $ 30/barrel. But in 2004 the price crossed $ 50, and is still $ 48 today. Yet instead of suffering a recession the world economy skyrocketed by 5.3 % in 2004, the fastest rate for three decades. Some slowing is evident today, with Japan, Germany and Italy registering negative rates. Yet the world economy as a whole (and India) look set for another year of good growth.

India and other Asian countries were crushed by the oil shocks of 1973, 1979-80 and 1990-91. Yet they seem barely touched by record oil prices today. After GDP growth of 8.5% last year, India is projected to hit 6.9% this year. Similar good news comes from other developing countries, even in Africa. What has suddenly made these economies impervious to high oil prices?

First, let us understand why high oil prices cause recessions. When consumers have to spend much more on oil, they have less money for other purchases. So consumer demand for goods and services other than oil falls. Higher fuel prices cut into profits of companies, which have less money to buy machinery. The fall in demand for both consumer goods and machinery means a recession. Lower demand translates into less growth, less jobs, less corporate profits, and more poverty.

Why has oil at $ 40-50/barrel not caused a global recession this time? One reason is that the dollar itself has depreciated. But the main reason is the flood of dollars unleashed by the fiscal deficits of George Bush and the easy money policy of Alan Greenspan of the US Federal Reserve. Between them, they have unleashed a veritable tsunami of greenbacks. Estimates of the total US fiscal deficit (federal, state and off-budget deficits) range from $ 450 billion to $ 600 billion/year, equal to the entire GDP of India! Greenspan has kept US interest rates below the rate of inflation for four years, sparking a huge expansion in money supply and credit card spending.

Americans are spending like there is no tomorrow, buying frenziedly from all corners of the globe. So, the US trade deficit is now running at an annualised rate of around $ 700 billion. This in turn has enabled developing countries to run huge trade surpluses, which they have converted into record forex reserves.

According to The Economist, the global supply of dollars (the US monetary base plus global forex reserves) rose in 2004 by a whopping 25%, the fastest rate for three decades. This has become an unwitting form of global Keynesian rescue from what should normally have been a global recession.

Keynes showed that the way out of a recession was for a country to run a big fiscal deficit and loose monetary policy, creating a flood of money to offset the drop in demand caused by a recession. But in our globalised world, a flood of local money leaks into the global economy. So, in order to lift the US economy, Bush and Greenspan have been obliged to release a flood of dollars big enough to lift the entire world economy.

Consider India. In past oil shocks, Indian companies faced with falling demand would try to export more. However, since demand was falling globally, they found exporting difficult, and often exports fell.

But not this time. India’s exports surged by 25.5% in the first 10 months of the fiscal year, rising to an astonishing 33% in January 2005. Imports surged even higher, by 34.7% in the first 10 months. This was partly because of costly oil, partly because the economy kept booming and sucking in more imports. Yet we have a current account surplus, and forex reserves are rising.

The dollar tsunami has provided enough for every Asian country to pay for costly oil and yet generate forex surpluses by exporting massive amounts of goods and services to the USA. The latest data show current account surpluses in not only India but Thailand, Taiwan, Korea, China, Indonesia, and every Tom Dick and Harry.

The dollar tsunami has lifted more than just global exports. It has lifted asset prices throughout the world. If property prices are shooting up everywhere from London and Madrid to Gurgaon and Bangalore, if stock market prices are shooting up in India and Indonesia, one important cause is the dollar tsunami.

However, the tide will turn one day. US fiscal and monetary policy will tighten, and the dollar tsunami will ebb. Watch out then for a crash in our property and stock markets.

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