Wayne Arnold argues the Chrysler Building's sale could help ease crude prices as much as Bush's plan to drill off the American coast.
The Adic deal for the Chrysler Building could ease oil prices
Deep beneath the Chrysler Building in midtown Manhattan, there is almost certainly not a drop of crude oil. And yet it can be argued that the building's sale earlier this month could help ease crude prices at least as much as US President George W Bush's plan to start drilling for oil off the American coast. This is because the buyer of 90 per cent of the building was the Abu Dhabi Investment Council, one of the newest vehicles that the Government uses to invest its expanding oil revenues. Investing abroad is an important way to grow the nation's nest egg, providing for the day when the oil either runs out or becomes too cheap to pay for the increasing services which the Government provides.
Through buying the Chrysler Building, the Council is showing faith that property prices in Manhattan may appreciate faster than its money would grow sitting in a bank. More importantly, by buying foreign assets like the Chrysler Building, Abu Dhabi believes such overseas investments may rise in value faster than the price of oil. Why is that important? Because if Abu Dhabi and its investment managers felt that oil prices, even after their breathtaking rise in the past few years, were going to continue to outpace the appreciation of other assets such as stocks, bonds and property, it would make more sense to simply stop pumping more oil than the Government needs to finance its budget.
Instead, Abu Dhabi continues to pump so much oil that it generates a massive and growing surplus that in 2006 exceeded Dh100 billion (US$27.2bn). That money is divided between the Council and the Abu Dhabi Investment Authority (Adia), which has at least 45 per cent of its more than $500bn invested in North America. Helmut Reisen, a German economist who serves as the head of research at the OECD Research Centre, uses much the same argument in a new report published by Deutsche Bank to make the latest case for why the West should welcome investment by Arab sovereign wealth funds. Shocked by the xenophobic rhetoric that emerged earlier this year from commentators and politicians in Europe and the US, Prof Reisen said he sought to demonstrate how "these people are really silly [in] rejecting sovereign wealth fund investment from oil-rich countries".
Prof Reisen invoked an economic principle known as the "Hotelling Rule", named after the economist, Harold Hotelling, who developed it in 1931. In a nutshell, Hotelling determined that the most efficient exploitation of a non-renewable resource - like oil - occurred when its price appreciation was equivalent to the prevailing interest rate. Any faster, and it would encourage the producer to hold back production and watch the value of his precious reserve rise in the ground. Any slower, and he would be encouraged to try to flood the market to try to cash in as fast as possible and invest the money elsewhere.
Clearly, this principle has a self-fulfilling tendency that can help explain short-term price movements: if a producer expects oil to rise faster than the return on cash, he'll cut production, which would tend to result immediately in higher prices. The reverse is also true. Prof Reisen goes further, though, suggesting that perceived political risk among Arab investors of investing in the West could actually be helping to push oil prices higher. "Protectionism, such as restrictions posed on SWFs from oil-rich countries, will tend to reduce the risk-adjusted return for oil exporters, and may well contribute to higher oil prices as oil supply is withheld."
As provocative as these findings are, Prof Reisen said his research turned up a conclusion that surprised even him - that the West has more cause to scrutinise investments by Asia's big sovereign wealth funds than it does those from the Gulf. "Commodity-based funds are much better supported by economic reasoning than the Asian funds," he said, referring to the China Investment Corporation and the two funds of Singapore ? Temasek and the Government of Singapore Investment Corporation.
Why? Because unlike the Gulf funds, which are filled with dollars obtained by feeding the West's addiction to oil - something the Gulf does not need to stimulate - the Asian funds are filled with dollars obtained by selling manufactured exports at exchange rates they work hard to keep artificially low. By fixing their currencies to the US dollar, Singapore and China keep their exports cheap at the expense of domestic purchasing power. The result is that both China and Singapore have a glut of savings, which they use to help finance consumption of their products, perpetuating trade surpluses, rather than spending the money at home and letting their currencies rise, helping trade imbalances right themselves.
"It's all part and parcel of the big global recycling phenomenon," said Prof Reisen. Both countries are now letting their currencies appreciate gradually to curb inflation, but Prof Reisen said bigger structural changes needed to be undertaken to help slow the accumulation of money into their sovereign wealth funds. Not so for the Gulf's funds, though. "For the Arab world," he said, "it means they should essentially continue to do what they're doing."