The Goldman Sachs Group Inc. believes that higher oil prices would be a boon for the global economy in complete contrast to the stagflation of the 1970s.
The bank’s analysts Jeff Currie and Mikhail Sprogis wrote in a Nov. 22 research note said that asset values and consumer confidence would be boosted as financial markets help distribute money through the rest of the world gathered by economies such as Saudi Arabia will take in more money collected form pricey crude which they can then spend.
In the 1970s, when Middle East turmoil hiked oil prices and pushed much of the developed world into recession and for anyone who lived through that period, it’s a counter-intuitive notion.
Back then, money was taken out of circulation and stagnated the economy as money flowed from developed economies where consumption was high to emerging economies where consumption was low, due to high oil prices.
Currie and Sprogis wrote that things changed in the 2000s. Savings that were building up in lower-consumption, oil-producing countries were taken up and circulated them around the world by modern financial systems. According to Goldman, in the 2000s as oil climbed above $100 a barrel, the theory helps explain why the global economy surged. It also explains why it slowed amid the recent crude crash.
“The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system. More sophisticated financial markets in the 2000s were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe,” Currie and Sprogis wrote.
As it expects the Organization for Petroleum Exporting Countries to agree on a production cut next week, Goldman earlier this week raised its forecast for West Texas Intermediate crude prices in the first quarter to $55 a barrel, from $45. Currie and Sprogis wrote that such a boost should be viewed as a positive for global growth.
The views of Goldman’ss analysts carry extra weight among natural resources investors as it is the biggest commodities dealer on Wall Street by sales.
According to Currie and Sprogis, excess savings outside the U.S. grew to $7 trillion from $1 trillion as oil climbed from 2001 to 2014. The credit market was loosened for consumers and values of things like homes and financial assets were driven up by the savings.
Global liquidity was reduced as Middle Eastern economies began eating into their savings to meet budget requirements when oil prices began to fall in 2014. However it would not be forever that the correlation between oil prices and global growth would last. Currie and Sprogis wrote that the financial spillover effects will stop as they did in the 1980s and 1990s when these economies set their budgets so that spending and oil revenue are the same.
(Adapted from Bloomberg)