Features

This ‘wall of money’ is collapsing – that’s bad news for markets

Saudi Arabia is used to having a big pot of money to spend as it pleases. But that's now changed. John Stepek looks at what it means for the markets.

150929-saudi

Saudi Arabia's King Salman isn't used to being strapped for cash

A sovereign wealth fund is a marvellous thing.

You happen to govern a country that is blessed with natural resources. You are foresighted enough to realise that you probably shouldn't blow the entire windfall at once. So you set up a big savings pot your sovereign wealth fund (SWF for short).

And over the last decade or so, amid the commodities boom, you've watched the cash pile up. A lot of cash. In fact, I've lost track of the number of times that I've seen SWFs described as a wall of money', just waiting to flood global asset markets.

But what happens when the fat years end, and the lean begin and that wall of money starts to crumble?

I'm guessing we're starting to find out

The river of petrodollars dries up

It could spend on keeping the populace happy. It could spend on insulating itself from the Arab Spring. It could spend on trying to find ways to boost solar energy use in the country, rather than consuming its own precious and limited reserves of oil.

But now the price of oil has crashed, and Saudi Arabia has decided that the best way to deal with it is to hunker down and starve out the competition in the US, the money isn't flooding in the way it used to. And the trouble is, the Saudis haven't yet adjusted their outgoings to reflect their reduced circumstances.

As the FT reported yesterday, Saudi Arabia's foreign reserves have fallen by around $73bn since oil prices started to slide last year, as it "keeps spending to sustain the economy and fund its military campaign in Yemen". The country recently issued bonds for the first time in a long time, to try to prop up its finances.

That money has to come from somewhere. It's not just sitting in a bank account at the local building society. It's invested in bonds, in equities, in assets across the globe.

What happens to savers when they suddenly find their income is under pressure? The world's central bankers would tell you that they are inspired to take more risk, to replace the lost income.

But that's where central bankers are wrong. If you're used to saving if you're used to your outgoings being smaller than your income then it's a horrible psychological blow when that changes.

And rather than take more risks with your capital, you want to take steps to preserve it in any way possible. That encourages less risk-taking, not more.

So not only are the Saudis pulling out money to fund their overspending, they're also rebalancing their portfolios to take less risk. According to Nigel Sillitoe of researcher Insight Discovery, quoted in the FT piece, the Saudis have "pulled out $50bn-$70bn over the past six months" from various fund managers.

Says one manager, "they are not comfortable with their exposure to global equities". As Izabella Kaminska puts it on FT Alphaville, it's probably fair to assume that means emerging markets'.

High oil prices led to massive overproduction

Quantitative easing and the financialisation of commodity markets helped to drive up commodity prices in the first place. Consumers in oil-consuming countries paid the price a massive petrodollar tax that flowed to the Gulf and other oil-producing areas.

Those petrodollars, in turn, were recycled back into the system. They had to be parked somewhere. So they helped to drive up asset prices.

But high oil prices again, combined with the widespread availability of cheap money encouraged producers to work on finding alternative sources of oil. That led to massive overproduction.

Oil prices gave way. But even now again, fuelled by cheap money companies that should have been forced to halt production have been able to access funding to limp on, still pumping desperately to produce the necessary cash to pay the interest on their debts.

Collapsing oil prices mean the flood of petrodollars stops dead. Saudi Arabia becomes a net spender, rather than a saver. That particular wall of money' stops being there to prop up asset prices.

How the tumbling oil price could be inflationary

The good news of course, is that consumers aren't paying the energy tax anymore. But the money they save on that won't be going into asset markets it's more likely to be spent.

In fact, you could argue that while this oil price collapse is asset-price deflationary, it's potentially consumer-price inflationary. You've taken a chunk of money that used to end up ultimately being funnelled into asset markets saved, in other words and put it in the hands of people who are far more likely to spend it.

Higher overall spending means increased demand, which all else being equal means higher inflation.

In the longer run, that'll present a headache for our central banks. But it's not one that they'll notice (or pay attention to) until it's too late.

For now, the sell-off will give the Fed all the excuse it needs to avoid raising rates this year despite all its protestations to the contrary.

Recommended

Rob Arnott: Covid's hidden investment opportunities
Investment strategy

Rob Arnott: Covid's hidden investment opportunities

Merryn talks to Rob Arnott of Research Affiliates about some of the unexpected consequences of Covid and their opportunities for investors, plus the "…
24 Sep 2021
The Information Age is about to get interesting
Economy

The Information Age is about to get interesting

The IT revolution has been around for a while now, says Merryn Somerset Webb. But we're just getting to the good bit.
24 Sep 2021
Evergrande: Chinese property giant spooks global markets
China stockmarkets

Evergrande: Chinese property giant spooks global markets

Global markets fell this week as investors worried about the fate of Evergrande, China’s most indebted property developer, which is teetering on the b…
24 Sep 2021
Investing in football clubs: how you can profit from the beautiful game
Share tips

Investing in football clubs: how you can profit from the beautiful game

Football clubs may often be money pits for oligarchs, but they are also huge global brands, says John Chambers – and investors are now starting to rec…
24 Sep 2021

Most Popular

Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
Should investors be worried about stagflation?
US Economy

Should investors be worried about stagflation?

The latest US employment data has raised the ugly spectre of “stagflation” – weak growth and high inflation. John Stepek looks at what’s going on and …
6 Sep 2021
A nightmare 1970s scenario for investors is edging closer
Investment strategy

A nightmare 1970s scenario for investors is edging closer

Inflation need not be a worry unless it is driven by labour market shortages. Unfortunately, writes macroeconomist Philip Pilkington, that’s exactly w…
17 Sep 2021