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Goldman Sachs: Higher Oil Prices Will Benefit Global Economy

Friday, November 25, 2016 5:33
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From OPEC is closing in on a deal to cut production, which will surely cause oil prices to rise. Oil is already almost back to $50 per barrel, so cuts of nearly 1 million barrels per day could boost prices well into the mid-$50s, even up towards $60 per barrel. That will provide a windfall to oil producers around the world and the sacrifice for OPEC members will be more than paid for by higher revenues. For example, Iraqi officials say that for every $1 increase in the price of a barrel of oil, their revenues jump by $1 billion per year.

As a result, the odds of rising crude oil prices are high. But while that could be welcomed by the industry, consumers might not be as excited to see cheap gasoline disappear. After all, U.S. motorists have enjoyed two years of incredibly cheap fuel. Will rising oil prices put a dent in already tepid U.S and global economic growth?

Perhaps not. As Bloomberg reported, Goldman Sachs wrote in a Nov. 22 research note that the global economy could benefit from higher oil prices. That conclusion may not be obvious, but here is the logic the investment bank lays out: Higher oil prices lead to a wave of capital that flows into major oil producing countries such as Saudi Arabia. Unable to use all the capital, Saudi Arabia sends the excess savings back into the global financial system. Banks then use that capital to lend. Interest rates also fall as the financial markets are more liquid. The end result is lower interest rates, more financial liquidity, higher asset values and ultimately greater consumer confidence. In short, higher oil prices could boost economic growth.

These conclusions echo those from a team of IMF economists from earlier this year. In March, the IMF said that the assumed connection between oil prices and GDP (falling oil prices will boost GDP as consumers have more money in their pockets) is not as solid as previously thought. Many analysts, including those at the IMF, once assumed that although oil producing countries such as Saudi Arabia would be damaged from low oil prices, the benefits to consuming countries would more than offset those losses, delivering net benefits to the global economy.

But over the past two years a surprising trend emerged. Equity prices tended to move in tandem with oil prices; in the past we had grown accustomed to expect the reverse to be true (crude prices rise, stock markets fall). The positive correlation between financial markets and crude oil prices caught many by surprise.

The reason that this unexpected link occurred has to do with monetary policy. In the past, central banks including the U.S. Fed would respond to falling oil prices with a cut in interest rates, spurring economic growth. Now, with interest rates near zero, central banks have no firepower left. Falling oil prices is causing some deflationary pressure as a result (falling asset values), and the lack of an interest rate cut means that the real interest rate is actually higher, dampening growth. As a result, the IMF economists argue that the reverse will also be true: a rise in oil prices will push up asset prices, and if central banks hold off on interest rate increases, the effect could be positive for growth.

While that explanation is convoluted and a little bit of a mouthful, Goldman Sachs’ interpretation is much simpler: An integrated financial system means that savings from oil producing countries finds its way back to consumer countries, where it can stimulate growth. The investment bank singles out the early 2000s, in which rising asset prices and global growth came even as oil prices (and prices across a range of commodities) rose substantially. “The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system,” Goldman Sachs analysts wrote in their note to clients. “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.”

Goldman says that the surplus in savings outside the U.S. ballooned from $1 trillion to $7 trillion between 2001 and 2014, pushing up asset prices. Of course, that can also have a darker side – asset bubbles in commodities as well as housing also led to widespread financial ruin.

All in all, the research from Goldman Sachs suggests that, while it may not be obvious to individual consumers who see higher prices at the pump, there could be a boost to the global economy in the coming months if oil prices rise.

The United States Oil Fund LP ETF (NYSE:USO) fell $0.11 (-1.03%) to $10.56 per share in premarket trading Friday. Year-to-date, the largest fund tied to WTI oil prices has declined 3%.


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