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Insight: Petrodollar tsunami to hit the euro and dollar
By Stephen Jen
Published: March 3 2008 16:39 | Last updated: March 3 2008 16:39
Over the past 20 years, spot crude oil has significantly under-performed global equities, by a factor of one to three in cumulative returns, and by a factor of two to one in terms of volatility. In other words, crude oil has had a much lower return and much higher volatility compared with global equities. Calculations using data from the past 100 years yield a similar result.
Thus, from the perspective of maximising the risk-adjusted long-term return on the combined underground wealth (crude oil) and above-ground wealth (financial assets), an exporter should be expected to embark on a multi-generational transformation from crude oil to equities.
Since most oil exporting countries have a much higher propensity to invest in equities than do Asian reserve holders, because petrodollars are deployed in the financial markets, there will be a bias in favour of global equities.
At the same time, if we assume that SWF/petrodollar portfolios have benchmarks of 25:45:30 on bonds, equities, and alternative investments, the currency composition of these portfolios will look significantly different from that of the official reserves. In fact, some 95 per cent of the world’s official reserves are held in only three currencies: the dollar, the euro and the pound.
While many observers focus on the shift in reserves between dollars and euros, the deployment of petrodollar investments will in fact likely tilt the balance in favour of emerging market currencies, at the expense of both the dollar and the euro. Specifically, we calculate that the theoretical share of emerging market assets in total petrodollar portfolios could be as high as 25 per cent, compared with the current exposure of official reserves to emerging market currencies of zero.
Stephen Jen is Chief Currency Economist at Morgan Stanley
Copyright The Financial Times Limited 2008