Geo-Graphics

In his recent book, Market Madness: A Century of Oil Panics, Crises, and Crashes, our colleague Blake Clayton explains the role of market psychology in contributing to the wild price swings that have characterized the oil market over the past hundred years.   Using data from Google Books NGrams, he shows that whenever oil prices climb for an extended period comments about “running out of oil” and “running out of gasoline” proliferate. These beliefs have repeatedly proven unfounded. We decided to run a similar experiment for downturns in the oil market, such as the one we’ve been living through over the past eight months. Google Books NGrams data, unfortunately, only go through the end of 2008 – so we can’t use it to look at the past eight months.  But, as the graphic above shows, we can use it to look at the end of the last major oil price spike in 1980.  And indeed, references to the “end of OPEC” soar with the plunge in oil prices immediately following the price-spike peak. Googling the phrase “end of OPEC” today, not surprisingly, also shows many prominent-source recent uses of the phrase: for example, “The End of OPEC as We Have Known It is Here" (Brookings), “Citi: Oil Could Plunge to $20, and This Might Be 'the End of OPEC'" (Bloomberg), “End of OPEC is closer to reality" (CNN), and “The End of OPEC" (Foreign Policy).  Given Clayton’s findings of misguided fears of “running out of oil” during price surges, this suggests that we may be in the midst of a short-lived era of unfounded optimism on copious supply.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

The “law of one price” holds that identical goods should trade for the same price in an efficient market. To what extent does it hold internationally? The Economist magazine’s famous Big Mac Index uses the price of McDonald’s burgers around the world, expressed in a common currency (U.S. dollars), to estimate the extent to which various currencies are over- or under-valued. The Big Mac is a global product, identical across borders, which makes it an interesting one for this purpose. Yet it travels badly—cross-border flows of burgers won’t align their prices internationally. So in 2013 we created our own index which better meets the condition that the product can flow quickly and cheaply across borders: the Geo-Graphics iPad mini Index, which we hereby rechristen the “Little Mac Index.” (H/T: Guy de Jonquieres) Consistent with our product, iPad minis, being far more tradable than The Economist’s product, Big Macs, our index shows that the law of one price holds much better than theirs does.  The average overvaluation of the dollar according to the Big Mac Index was 19% in January - a Whopper.  The average dollar overvaluation according to the Little Mac Index was a mere 5% - small fries. So what’s happened since we last updated our index in May?  The U.S. dollar index (the DXY) has appreciated nearly 20%.  The rising dollar is lowering U.S. corporate profits and putting downward pressure on U.S. inflation.  Measured in terms of iPad minis, the dollar has over this period gone from being cheap against most major currencies to being expensive – a reflection of the fact that America’s central bank is almost alone in having virtually committed to tightening policy later in the year. One notable exception to the dollar’s strength in the Little Mac Index is the Swiss franc, which will buy you fewer iPad minis than the buck.  The franc skyrocketed after the Swiss National Bank unpegged it from the euro on January 15. When we first launched the index in June 2013, the dollar looked undervalued against most currencies.  Now that the dollar is looking pricey, there is more reason to fear currency conflicts spilling over into the trade sphere.  This is highlighted by the growing threat to a Trans-Pacific Partnership (TPP) trade deal from U.S. corporate interests seeking to hold it up until anti-currency-manipulation provisions can be welded in.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Russia’s foreign exchange reserves have fallen by nearly 1/3 since October 2013; they’ve fallen 20% just since September 2014.  Whereas the country still has over $300 billion in reserves, about $150 billion of this may be illiquid; it also has close to $700 billion in external debt. Whom would Russia turn to for dollars in a crisis? The IMF is the most obvious place.  The IMF approved lending to Russia of about $35 billion (SDR 24.8 billion) in the 1990s. With the sort of “exceptional” access that the Fund has granted to Greece, Portugal, Ireland, and Ukraine, Russia could potentially borrow up to $200 billion today, as shown in the figure above.  But when it comes to Russia, the United States and Europe are not in a generous mood at the moment.  Moscow would almost surely want to look elsewhere. What about its new BRICS friends?  Putin had said in 2014 that the new BRICS Contingent Reserve Arrangement (CRA) “creates the foundation for an effective protection of our national economies from a crisis in financial markets." Russia could potentially borrow up to $18 billion through the CRA.  But here’s the rub: it can only do so by being on an IMF program.  Without one, Russia could borrow a mere $5.4 billion – chicken-feed in a crisis.  In fact, borrowing such a pitiful sum might only precipitate a crisis by hinting that one was coming. What about China?  Here, things get interesting.  Under a central-bank swap line agreed in October, Russia could borrow up to RMB 150 billion – the equivalent of $24 billion at current exchange rates. China’s Commerce Minister Gao Hucheng has reportedly said the swap line could be expanded. What would Russia do with RMB, though?  Why, sell them for dollars, of course – as Argentina is apparently prepared to do with the funds received through its swap line from China. China might be happy for Russia to sell the renminbi it receives for dollars, as doing so would put downward pressure on the RMB without implicating Beijing in “currency manipulation.” “Russia plays an indispensable role as a strategic partner of China in the international community,” according to a December 22 editorial in China’s Global Times. “China must hold a positive attitude to help Russia out of this crisis.” In short, China may well have both economic and geopolitical reasons for offering Russia a helping hand.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”