The same throng of experts thriving on prophecies of impending
catastrophe (out of too many aging people, too few cash for everything,
too few labour-force etc) on early may 2004 revealed a new prophecy : the
new oil shock was coming, it will force a strait-jacket on the world economy
etc…The times of real squeeze and financial inflation (the so-called Petro-Dollars)
were back from the late seventies of the twentieth century.
In this very short-note I want to prove that the prophesied oil-shock cannot exist (and never existed). There is no exogenous oil strait-jacket but a self-imposed one.
There is no automatic real squeeze
It would only happen if the rise in the wage-bill (taking care for countries other than the USA of the floatable but predetermined exchange-rate1) determined a net fall in profits which could not be compensated. Following the principles of the general theory of the monetary circuit, the oil-bill has three effects on the generation of profits.:
- For a part, it is a cost of production for firms
producing in the economy by an amount of E1. E1 is spent in the flux
phase as part of initial finance generated by credit granted by domestic
- For another part, by an amount of E2, it is a «user cost» of durable or equipment goods owned by households. It is a leakage of income for domestic firms compounding the impact of desired thriftiness-led saving. E2 is that part of the aggregate private income which is not recouped as sales in the reflux-phase because of the oil-drain (it can be interpreted as a forced saving)
- At last, since the oil-bill is an income for producers, a share R is spent to buy commodities in the oil –importing economy.
It is now possible to unveil the full-impact of the oil-bill on profits
Flux phase Reflux phase
1/ Cost E1
2/ induced leakage E2
3/ induced receipts R (E1 + E2)
There are three cases
Case a : 1>3-2 negative impact
b : 1<3-2 positive impact
c : 1= 3-2 no impact
In case a, the negative impact can always be compensated,
as it has been shown, by the State net spending providing the economy with
the required amount of profits.
Now, let us assume some strong hike in the price of oil. At first glance, the case a could get worse and b could be turned in a . This conclusion ignores two crucial compensating factors :
- Households could respond by squeezing
their desired financial saving (or by getting net debtors).
- The State may increase its net spending (deficit) both by raising expenditures whatever and lowering
taxation (It could encompass therefore a lower taxation of oil at least for some users of
What is the worse
situation is the mix of a strong hike of the oil-price and a policy
of fiscal squeeze
targeting zero or negative deficits.
There cannot be an automatic financial inflation : the true role of the «Petro or oil-dollars»
A share 1-R of the income generated by the oil-bill is
diverted to financial accumulation or «saving» . it is encompassing
two financial operations :
- The settlement of past debts since many oil-producers are heavily indebted.
- The accumulation of new financial assets (net saving).
Since the first one cannot generate «petro-dollars», it is just destroying liabilities and dollar deposits at the same time in the final finance or reflux stage, the famous «petro-dollars» could only appear as the outcome of the second one :
1- At the most aggregate level, oil-importers A on one
side, Oil -producers on the other side, they cannot exist as a source of
finance. The general law of circulation applies : net acquisition
of liabilities by B is just providing final finance of A debt not already
extinguished by receipts.
2- We must rely on a disaggregated analysis and make the perfectly sensible assumption that for a given S, the whole net desired saving of B is absorbed by the desired acquisition of liabilities issued in a very small subset of A, A1. It means that acquisition of liquid assets issued by banks of A1 (C.D denominated in dollar for instance) exceeds by a very large amounts initial debts not yet extinguished. A1 banks balance-sheet reflects henceforth on their asset-side liquid reserves in dollars. Herein could be the starting «Petro-dollar» financial process as A1 banks leverage on their reserves and grant new loans denominated in dollar. This leverage-led process is submitted to severe constraints :
- Excess financial investment in A 1 has a counterpart, the lack of compensating final finance in
A2 banks (banks of oil importing countries which do not benefit from petro-dollars). A 1 banks
accumulate reserves while A 2 banks are still unable to be repaid for their initial loans.
The minimum stability condition is that A 1 Banks leverage-led loans finance A 2 unpaid debts.
It is the standard rule for the closure of the circuit.
- A1 banks can leverage if and only if the whole initial finance has been paid back. It requires a
full-compensation of the oil-bill hike by the increase on the State net spending.
- As it has been shown, the scale of the leverage depends on the amount of the accumulated debt of
Ultimately «Petro-dollars» cannot generate
a dangerous un-manageable Ponzi-like financial inflation. There is no reason
to be lured by the doomsday prophets as always and renounce sensible
policies of genuine full-employment.