Will the dollar benefit from the shale revolution

Dr. Naser al-Tamimi

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The U.S. dollar or greenback have dominated the world’s cash transactions and the foreign exchange reserves for more than half a century, and still considered the “King” of the world currencies despite its value has been declining since 2003. The recent global financial crisis clearly put the role of the dollar in the international market under spotlight after the confidence in the currency was shaken with the staggering performance of the U.S. economy.

From the point of view of macroeconomic indicators for the United States, the situation seems scary, the budget deficit reached astronomical figures, and the size of the public debt is over $ 16 trillion, as well as the high rates of unemployment and low economic growth. However, there are no signs supporting that the dollar will collapse. In fact, the decline in the value of the U.S. currency could be described as “orderly” and there are no compelling signs that things may get out of control and that the dollar will seriously deteriorate. On the contrary, all indicators show that the dollar may start a gradual rise again.

Eyes on America’s shale boom

For the time being the dollar will continue to be the “king” of the currencies and the greenback will maintain its position strong for years to come. The dollar may remain as the dominant currency for at least the next decade because: (a) the Chinese currency ‘yuan’ currently is non-transferable and could take at least another decade to become a convertible currency in world markets or until the Chinese financial system and its exchange rate regime are substantially more liberalized. (b) The troubles facing the European union now which cast a shadow over the euro; (c) the small size of Japan and the British currency markets. And (d) the IMF’s special drawing rights (SDRs) enjoy neither the liquidity nor the confidence to be able to function as global currency.

Above all, the influential commentator, the celebrated financial historian and Harvard University professor, Niall Ferguson, argues that the abundant availability of indigenous energy could spark a new economic “golden age” for the United States. Indeed, the most immediate impact of the shale-gas bonanza has been on America itself.

Fatih Birol, the International Energy Agency’s chief economist, stated recently “it means that the many people who had written off the U.S. economy have made a big mistake (…) The U.S. current account deficit is declining, there will be downward pressure on inflation and the dollar will strengthen.” As a result; foreign exchange investors should pay close attention to America’s shale boom over the next few years, and take a more constructive longer-term view on the greenback.

Unconventional oil and natural gas activity is already revolutionizing America’s energy future and bringing enormous benefits to its economy

Traditionally, crude fell when dollar rose, but global influences have changed relationship. If the U.S. becomes less reliant on oil imports, the negative relationship between oil and the dollar should break down. By boosting domestic crude oil production significantly over the next decade, the U.S. will be able to cut its reliance on foreign petroleum to the benefit of the dollar.

The U.S. in 2011 spent more than 2 per cent ($ 465 billion) of gross domestic product each on net imports of crude oil and other petroleum products. According to forecasts by Deutsche Bank, reduced energy dependence would cause the U.S. current account deficit to fall 30% by 2016. While, UBS, Switzerland’s largest bank and one of the biggest financial institutions in the world is optimistic about the shale “revolution” as the boom from shale oil will bolster the greenback by narrowing the current-account deficit and trimming cash paid to oil exporters that then diversify away from U.S. assets.

Unconventional oil and natural gas activity is already revolutionizing America’s energy future and bringing enormous benefits to its economy.

The IHS expects substantial growth in capital expenditures and employment to occur in support of the expansion of production within the unconventional sector. IHS Global Insight recent report claims that already in 2012, employment in the entire unconventional oil and gas production sectors have added more than 1.7 million jobs to the economy. This number is expected to grow up to 2.5 million jobs by 2015, and 3 million jobs by 2020.

Additionally, in 2012, unconventional oil and natural gas activity will contribute nearly $ 62 billion in federal, state and local tax receipts. By 2020, total government revenues will grow to just over $ 111 billion. On a cumulative basis, unconventional oil and natural gas activity will generate more than $ 2.5 trillion in tax revenues between 2012 and 2035. Also, more than $ 5.1 trillion in capital expenditures will take place between 2012 and 2035 across unconventional oil and natural gas activity.

At the same time, historically low U.S. natural gas prices, which are a third of those in Europe and Japan, are prompting billions of dollars of investments in U.S. advanced manufacturing - thus fuelling a new export economy. According to Dow Chemical, which has announced its own $ 4 billion investment plan in petrochemical plants in Texas and Louisiana, has calculated the total value that manufacturers industry has announced over 100 capital investments representing over $ 90 billion in spending in the U.S. in the past two years or so to take advantage of its cheap natural gas.

Bright prospect

Within this context, the correlation between the dollar and crude will increase over the next two years as U.S. energy production grows which means the greenback would strengthen as oil prices rise according to UBS. Recent Bloomberg’s survey predicts that the dollar will be on average 2 percent stronger against 46 currencies by the end of 2014, as the price of West Texas Intermediate crude rises 14 percent. Furthermore, in a recent research on domestic oil production, analysts at Citi suggested that the cumulative impact of new production, reduced consumption, and associated activity may increase real GDP by 2 to 3%, creating from 2.7 million to as high as 3.6 million net new jobs by 2020. The current account deficit could shrink by 2.4% of GDP, a 60% reduction in the current deficit, by 2020. The research also suggests this would also have implications for the U.S. dollar, potentially helping it to “appreciate in real terms by +1.6 to +5.4% by 2020, reversing its long-term decline and maintaining its status as the global reserve currency of choice.” Additionally, Goldman Sachs is bullish on long-term growth prospects as a recent note to the investors suggests that: “These shifts in production are also likely to support an improving U.S. current-account position and a somewhat stronger U.S. dollar.”

Above all, the dollar is still attractive and safe haven for investors. According to the U.S. Treasury data the total major foreign holders of U.S. treasury securities rose by end-October 2012 to $ 5,482.2 trillion comparing with $ 4,918.3 trillion at the same period in 2011. The oil-exporting countries are again adding to holdings of U.S. government debt. Treasuries owned by oil producers and proxies for Middle East nations rose 9.2 percent in 2012 through September, to $ 634.8 billion, after an 11 percent decline in 2011, according to Treasury data. The amount includes the sovereign wealth funds of the OPEC countries as well as some UK banks that often act as proxies for Middle East nations. Even as the world’s reserve currency - the dollar accounts for almost 62 percent of Currency Composition of Official Foreign Exchange Reserves (COFER) according to the latest figures (end-September 2012) by the IMF, almost 2.5 times more than that of the euro and almost 5 times than that of the other major currencies (excluding the euro).

No alternative currency

At present there is no alternative currency rivalling the dollar or it will displace the U.S. greenback for the throne that sits currently. As for the future, it’s safe to say that the center of gravity of the global economy is shifting toward China, India and emerging economies and that could suggest, the world may turn into a multi-currency system, but the size of the shift away from the dollar will be mainly depends on finding suitable competitor (or replacement) of the dollar. Barry Eichengreen, a professor of economics and political Science at the University of California, Berkeley, in his excellent report “Is the Age of Dollar Dominance Coming to an End?” published recently by the Global Financial Institute puts it bluntly: “Recent events in the world economy have reinforced the dollar’s international role. They have delayed the euro’s emergence as a full-fledged rival while accelerating the emergence of the renminbi. But they have done nothing to alter the central conclusions (…) the dollar remains the only true global currency for the time being.”

But what is true now will not be true forever. Paul Kennedy, professor of history and director of international Security Studies at Yale University; and the author/editor of 19 books, including “The Rise and Fall of the Great Powers” warned recently the “optimists” that: “While the discovery of newer energy sources inside the United States may enhance America’s strategic power (…) it may possess unintended consequences that will come back to haunt future generations.”

(Dr. Naser AL-Tamimi is a UK-based Middle East analyst with particular research interest in energy politics and political economy of Saudi Arabia, the Gulf and Middle East- Asia relations.)

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