You probably have heard this numerous times before; the Chinese position in US Treasuries is outright dangerous and China could single-handedly force the US Dollar to weaken quite substantially. Whilst that’s definitely correct, it sure looks like one is overlooking the impact the low oil price has on the public finances of Saudi Arabia.
As the country is mainly depending on exporting its oil to keep its government budget balances, the Kingdom has been hit extremely hard by the 60% drop in the oil price as an almost certain budget surplus was suddenly converted in a huge budget deficit. In fact even during the darkest hours of the Global Financial Crisis, not a lot of countries saw their government budgets dip into the red by in excess of 20%!
Source: The Guardian
The main problem is the fact Saudi Arabia had been using an assumed oil price of $100/barrel to balance its budget and as the current oil price is less than $50/barrel, a lot of government officials will be scratching their heads. A huge budget deficit also means the Saudi’s will be scrambling to get their hands on cash and earlier this year the country has completed the first debt offering in almost 10 years!
But that won’t really help much. Raising a few billion dollars in government debt won’ offset a lot of the expected $150B deficit and the officials in Riyadh will continue to target the country’s sovereign wealth fund (well, it’s not ‘officially’ a sovereign wealth fund, but just an investment division of the central bank) which is the third largest in the world and had in excess of $750B in assets before the oil price started to fall.
The Saudi Arabian wealth fund was an excellent performer as it yielded an average 11% return over the past 10 years and this might be the country’s best bet to get out of the current oil crisis. But that’s also where the US Dollar comes into play.
And zooming in:
Source: International Monetary Fund
The original purpose of the fund was to make sure the Saudi economy remained relatively stable, and the assets could and should be monetized to soften sudden economic shocks. To serve this purpose, the country’s cash was invested in low-risk and highly liquid investments, such as US Treasury bills. It’s impossible to know how many hundreds of billions Saudi Arabia has invested in US debt securities as the American government doesn’t want you to know how which gulf country owns how much of the US debt (Government Accounting Office, 1979). But as the Saudi’s have virtually pegged their currency to the US Dollar, we would dare to bet in excess of half of the fund’s assets are held in US debt securities as it fits the bill in terms of a) liquidity, b) ‘safety’ and c) currency protection.
Even if you’d assume Saudi Arabia would be able to raise $30B per year in government debt, it still has a $120B gap to cover and the only decent solution would be to start selling US debt. This could put additional pressure on the financial markets as it won’t be easy to absorb this kind of selling.
That’s yet another reason why the Federal Reserve won’t be able to increase the interest rates anytime soon. Saudi Arabia’s gradual selling could be taken care of by the market but imagine the USA would start to increase its interest rates as well. A snowball-effect isn’t out of the question at all, and the pressure on the government bonds would be even higher and instead of a stronger Dollar, the US Dollar would be weaker. It will be extremely interesting to see more updates from the Saudi’s to see how much of the US treasuries it has already sold and how it plans to tackle its government deficit.
Because no matter what happens (excluding a sudden jump in the oil price), in 4 years from now, Saudi Arabia’s foreign reserves will be depleted. And that will most definitely fuel additional unrest in the Middle East.
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