This thesis helps reader to track petrodollar flow of investment of Oil windfalls today as in 1970s. One should be able to understand best of petrodollar tracking flow after review of this writeup.

1. (PETRODOLLAR TRACKING THE FLOW OF INVESTMENTS OF OIL
WINDFALLS TODAY vs. 1970)
A Thesis Presented
by
************
**************************
To
The Committee on Academic Degrees in partial fulfillment of the requirements
For a degree with honors
**********
Business School,
AUGUST 2011

2. Contents
Abstract.............................................................................................................................................3
What Does Petrodollars Mean?...........................................................................................................4
Petrodollars....................................................................................................................................4
BACKGROUND....................................................................................................................................4
INTRODUCTION..................................................................................................................................5
Literature Review ...............................................................................................................................6
Oil Prices and Oil Revenues: ............................................................................................................6
The Hypothesis............................................................................................................................6
Defining the Petrodollar Exchange System ...........................................................................................7
The Role of the Oil Sectorin the Arab Economies .................................................................................8
Intricacies of 1970’s Windfalls.............................................................................................................9
Absorption Problems........................................................................................................................10
Additional Flows of Petrodollars........................................................................................................11
LDC Debt Crisis:................................................................................................................................11
Political events:................................................................................................................................13
American vulnerability ..................................................................................................................13
Oil Prices & GCC countries Investment Strategy affect ........................................................................13
What is the future of oil prices and how itis going to impact/shape global economy?..........................13
How much of this capital will be deployed domestically by GCC countries?..........................................14
Fueling liquidity and creates asset bubble..........................................................................................14
Growing concerns.............................................................................................................................15
Conclusion .......................................................................................................................................16
References:......................................................................................................................................17

3. Abstract
With growing fears of a potential energy crisis in the US, much dialogue has appeared comparing the
present situation to the infamous energy crisis of the 1970’s. This paper compares the two cycles of high
oil prices through the lens of petrodollar flow and usage by oil-exporting countries. The management and
ultimate outcomes of petrodollars during the initial period (1970’s & 80’s) provide a context for
understanding the complications and factors behind effective handling of petrodollars.
The unproductive and wasteful domestic spending by the oil-surplus nations in the 1970’s and 1980’s
demonstrates the need for skepticism today; the preliminary results in the first period also appeared to be
positive in regards to construction spending, industrial diversification, and investment. The lack of
investment know-how that resulted in the majority of OPEC’s external assets being deposited in western
banks emphasizes the necessity of thoroughly scrutinizing the flow of petrodollars. As the windfalls
channel across the world’s financial and banking systems, they have potential for significant global
implications. Lastly, the influx of petrodollars into the global banking system, in combination with
excessive lending by private banks and precarious macroeconomic conditions, sheds light on the complex
set of factors behind the LDC financial crises and the possibility of a similar predicament occurring today.
Using the lessons learned from the initial high oil price period, the paper then scrutinizes both the
differences and points of concern present in the world today. By laying out a serious of factors already set
forth in the global markets, the paper comes to the conclusion that despite the apparent prudence and
effectiveness with petrodollars today, the funds cannot be ruled out as a potential source of danger in the
world.

4. What Does Petrodollars Mean?
The money that oil exporters receive from selling oil and then deposit into Western banks. Petrodollars
are also known as petrocurrency.
Petrodollars
1. Petrodollars refer to the money that Middle Eastern countries and members of OPEC receive as
revenue from Western nations and then put back into those same nations' banks. For example if Libya
were to receive money from the U.S. for oil and then put the money into a U.S. bank, that deposited
money is referred to as petrodollar Petro dollar warfare.
2. Dollars paid to oil-producing countries and deposited in Western banks. When the price of oil
skyrocketed in the 1970s, Middle Eastern oil producers built up huge surpluses of petrodollars that
the banks lent to oil-importing countries around the world. In the mid-1980s and 1990s, these
surpluses had shrunk because oil prices fell and oil exporters spent a good deal of the money on
development projects. By the mid-2000s, the sharp rise in oil prices had again filled the coffers of oil-
producing countries, which reinvested billions of dollars back into the West. The flow of petrodollars,
therefore, is very important in understanding the current world economic situation. Also
called petrocurrency or oil money.
BACKGROUND
The discussion of petrodollars has caused a mixture of debate all the way through the years. From hope of
that this Global increase in Oil price will adjust the global imbalance or some others not believe this that
this will prove in this fashion, to hesitation from the enormous implications their vast size carries for the
world’s financial markets petrodollars never fail to arouse passionate discussions. With the world
possibly smaller and the financial markets more complex and dependent than ever before, the flow and
Investment of petrodollars presents a fascinating study of various facades of the international community.
From the global banking systems, to domestic economies of the oil-exporters, to current account deficit
countries in dire need of correction, the study of petrodollars entails consequences for a variety of critical
issues.
This is believed that, if we analyze the Petrodollars in the high oil price tenure of the years like 1970s and
980s and current global surge in oil prices then it provides valuable insight as to form where these
petrodollars are mostly drawn ad what are the possible aftermaths of the petrodollars. The backbone to
this analysis is the question of how are the oil exporting countries using the petrodollars differently.
Moreover, as both the world and its financial markets have drastically changed, the subsequent question is

5. how will today’s global economic platform handle the petrodollars differently than in the past, and Will
their use result in successes or failures of the international financial markets. The petrodollar discussion
also takes on greater complexity and importance given the acute global imbalances already set forth in the
world. Though no complete conclusion can be made as to what will happen, using the lens of the
petrodollars provides a thorough analysis of the global economic interplays of today.
INTRODUCTION
The term “petrodollar” is a macroeconomic term that is little understood and even less discussed in the
major news media today. Exactly how a petrodollar exchange system has helped maintain the US dollar
as the world’s reserve currency is a general theme in my book and will be the focus of this special report.
As William Clark suggests in his book Petrodollar Warfare, the current “war on terror” has been exploited
by the neocons in an effort to establish permanent US military bases in the Persian Gulf and also
dissuade” other nations from switching their crude oil contracts into an emerging euro currency. In what
is now being called the first oil currency war of the 21st century, the Iraqi War in 2003 was more about
protecting US dollar imperialism and preventing a “petro euro exchange system” than the alleged threat
of WMDs or terrorist links to Osama bin Laden and his al-Qaeda network.
Oil and its relations have shaped Arab economies in one way or another since the Dawn of independence
and/or the formation of nation states in the Arab World. The discovery of oil and the realization of its
importance and potential for meeting world energy needs not only increased the strategic significance of
Arab countries, but also helped integrate their economies into the global economy. During the 20th
century, the socio-economic and political transformation of the Arab countries and their relationship to
major powers was influenced by the international political economy of oil on the one hand, and by the
impact of the development of the oil sector on individual Arab economies on the other. The term “the
Arab world” is often used to refer to the countries of the Middle East and North Africa (MENA) region,
and the member states of the Arab League.1With a population of 310 million (5% of the world
population), a combined GDP of $870 billion (3% of global GDP), and a per capita income of around
$2,900, Arab countries are classified as low middle-income countries, as defined by the World Bank.
Despite the historical and cultural ties that exist among Arab countries, there are wide ranging differences
among Arab sub-regions (the Gulf and the Arabian Peninsula, the Mashreq and the Maghreb) in terms of
population size, resource endowment, levels of socio-economic development, output structure and per
capita income, among others. These differences not only influence the growth patterns of Arab
economies, but also have an impact on the process of economic integration and the political unity and
cohesion in the Arab world. The countries of the Arab world have witnessed massive social, economic,
and political transformations in the past three decades. The oil sector and the political economy of oil
have played a pivotal role in such transformations at different historical Junctures. During the early years
of oil discovery, when production was still in the hands of international oil companies (IOCs) under the
old concessions, these transformations were shaped by rivalries among the major world powers, as well as
by the various alliances of the IOCs and their worldwide influence on oil production and pricing policies.
After the wave of nationalizations and takeovers of the former concessionaires ended, the oil sector was
gradually integrated into the economies of the oil producing countries, and, consequently, into the Arab
economies at large. Following its integration into the Arab economies, the role of the oil sector Went
through various stages and forms depending on developments in the oil market and the flow of oil

6. revenues on the one hand, and the utilization of the comparative advantages of Arab economies on the
other. The role of the oil sector also differed among countries where the sector is dominant, depending on
the political, institutional and fiscal relations between the oil sector, represented by the national oil
companies (NOCs) and their respective governments.
Literature Review
Oil Prices and Oil Revenues:
The global economy has had to adjust to large swings in oil prices in the past as shown in the Chart 1.
After the OPEC oil embargo was imposed in late 1973, oil prices jumped from an average of to some
extent less than $4.00 a barrel to $11.40 a barrel in 1974 (or from about $16.75 to $45.40 a barrel in 2005
dollars, adjusted using the U.S. consumer price index).A decrease in Middle East oil production caused a
second major oil shock in 1979-80, pushing prices from approximately $14.00 a barrel in 1978 to $37.20
a barrel in 1980 (or from $41.95 to $88.25 a barrel in 2005 dollars). The recent rise in oil prices rivals
these two episodes in magnitude, although it has occurred more gradually. Oil prices averaged just under
$25.00 a barrel in 2002 and climbed only modestly in 2003. In early 2004, in part owing to rising and
falling demand by China, prices began a strong upward trend, averaging $37.75 a barrel that year, $53.35
in 2005, and $65.35 over the first ten months of 2006. These three episodes of price volatility generated
large swings in export revenues for oil-exporting countries. In 1972, oil exporters recorded $24 billion
in foreign sales. By 1974, after the first oil price shock, export revenues had grown to $117 billion.
Revenues increased steadily but not dramatically over the next several years.
The second oil price shock, conversely, propelled export revenues to roughly $275 billion in 1980 and
$250 billion in 1981. The most recent rise in oil prices has meant new gains for oil-exporting countries.
All told, oil-export revenues appear set to reach about $970 billion in 2006, up from just $300 billion in
2002. This dramatic increase raises the natural question of how oil exporters have spent their windfall.
TheHypothesis
Most oil sales throughout the world are denominated in United States dollars (USD).[1] According to
proponents of the petrodollar warfare hypothesis, because most countries rely on oil imports, they are
forced to maintain large stockpiles of dollars in order to continue imports. This creates a consistent
demand for USDs and upwards pressure on the USD's value, regardless of economic conditions in the
United States. This in turn allegedly allows the US government to gain revenues through seignorage and
by issuing bonds at lower interest rates than they otherwise would be able to. As a result the U.S.
government can run higher budget deficits at a more sustainable level than can most other countries. A
stronger USD also means that goods imported into the United States are relatively cheap.
Another component of the hypothesis is that the price of oil is more stable in the U.S. than anywhere else,
since importers do not need to worry about exchange rate fluctuations. Since the U.S. imports a great deal
of oil, its markets are heavily reliant on oil and its derivative products (jet fuel, diesel fuel, gasoline, etc.)

7. for their energy needs. The price of oil can be an important political factor; U.S. administrations are quite
sensitive to the price of oil.
Political enemies of the United States therefore have some interest in seeing oil denominated in euros or
other currencies. The EU could also theoretically accrue the same benefits if the euro replaced the dollar.
However, the European economy could also be seriously damaged if the euro were to appreciate
significantly against the dollar or other world currencies, particularly its exports which would become
relatively more expensive for the rest of the world. The same dynamic can apply to the dollar and the U.S.
economy, as well.
Defining the Petrodollar Exchange System
So what is the petrodollar exchange system? This is basically a complicated monetary arrangement that
was developed in the early 1970s to effectively recycle our trade deficits back into US capital markets and
major banks. For reasons that I will discuss in the next section, the US dollar was established as the
world’s reserve currency following WWII with a nominal guarantee that foreigners could exchange these
dollars for gold specie. By 1970 the US had reached peak oil production and began importing oil from
OPEC.4 In addition to exporting dollars for oil we also had mounting trade deficits due to the Vietnam
War and an expansionist Welfare State that was contributing to our escalating national debt being
monetized by the Federal Reserve. By 1971 foreigners began to bring pressure upon the US to exchange
their huge US currency reserves for gold at the Federal Reserve Bank of New York (our defacto central
bank). In August of that same year President Nixon suspended gold payment on these foreign accounts
and created a truly fiat currency on global markets. This had the net effect of contributing to a steady
loose fiscal policy in the US, and every financial chart that documents our nation’s annual budget and
trade account deficits can be traced back to this generalperiod.
Although the US managed to maintain the US dollar as the unofficial reserve currency for world trade our
US dollar imperialism has created an excessive amount of US currency held in offshore banks. These
large exchange reserves are formally known as “Eurodollars” and represent US dollars that are held in
foreign banks, or foreign branches of US banks. This term is not to be confused with the EU “euro
currency unit” now being used exclusively within the Euro zone. This term first originated in the London
financial district in the postwar period to represent US dollar deposits not converted to local currency
units throughout Europe which were being used to purchase oil in the US and repay US loans, thus
avoiding a double currency conversion and not pushing up their local currencies. Today, Eurodollars refer
to all US dollar deposits held by foreign banks or central banks in order to service dollar-denominated
debt to US banks, help sustain the exchange value of their own currencies and purchase commodities on
world markets – particularly crude oil in the Middle East.
By 1973 the CIA and US monetary authorities were getting concerned about the “one-way flow” of
Eurodollars being held by offshore banks to purchase crude oil from the OPEC cartel. Since the US dollar
was used as a worldwide currency OPEC members preferred to invoice their crude oil contracts in dollars
as a practical exigency. This economic distortion, however, was causing enormous exchange currency
reserves to accumulate in member bank accounts. These currency reserves came to be known as
“petrodollars,” a term that was coined by economics professor Ibrahim Oweiss at Georgetown University.

8. In October of 1973 the world experienced its first “oil price shock” when war broke out between Israel
and Arab states. The Yom Kippur War lasted 20 days and resulted in a 70% increase in the price of crude
oil from $2.90 to $5.12 a barrel. Because of US support for Israel OPEC members imposed an oil
embargo upon the US and further raised crude oil to $11.65 a barrel by December 1973, a full 400%
increase! According to analysts this period netted the single largest profit margin for oil refineries in US
history and there is considerable evidence to suggest that this conflict and outcome was not only
anticipated but actually planned. We now know that the annual Bilderberg meeting held from May 11-13,
1973 in Saltsjobaden, Switzerland was hosted by Henry Kissinger and attended by select politicians, oil
executives and bankers from the US and London financial districts. According to official documents
obtained, “the balance of payments of [oil] consuming countries” was a major concern because “the
financial resources of the oil producing countries could completely disorganize and undermine the world
monetary system.”5 It was proposed at this clandestine meeting that a way should be devised to “recycle”
Petrodollars back into capital and financial markets in the US to help support the US dollar.
The Role of the Oil Sector in the Arab
Economies
By the end of 2005, the countries of the Arab world held 667 billion barrels of oil reserves and 53 trillion
cubic meters (1,870 tcf) of gas reserves, or 56% and 30% of the world’s total oil and gas reserves,
respectively. In 2005, the Arab oil exporting countries produced 25 million barrels a day of oil and 30
billion cubic feet per day of gas, or 303 billion cubic meters, thereby accounting for 32% and 12% of the
total global oil and gas production, respectively. With oil exports of 20.5 and gas exports of 100, the Arab
countries were responsible for 43% and 15% of total oil and gas exports, respectively. For the past three
decades, the countries of the Arab world have had a higher share of worldwide oil reserves, production
and exports than any other group of countries, a fact that explains the relative dominance of the oil sector
in the economies of the Arab oil producing countries and consequently of the whole region. Of the 19
Arab League member states, 14 are producers of oil and gas. The six countries of the Gulf Cooperation
Council together with Iraq, Algeria and Libya account for 98% of total Arab oil reserves, 95% of gas
reserves and 90% of all Arab oil and gas production. In 2004, the oil sector (oil and gas production,
processing and refining) contributed between 30 to 60% of the respective gross domestic product (GDP)
of those economies.
In 2004, the average share of the oil sector in Arab economies reached 35%. This exceptionally high oil
sector share in the combined GDPs of the Arab economies reflected the major oil production and price
increases recorded that year. That year also witnessed a higher share of the group of major oil producers
in total Arab GDP, at 72%. during the period 1990-2004, however, the share of the oil sector in total Arab
GDP followed the booms and busts in the global oil market, dipping to a low of 16% in 1998 and peaking
at 35% in 2004.
There are also differences among the various sub-regions in the size of the GDP and its contribution to
overall Arab GDP. During the period 1995-2004, four countries, namely, Saudi Arabia, the United Arab
Emirates (UAE),Algeria and Egypt, accounted for 60% of the combined GDP of Arab countries.

9. Intricacies of 1970’s Windfalls
From the period of 1974 to 1980, the annual oil revenues of the Arab OPEC countries quadrupled from
$52 billion to $208.3 billion respectively. Moreover, out of the $320 million of OPEC’s total 1981
investible cash surpluses, nearly $300 million belonged to its Arab members. In addition, nearly 45
percent of all crude oil in 1980 was sold directly by OPEC producer governments in the world market, up
from only 8 percent in 1973.5 The main Arab and Gulf producers in terms of 1972 production were (in
order of magnitude) Saudi Arabia, Iran, Kuwait, Libya, Iraq, Algeria, Abu Dhabi, and Qatar. Table 1
reproduced from the IMF provides perspective on the relative magnitude of OPEC’s drastic riches during
the period. Indeed with such enormity of windfalls, many lessons can be derived from the complexities in
dealing with the excess profits.
The vast windfall sparked rapid growth in GDP’s, imports, and investments. As seen in the Figure 4 on
the next page, OPEC’s total current account balance soared on the back of the major oil price spikes.
However, it is also clear that the surpluses tended to vanish quickly. In just four years, a surplus of about
$60 billion in 1974 became a slight deficit in 1978, followed again by a similar cycle beginning in 1980.
Graph 5 illustrates how total OPEC GDP climbed stoically during the 1970’s before leveling off in the
‘80’s. It does actually beg a closer look into the individual sources of the GDP rise; Appendix 1 illustrates
that the main countries contributing to the sizable rise in total GDP were Saudi Arabia, Indonesia, and to a
lesser extent Algeria and the UAE.
The investment policies of OPEC nations during the period have long been criticized as being either
overly conservative or lacking respectable investment know-how. This argument is founded on the fact
that most of the petrodollars were ineffectively domestically spent, while the majority of saved assets
were simply placed in bank deposits or government securities. OPEC was charged with simply following
a global lending trend that began even before their petroleum windfalls (see next section). In fact,
Mikdashi points out that the major banks which accepted large deposits offered lower interest rates on
them than smaller-sized deposits of the same maturity, simply to compensate for the potential of an
unplanned withdrawal. As Mikdashi puts it, their investment decisions were “largely due to their a-
speculative predisposition and their limited sophistication in this area.”
These bold assertions however paint a relatively uncomplicated picture. In “Issues in Economic
Diversification for the Oil-Rich Countries” Rudolf Hablutzel writing for the IMF, stressed that OPEC
nations took considerable initiatives to strengthen their economic viability. One indication of this was the
robust growth of investment expenses as a percent of non-oil GDP. The numbers reproduced below from
Hablutzel work show considerable investments in the early years of the oil boom by the oil-surplus
countries.
Oil exporters wasted no time in increasing domestic spending on areas such as physical and social
infrastructure. By the mid-1980’s Saudi Arabia’s massive infrastructure spending totaled $500 billion.
OPEC nations achieved a 10% average annual growth rate of manufacturing from 1970-1980, one of the
highest in the world. Private consumption rose by nearly 7% on average, with some nations achieving as
much as 16%. Other areas of spending included defense spending and foreign aid. Furthermore the World
Development Report in 1982, reported significant improvements in life expectancy, decline in infant
mortality, greater medical care access,and higher enrollment of children in schools.

10. While the numbers indicate legitimate undertakings to modernize and industrialize their economies, the
real problem lied in the quality and timing of the investments. Anecdotal reports from numerous papers
from both the previous period and today emphasize the haste and expediency taken by oil-exporters in
their domestic spending. The exporting countries gaily spent their petrodollars on lavish construction
projects that required imported equipment and skilled foreign workers, but did little to create local jobs.
The robust spending in Saudi Arabia was soon cast with doubt as concerns over the maintenance and
overall usefulness to society began to build. Moreover, Saudi subsidies to various industries proved to be
extremely inefficient as reduced electricity costs only caused excessive usage and agricultural subsidies
only benefited large conglomerates rather than the small farmers.
Jahangir Amuzegar in “Managing Oil Wealth” attributes the mishandling of petrodollars to the fact that
investments in non-oil sectors were primarily dictated by bureaucracies in the respective countries. He
underscores the notion that these governments typically did not have the discipline nor did they take the
time for strict cost benefit analyses. As Amuzegar puts it, “there has been a clear tendency to tolerate
some “uneconomical outlets” of expenditures.” The bureaucracy and cronyism of the nations also caused
social tensions to arise; subsidies and transfer payments awarded during peak oil profits were later
substantially reduced, resulting in bitter social anxiety.
One aspect of investment misjudgment and possibly the most visible to onlookers at the time was the
region-wide construction boom. Petrodollar influx into the regional construction markets saw rapid
overinvestment and over-speculation by both governments and inexperienced investors. The construction
bubble grew to such extents that, as Hablutzel brilliantly put it, “in some instances it was cheaper to
reclaim land from the sea than to build on existing areas - which is ironic considering the large desert
hinterland.” This real estate bubble was however short-lived and subsided in 1977.
The most incriminating argument against the management of petrodollars has to be the outstandingly little
time it took the oil-exporters to go into budget deficit territory. Saudi Arabia overspent its oil revenues
and ran up a fiscal deficit of $4.1 billion in 1977-78 and $6.2 billion in 1978-79 that forced it to draw
down its foreign assets nearly 10 percent. A budget surplus as a percent of GDP of 4.6% for Iran in 1974
turned into a 4.89% deficit in 1977. Similarly, a 1.5% surplus in 1975 for the UAE became a 0.33%
deficit in 1977 and a 0.83% deficit in 1978.
Absorption Problems
A traditional reason for OPEC’s petrodollar investment tribulations was their low absorption capacity. A
major determinant of their limited capacity was the relatively low populations the countries had at the
time. Beyond the mere aspect of relatively low populations, the fundamental underdevelopment of the
OPEC countries in terms of technology, infrastructure, and human capital deterred the effective
absorption of rapidly building petrodollars. Dramatic rises in real economic activity, and particularly
imports, created stubborn bottlenecks in ports, roads, transport facilities, warehouses, and other aspects of
infrastructure. However, mere restricted capacities were actually overshadowed by investment and
spending mismanagement. Substantial domestic and consumer outlets for the petrodollars actually ran
into budget deficits sooner than those countries with limited need for the money. This undoubtedly
demonstrates the haste and ineptitude exhibited by windfall bestowed countries.

11. Additional Flows of Petrodollars
There were of course other pathways that petrodollars took during the period, namely reinvestment of the
petrodollars in Europe. Philip Windsor points out that most Arab oil revenue from Europe never left the
continent but stayed as investments. He firmly deducts that, “It is the power which the Arab nations
acquired from leaving their money in Europe which is at the root of the problem;” the problem of course
being the often conflicting Euro-Arab, Euro-American, and Arab-American relations. Though Europeans
faced serious anxiety over the potential flight of Arab money, numerous authors including Windsor
himself stressed the same reality – there was no high chance of this occurring because it would not be in
the interests of the Arabs as it would inevitably hurt their bread and butter industry, oil.
Lastly, Arab oil-exporters also tried to diversify into private and public equity. According to a Business
Week article published in 1981, “Kuwait and other Arab investors owned 4.9 per cent of the equity of
hundreds of America’s top corporation, to just below the minimum required by the SEC for full
disclosure. It is interesting to note that similar uproar over selling domestic businesses to Arab investors
took place in the ‘70’s and ‘80’s as is occurring at the present moment.
LDC Debt Crisis:
The flow of petrodollars during the 1970’s and ‘80’s has been associated with no matter more closely
than the Less Developed Countries (LDC) Debt Crisis. The conventional story states that oil exporters
lent their money to western banks, which then proceeded to lend en masse to the developing world. In
reality, the injection of petrodollars into the world’s banking system only exacerbated a lending trend that
had begun some years earlier. For more than a decade before oil prices quadrupled in 1973-1974, the
growth rate in the real domestic product of the LDC’s averaged about 6 percent annually. For the
remainder of the 1970’s the growth rate slowed but averaged a respectable 4-5 percent. Such growth
generated new US corporate investment in these markets, and the international banks followed by
establishing a global presence to support such activity.
The injection of petrodollars into the global banking system can be seen in Figure 8 reproduced from the
BIS Quarterly Review of December 2005. The graph shows that BIS reporting bank’s net liabilities to
OPEC member countries roughly doubled over this period, making OPEC countries one of the largest net
suppliers of funds to the international banking system. Contrary to conventional understanding, however,
the Less Developed Country Debt Crisis cannot solely be blamed on the influx of petrodollars into bank
deposits. Rather, there are two more sides to the story – the eagerness of the banks to expand their market
base and the global macroeconomic factors that prevailed during the time. Intricacies of Today
The situation today in terms of surging oil prices, accumulating petrodollars, and their subsequent usage
entails several essential distinctions. For one, today’s windfalls are largely sustained by strong
fundamental reasons increased global demand, little excess refinery capacity, and few significant
discoveries, which is in stark contrast to the short-term supply shocks of the 1970’s. These underlying

12. factors suggest that while today’s prices have not reached the same real highs as in the previous cycle, the
high prices may be here to stay. It is important to note that for now, in the face of the surging oil prices,
the IMF reported that, “More expensive energy will have only a modest impact on global growth”
Secondly, in regards to the investment of petrodollars, there is no doubt that today’s financial markets
offer a drastically broader investment spectrum. This implies that petrodollars are more likely to be
diversified throughout the world and the domestic economies of the oil-exporters, so as not to create the
same concentration of funds in western banks as before. As was seen in the BIS report on petrodollar
flow, OPEC as a source of funds for BIS reporting banks does not have the same importance as it once
did. Moreover, given the encouraging preliminary results from oil-exporters’ domestic economies it
seems that today’s cycle has at least started off on a better footing.
In spite of some of these apparently encouraging differences, there are enough intricacies in today’s
markets to actually consider the current global situation an unpredictable one. For one, there is yet another
rush into the emerging markets. As seen in the graphs below, equity prices have been soaring while in the
debt markets, bond spreads have been consistently tightening around the benchmark US Treasuries. Not
only has there been a strong downward trend in bond yields, they are now even lower than their previous
record-lows of 1997. Lending to the emerging markets totaled $56 billion, a sum not observed since 1997.
Furthermore, the emerging debt markets have also seen a growth in derivative instruments, in particular
credit default swaps and the inception of new synthetic collateralized debt obligations.
The critical difference here is that the lending is formed through debt issuances on the capital markets
where hedge funds, pension funds, and investors dictate the demand and the yields, as opposed to direct
bank lending of the 1970’s and 80’s. Theoretically speaking the markets should be better able to dictate
the lending process as access to borrowing is tied to market sentiments and movements. Furthermore, the
current rush into the emerging markets has been attributed to sounder financials of the developing
countries, in particular the current-account surpluses of the major nations due to high commodity price.
In regards to the development and proliferation of innovative financial instruments in these markets,
caution and mistrust of market’s pricing abilities are also not uncommon. Soroosh Shambayati, managing
director of EMEA global emerging markets credit derivatives at Citigroup, clearly stated in regards to
CDO’s, “The cracks will only get exposed if we have a proper credit cycle."35 If the 1970’s and 1980’s
can teach us anything, it is that the mere introduction of new financial products or platforms carries no
guarantee of stable and resilient financial systems in times of crises.
The low interest rates still prevailing throughout the world have solidified worries of “excess liquidity”
and global imbalances. In the United States, the lack of personal savings accompanied by relatively low
interest rates has caused a resistant property bubble. One study by the National Association of Realtors
estimated that 23 percent of homes in 2004 were purchased primarily for investment.36 To add fuel to the
fire, there has also been an explosion of “exotic” mortgages to the real estate scene that has made
financing a home even easier.
Other evidence of global imbalances include countries with pegged exchange rates, in particular the Gulf
Cooperation Council and China, which has allowed them to accumulate excess reserves while threatening
domestic industries elsewhere. While, on the other side of the spectrum is the United States which
depends on a volatile source of savings in order to finance the ever widening trade deficit. It has been

13. discussed that changes in interest rate differentials may move petrodollars away from US Treasuries.
Though OPEC members have solid reasons to invest in US Treasuries, it is still possible that if the Dollar
starts to depreciate even further (a prediction investment legend Warren Buffett adheres to) oil exporters
may shift a portion of their savings away from the US Dollar. With the realization that the US deficit
cannot be sustained forever this surely presents a disconcerting notion.
Political events:
American vulnerability
Of particular concern among many politicians, academics, and pundits is America's dependence on
foreign oil. Many economists feel that the recent rise in oil prices is at least partially tied to the fall of the
US dollar relative to most currencies. Since oil is priced in dollars, sellers have increased prices to
compensate for the purchase of their product with a less valuable currency. Economists generally agree
that higher oil prices pose a risk of inflation, recession, or both. Inflation would almost certainly rise if the
dollar were to depreciate heavily.
At least one U.S. Representative, Republican Ron Paul of Texas, has made very strong statements
advancing similar views, using the phrase “dollar hegemony” to describe U.S. policy and proposing
related reforms.
Oil Prices & GCC countries Investment
Strategy affect
Oil prices & Oil exporting countries are the major cause of high liquidity & leverage in global economy.
Once liquidity overstretched then it creates asset bubble and, crash of financial market. We have seen the
same in the last recession when oil price reached its highest level of $ 147.
What is the future of oil prices and how it is
going to impact/shape global economy?
As I mentioned oil exporting countries plays a very important role in global capital flow. If oil prices rise
then we see huge amount capital flow in global financial market. Apart from this lot depends upon these
countries domestic investment strategy. In the past they have invested quite less as compare to emerging
countries like China, India & Russia etc. If they increase investment domestically then we see less flow in
global market which reduces liquidity globally and makes market to stabilize.
As per the survey conducted by top Consulting firm, exports of crude oil will earn Gulf Cooperation
Council (GCC)/Petrodollar countries $5 trillion to $9 trillion from 2007 to 2020.

14. The GCC foreign-investment choices influence interest rates, liquidity, and financial markets around the
world. And the domestic investments affect the region’s urban development, economic diversification,
and ability to create jobs. Fortunately for the citizens of the GCC states and global policy makers, there
will probably be enough petrodollars to satisfy both sets of needs.
How much of this capital will be deployed
domestically by GCC countries?
Since 1993, GCC investment rates have averaged 20 percent of GDP, on par with European and US levels
but almost one-quarter lower than the average investment rate of Brazil, China, India, and Russia
combined. Petrodollars not invested locally will spill over into global capital markets. If oil lingers at
around $100 a barrel and domestic investment stays at 20% level as mentioned above, the GCC would
send $5.1 trillion in new funds into world markets and boosting these states’ total foreign wealth to $10.5
trillion by 2020. Domestic-investment rates as high as 28% combined with $70-a-barrel oil, would
generate around $2.5 trillion of new funds for GCC investors to deploy in global capital markets until
2020. Only a major decline in oil prices-to less than $30 a barrel,-combined with high levels of domestic
investment would make it difficult for the GCC to continue pumping significant liquidity into global
capital markets which seems unlikely situation.
As oil prices continue to set new records, investors outside Europe and the United States are increasingly
shaping trends in financial markets. Petrodollar investors have a newfound influence, and the more than
tripling of oil prices since 2002 makes them the largest and fastest-growing component of a broad shift in
global economic markets-a shift that also includes Asian central banks, private-equity firms, and hedge
funds. High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting
nations, which in 2006 became the world’s largest source of net global capital flows, surpassing Asia for
the first time since the 1970s. A majority of these revenues have been recycled into global financial
markets, making petrodollar investors increasingly powerful players.
Fueling liquidity and creates asset bubble
Since 2002, oil prices have tripled, and much of the incremental increase has ended up in the investment
funds and private portfolios of investors in oil-exporting countries. Most of the money is then recycled on
global financial markets, whose liquidity is therefore rising.
In fixed-income markets, this added liquidity has significantly lowered interest rates. Estimated total
foreign net purchases of US bonds have brought down long-term rates by about 130 basis points. Twenty-
one of them can be attributed to purchases by the central banks of oil-exporting countries, and impact as
large as that of the capital flows from financial hubs such as the Cayman Islands, Luxembourg,
Switzerland, and the United Kingdom, though less than half the impact of Asia’s central banks on US
interest rates. Petrodollars have added liquidity to international equity markets as well.
The story is different in global real-estate markets. According to research by the Economist Intelligence
Unit, real-estate values in developed countries have increased by $30 trillion since 2000, reaching $70

15. trillion in 2005 and far outstripping GDP growth over the same period. This rise reflects not only the
preference of petrodollar investors for global real estate but also the home-equity loans and larger
mortgages that low interest rates and risk spreads have made possible.
Indeed, petrodollars have helped increase global leverage in many forms. Low interest rates and credit
spreads have enabled the rise of hedge funds and the private-equity boom. Although low rates and spreads
have created ample liquidity for consumer credit in the United Kingdom, the United States, and many
other countries, a reassessed appetite for risk could burst this global credit bubble, causing pain to lenders
and borrowers alike. In mid-2007 problems in the US sub-prime-mortgage market sparked a re-pricing of
credit risk and a credit crunch.
Growing concerns
Despite the many beneficial effects of petrodollars in increasing global liquidity and spurring the growth
of various financial-asset classes throughout the world, the rise of investors in oil-exporting countries has
created concerns.
One worry is that the huge size of petrodollar sovereign wealth funds, coupled with their relatively high
appetite for risk, could make global capital markets more volatile. The limited transparency of these funds
amplifies the anxiety. Research, however, finds that their investment portfolios are widely diversified not
only across asset classes and regions but also through a number of intermediaries and investors.
Diversification reduces the risk that the funds could make financial markets more volatile. Moreover,
petrodollar investors have a track record of sensitivity about the broader market impact of large flows and
use derivatives and intermediaries to lessen it. ADIA, for instance, reportedly invests 70 percent of its
funds through external asset manager’s intermediaries who know they must move slowly in markets to
avoid adverse price adjustments. Direct petrodollar investors tend to adopt a relatively low profile.
A second concern has also attracted growing attention among financial-market regulators in Europe and
the United States; the prospect that sovereign wealth funds could use their growing financial hefts for
political or other non-economic motives. The rise of large government investors in financial markets is a
new phenomenon-and one at odds with the shrinking role of state ownership in real economies. Given the
limited transparency and enormous size of these investors, some observers question the motivations
underlying their investment strategies.
Final concern the long-term economic impact of higher oil prices. In the 1970s their rise sparked inflation
in the major oil-consuming economies and sent global banks on a petrodollar-fueled lending spree in
Latin America. Both developments inflicted significant economic pain on the countries involved. Today
higher oil prices have been a boon for global financial markets, but, paradoxically, inflation hasn’t risen
very much. Can higher oil prices really be good for the world economy? As we have seen, petrodollars
are creating inflationary pressures in markets for illiquid investments, such as real estate, art, and
companies. If the pressures move beyond those markets, the potential asset price bubbles could burst. So
far the world economy has accommodated higher oil prices without a notable rise in inflation or a
economic slowdown, but this may change in the future.

16. Conclusion
High oil prices will create more revenue for GCC countries and if domestic investment of these countries
will not increase appropriately then more money will be available in global financial market which may
cause high liquidity & emergence of more private equity & hedge fund players that increases global
financial leverage and may create asset bubble & crash of financial market.
Though praise and confidence has been bestowed upon the oil-exporters, history should teach us to still
remain skeptical. As we have seen in the previous cycle, preliminary attempts and apparent successes in
the management of petrodollars by the oil-exporters may not be sustainable for a number of reasons. The
complex interplay of bureaucracies, rulers, and regional politics may hinder the effective use of
petrodollars at some point in the future.
Even if we were to fully subscribe to the oil-exporters’ domestic improvements today as being a sign of
prudence and aptitude, the global macroeconomic situation still presents credible concern. With no real
consensus regarding the threat posed by the prevailing excess liquidity and global imbalances in the
world, and the United States unable to sustain its deficits and energy consumption forever, the current
situation is indeed a capricious one. As the LDC crisis made it clear, regardless of the confidence in the
global financial and banking systems or in the counterparties accepting the funds, the petrodollar
recycling mechanism can still succumb to unique sets of macroeconomic factors that are capable of
undoing the seams of the system. This being said, petrodollars today cannot be ruled out as a potential
source of danger for the world.

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