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Economists warn of rising oil prices fueling imbalances

While Western countries have so far managed to avoid recession despite a trebling of oil prices, economists fear the surge is fueling imbalances in the world economy and increasing the threat of a financial crisis.

Oil prices touched a historic peak of US$70 a barrel over the past week, just ahead of the IMF's Spring Meetings that begin on Saturday.

In Washington, the IMF is expected to deliver a warning about the more pernicious effect of persistent high oil prices, according to early extracts of its Spring 2006 World Economic Outlook.

Global current account imbalances are likely to persist for longer than if oil were, "heightening the risk of a sudden, disorderly adjustment," according to the report.

"In some ways, this is the third act in the saga of imbalances," said Raghuram Rajan, research director at the IMF.

"In the first act in the late 1990s, foreign capital was attracted to the United States, causing a counterpart current account deficit. In the second act, expansionary policies in the US caused the deficit to widen," he said.

"And in the third act, which is what we are seeing now, higher oil prices will widen existing global current imbalances and prolong them," he added.

Warnings of the kind from the IMF are not entirely new.

But with little sign that oil traders are likely to temper their ardor as long as international tensions over Iran -- OPEC's second-largest oil producer -- persist, economists believe the situation is increasingly fraught.

"The likelihood of a bond market crash has increased considerably in recent months and there is a joint risk of a slide in the dollar," said Veronique Riches-Flores, chief economist at the French bank Societe Generale.

The persistent rise in oil prices is "a major risk for bond markets and consequently a major risk for the world economy," she added.

Meanwhile, the US is relying on the huge dollar reserves held by Asian central banks and oil producing countries -- nations with big current account surpluses -- to finance its deficit.

Without them, the US currency would lose a crucial prop and could collapse.

High energy costs account for about half of the deepening of the US deficit between 2001 and last year, according to the IMF.

Last year the US current account deficit reached a record US$804.9 billion, equivalent to 6.4 percent of its GDP.

"The big fear is a chain reaction that would start with the external creditors of the United States, especially the central banks," said Antoine Brunet, chief economic strategist at HSBC CCF.

Brunet points to the recent surge in the price of gold, a traditional refuge for investors. Gold reached US$600 an ounce during trading in London over the past week, its highest in 25 years.

"It's a sign of concern about inflation and about the US external deficits," he said.

Brunet also believes that the US Federal Reserve has betrayed an underlying concern by "over-reacting" to the threat of inflation with repeated interventions to raise interest rates.
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