Brad Setser: Taxes drive currency demand, the 1970s oil shock reshaped finance, and current oil supply shortfalls reveal market complexities

Key takeaways

• Taxes play a crucial role in creating demand for currency, which is fundamental to monetary policy.
• The 1970s oil shock significantly influenced the development of the financial system.
• Current oil shocks are less severe in magnitude compared to those in the 1970s.
• Historical oil price increases were much larger than current price changes.
• The oil market is experiencing a significant supply shock, but prices have not reacted proportionally.
• The current global oil supply shortfall is between 10% to 15%, indicating a massive shock.
• The futures market for oil balances current supply disruptions with future availability concerns.
• Higher oil prices do not necessarily benefit petro states due to export limitations.
• Gulf countries face economic challenges despite high oil prices due to high breakeven costs.
• Countries like Russia, Kazakhstan, Nigeria, and Angola are well-positioned to benefit from current oil market dynamics.
• The geopolitical landscape influences oil production capabilities and economic benefits.
• Understanding the relationship between oil supply, demand, and pricing is crucial for market analysis.
• The disconnect between physical oil supply disruptions and market price reactions highlights complexities in commodity economics.
• Economic dynamics of oil-exporting countries are shifting, affecting global market conditions.
• The current oil market situation may lead to shifts in global power dynamics.

Guest intro

Brad W. Setser is the Whitney Shepardson senior fellow at the Council on Foreign Relations. He previously served as deputy assistant secretary for international economic analysis in the US Treasury from 2011 to 2015, where he worked on commodity shocks, financial sanctions, and currency policy. His expertise covers global trade and capital flows, including reserve management and financial imbalances.

The role of taxes in currency demand

• Taxes are a fundamental driver of currency demand, influencing monetary policy.

• Taxes create demand for currency, which is a core principle of monetary mechanics.

  — Brad Setser

• Understanding this relationship is crucial for grasping economic theory.
• The assertion highlights the role of taxes in influencing currency demand.
• This principle is foundational to modern monetary policy.
• Taxes can shape the demand and value of a currency within an economy.
• The demand for currency is linked to the need to pay taxes.
• Economic policies often leverage this relationship to stabilize currency.

Historical impact of the 1970s oil shock

• The 1970s oil shock had a profound impact on the development of financial systems.

• The 1970s oil shock is historically intertwined with the development of the financial system.

  — Brad Setser

• This event reshaped economic structures and policies.
• The oil crisis led to significant changes in global finance.
• Understanding this historical context is essential for analyzing current economic dynamics.
• The crisis influenced monetary policies and financial regulations.
• It serves as a reference point for current oil market analyses.
• The oil shock’s legacy continues to affect financial systems today.

Comparing current and historical oil shocks

• Current oil shocks are less severe than those of the 1970s.

• The current oil shock is not comparable in magnitude to the oil shocks of the 1970s.

  — Brad Setser

• Historical oil price increases were significantly larger.

• In ’73 and then in ’79 oil doubled or tripled.

  — Brad Setser

• The scale of current price changes is much smaller.
• Understanding these differences is crucial for market analysis.
• The 1970s saw oil prices increase by six to seven times.
• Current price increases are around 50% from spot oil.

The disconnect in oil market reactions

• The oil market is experiencing a significant supply shock.

• The oil market is experiencing a significant shock, but the price reaction is not proportional.

  — Brad Setser

• Price reactions do not match the physical supply shortfall.

• The physical interruption is bigger, the price reaction is smaller.

  — Brad Setser

• This disconnect highlights complexities in commodity economics.
• Market expectations influence pricing beyond physical supply factors.
• Understanding supply and demand dynamics is crucial for analysis.
• Elasticities suggest a larger price increase for sustained interruptions.

Global oil supply shortfall implications

• The current global oil supply shortfall is between 10% to 15%.

• The current oil supply shortfall is between 10% to 15% of global supply.

  — Brad Setser

• This represents a massive shock to the market.
• The shortfall has significant implications for global economies.
• Understanding the metrics of global supply is crucial for analysis.
• The severity of the situation underscores the need for strategic responses.
• Market reactions to the shortfall are complex and multifaceted.
• The shortfall impacts pricing, production, and geopolitical dynamics.

Complexities of the oil futures market

• The futures market for oil is influenced by current and future supply dynamics.

• The futures market has to balance between current supply disruptions and future availability.

  — Brad Setser

• Pricing is affected by geopolitical events and market expectations.
• The market must consider potential future supply trajectories.
• Understanding futures contracts is crucial for market analysis.
• The complexity of pricing reflects uncertainty in supply and demand.
• Futures markets play a critical role in oil pricing strategies.
• Market participants must navigate a complex pricing environment.

Economic challenges for petro states

• Higher oil prices do not necessarily benefit petro states.

• Higher oil prices are not necessarily benefiting petro states.

  — Brad Setser

• Export limitations reduce potential economic gains.

• If you can’t physically get as much oil out, you’re not generating as much money.

  — Brad Setser

• The economic dynamics of oil-exporting countries are shifting.
• Understanding production capacity is crucial for economic analysis.
• Petro states face challenges despite favorable price conditions.
• Export limitations impact revenue generation and economic stability.

Gulf countries and high oil prices

• Gulf countries face economic challenges despite high oil prices.

• Countries in the Gulf are not the primary winners from high oil prices.

  — Brad Setser

• High breakeven costs limit economic benefits.

• They need $100 a barrel oil with 7,000,000 barrels a day of exports to breakeven.

  — Brad Setser

• Understanding breakeven prices is crucial for economic analysis.
• Current account dynamics influence economic stability in the Gulf.
• High oil prices do not guarantee economic prosperity for these countries.
• The economic landscape is complex and influenced by multiple factors.

Beneficiaries of current oil market dynamics

• Countries like Russia, Kazakhstan, Nigeria, and Angola benefit from current oil dynamics.

• Russia should win… Nigeria will win… all the South American oil exporters will win.

  — Brad Setser

• These countries are well-positioned to gain economically.
• Geopolitical landscape influences production capabilities and benefits.
• Understanding these dynamics is crucial for global market analysis.
• Economic benefits are not evenly distributed among oil-exporting countries.
• The current market situation may lead to shifts in global power dynamics.
• Identifying beneficiaries helps predict future economic trends.