PERSPECTIVE ON THE WORLD ECONOMY : Petrodollar Windfall to the Rescue : Just as the well was running dry on capital for worldwide needs, a geyser of new oil wealth comes along to keep interest rates under control.

Ever since the Iraqi invasion of Kuwait sent the price of oil skyrocketing, American newspapers have been full of estimates of the impact on our rate of inflation and on the pace of economic growth during the coming year. But the jump in oil prices also creates a new pool of “petrodollars.” How big will that pool of wealth transferred to oil-producing countries be? And what effect will it have on the world economy?

Even with conservative assumptions, the Organization of Petroleum Exporting Countries could easily end up with more than $125 billion of new income over the next year. The price of oil is now about $15 a barrel higher than it was before its recent jump. Since the OPEC countries are now selling about 55 million barrels of oil a day, that hike adds a good $700 million a day to their coffers, even after allowing for reductions in consumption.

If the oil price remains at its current level for the next 12 months, the $700 million a day would add up to about $250 billion. Most oil experts expect that if the political stand-off does not worsen, the price will drop back over the coming months to an estimated $25 a barrel, about $7 higher than its pre-invasion level. At that price, the increased OPEC revenue would be $125 billion over the next year.

But Baghdad will not share in the extra revenue if the Iraq-Kuwait embargo is effective. Instead, the extra revenue will go to countries like Saudi Arabia, Venezuela, Mexico and the small sheikdoms of the Arabian peninsula. Most of these countries have nationalized oil industries, so the extra income will go directly to the governments.

What will they do with this windfall? In the long run they may spend it on increased imports as they seek to improve their countries’ infrastructure and raise their people’s standards of living. But it takes time to develop plans for major infrastructure projects and other investments. And uncertainty about how long high oil prices will persist will probably discourage increases in consumer purchases for some months. So the most likely outcome is that for at least a year almost all of the extra revenue is likely to be saved.

In the 1970s, when the OPEC countries had a similar windfall, they lent most of their petrodollars to banks in the United States, Japan and Western Europe. In turn, these banks loaned the funds to developing countries in Latin America, Asia and Africa. This process of recycling petrodollars got the banks in trouble in the early 1980s when the debtor countries discovered that they had taken on more debt than they could afford. It’s a safe bet that the banks will not want to go down that road again.

This time, the banks will be looking for safer, traditional borrowers. More than in the 1970s, a large part of the new petrodollars will be invested directly in government bonds and corporate stocks and bonds. Whether invested directly or through the banks, the magnitude of the increased in petrodollars is large enough to have a substantial impact on the capital market and world interest rates.

Only a few weeks ago, financial market analysts were worried about the increased demand for funds to finance investments in infrastructure and new plant and equipment in Eastern Europe. The result of this was a rise in interest rates worldwide. But now the jump in OPEC savings during the coming year will almost certainly exceed the total capital flow to Eastern Europe. By improving the balance between supply and demand for savings in the world capital market, the increased supply of petrodollars should therefore reverse the previous rise in real interest rates.

When the dust settles, real interest rates should be lower than they were before the Iraqi invasion and probably lower than they were before last winter’s events in Eastern Europe. The reduction in real interest rates will be dampened but not canceled by other effects of the rise in oil prices. Higher oil prices will cause some households to reduce savings to pay for more expensive heating oil and gasoline. Governments may save less or borrow more because of the slowdown in economic activity caused by the rise in oil prices.

In the meantime, what has actually happened since the Iraqi invasion is that interest rates have increased world wide because of fears that the oil price rise will initiate a new round of inflation similar to the experience of the 1970s. We’re optimistic that a renewal of inflation is unlikely unless the international political situation explodes, since the rise in oil prices is relatively much smaller this time than it was in 1973 or 1979. But even more important, we believe that the Federal Reserve and other central banks will not repeat their mistake of the 1970s. If they stick to a policy of keeping total spending growing just as it would have before the rise in oil prices, the increase in the price level will be temporary and there will be no rise in the future rate of inflation.