Trolling for Petrodollars

ABU DHABI, June 2, 2008 — -- At a time when record oil prices are making Arab investors rich, U.S. Treasury Secretary Henry Paulson is courting those investors to pour their billions back into the United States.

During his weekend tour in Saudi Arabia, Qatar and the United Arab Emirates, Paulson met with sheikhs and financial decision-makers.

At a forum in Abu Dhabi today, he assured investors that while it may take months to heal the troubled U.S. economy, America is still a sound investment.

The nations of the Gulf Cooperation Council (GCC), a union of six states in the Arabian Peninsula, represent the rising financial power behind a series of high-profile investments over the past year.

Kuwait's Investment Authority invested $2 billion in Merrill Lynch and $3 billion into Citigroup. Abu Dhabi, the capital of the United Arab Emirates, sunk $7.5 billion into Citigroup and $1.35 billion into a minority stake of the Carlyle Group, the Washington-based private equity firm.

Paulson made it clear that the United States is hoping for more.

In a speech that sounded at times like a sales pitch, Paulson said America was "open for business" and hailed foreign investors as "the ultimate vote of confidence in an economy."

"[Paulson] wants to keep the U.S. open because they need GCC money. America desperately needs handouts after the subprime crisis," said Eckart Woertz, an economist with the Dubai-based Gulf Research Center.

Luckily for Paulson, Gulf countries are looking to keep up the pace of investments, diversifying their economies away from total dependence on oil.

At the same time the black stuff will be amply financing their spree. All told, GCC nations are expected to take in $6.2 trillion in profits over the next 14 years, according to a report by the McKinsey Global Institute. As Paulson passes through Dubai, Doha and Abu Dhabi he can see the economic boom at work, with cranes and construction sites moving at full speed.

In his speech, Paulson conceded that the American economy is going through a "rough period," driven downward by the housing correction, slumping financial markets and rising energy costs.

But, he said, "our long-term prospects remain strong. … I wouldn't bet against the American worker or American economy."

"The man came in to do PR," economist Mohammed Ramady said of Paulson's visit.

"He is concerned with giving assurances on the U.S. economy. … This is something that the Gulf countries want to hear," said Ramady, who teaches finance and economics at Saudi Arabia's King Fahd University.

Paulson also gave assurances that America "welcomes sovereign wealth funds," a reference to the state-owned investment firms that have invested billions in the U.S. economy.

Earlier this year sovereign wealth funds faced a domestic backlash in the United States. Presidential candidates slammed them on the campaign trail, while the Senate ordered an investigation into the funds, criticizing a lack of transparency.

The backlash was seen by many in the Gulf as anti-Arab protectionism reminiscent of the 2006 controversy over Dubai Ports World (DPW). That company was forced to abandon investments in American ports amid public concerns over national security.

"[Gulf investors] see this happening with allies who are the most trusted and loyal, like Dubai," Ramady said.

"The governments here have been very helpful to the U.S. and to hear these stories again and again, the private sector here will go elsewhere," he said. "Asia is beckoning, Latin America is beckoning, and there we don't have these kinds of situations."

A repeat of the DPW controversy, with its loss of potential investment, is what Paulson seemed intent to avoid. But there were other goals on the agenda.

Paulson raised the impact of record high oil prices on the global economy. Prices rose to $135 a barrel two weeks ago.

"There is no doubt that the current prices are a burden on economies around the world and a burden on people around the world," Paulson said during the Saudi leg of his trip.

He also gave a nod to the ongoing peg of most Gulf currencies to the U.S. dollar (all but Kuwait's are fixed to the greenback). Maintaining the peg gives the dollar a needed boost, while raising inflationary pressure on Gulf economies as the U.S. Federal Reserve lowers interest rates.

But, according to economist Woertz, the currency pegs do little good compared to the vast benefit of Gulf investments.

"It might signal a lack of confidence in the dollar, but releasing the peg is not that important as long as these countries keep financing U.S. debt," Woertz said. "If they should stop buying or even start selling U.S. assets it would be a catastrophe."