Raiders of the soft dollar

The greenback’s status as the hegemonic currency is here to stay

The just-concluded GCC summit would be one of the few ever in the history of the group which have evinced so much interest among expatriates and even ordinary nationals. The reason for this is well known. Ever since Sultan Nasser Al Suweidi, governor of the UAE central bank, hinted at delinking the dirham from the falling dollar, the buzz was on. The latest issue of the Economist weekly focused on the greenback’s travails just in time for the GCC meeting in Doha, where the media also focused mainly on the chances of the GCC states delinking their currencies from the falling greenback. But is it really workable? Has the once-mighty dollar run its course as the globe’s hegemonic currency? That looks a bit far-fetched.
Most of the Gulf countries, during the 1970s, pegged their currencies to the dollar to stabilise their revenue from their sole revenue earner – oil, which is traded in dollars. With the withdrawal of imperial power Britain from the Gulf, most of the countries, which did not have much expertise in running central bank operations, found it easier to follow the policies of the US central bank, the Federal Reserve, to maintain a stable and strong currency. And this policy has stood the Gulf countries in good stead. That is, so far.
With the subprime crisis exploding over the US banking sector, the Fed has been forced to cut rates. This has led Saudi Arabia, the UAE, Qatar, Kuwait and Bahrain to cut rates in November to mirror the Fed’s decision. The US is now facing a recession and this is forcing the hand of the Fed to go in for more cuts. This has put the Gulf states in a bind. Since the GCC countries’ interest rates are linked with the US rates, it was only a matter of time before they followed the Fed to avoid the unthinkable – capital moving away to currencies with better rates of return. This makes fine economic sense but for one reason. Inflation is galloping in the region which is awash in petrodollar liquidity, thanks to the unprecedented oil prices. Therefore, to rein in inflation, central banks should be raising, instead of cutting, rates, if what the economics text books say is right.
According to the UAE Ministry of Economy, inflation last year hit 9.3 per cent. In Qatar, inflation hit 11.8 per cent last year, and the International Monetary Fund says it could go up to 12 per cent this year. This week, Doha raised taxi fares by a third. Prices are expected to remain high across the Gulf this year. In addition to this, expatriates, who make the bulk of the population of the UAE and also a sizeable chunk of the population in other Gulf countries, have had to endure the double whammy of seeing their remittances losing value as the dollar has lost value against their home currencies also. Also, this exchange rate loss has been making imports more expensive leading to a further rise in prices. This scenario is more or less replicated in most Gulf countries, though in varying degrees.
The strains are the maximum in the UAE, with investors betting on a “depegging”. The chance of making a quick buck once the peg snaps is attracting so much money that deposits in UAE banks have exceeded one trillion dirhams ($272.3 billion) for the first time, which is more than what is deposited in powerhouse Saudi Arabia, reports quote central bank figures.
The greenback’s decline has also to some extent diluted the GCC states’ earnings from the record oil price that is expected to lead to a surplus in excess of $500 billion this year. With the inflation rate expected to remain high for the second year running in the UAE, the government is facing its most difficult fiscal policy challenge since Britain devalued the sterling in 1967, which forced the Gulf states to turn to the dollar as the benchmark currency.
So is there a one-shot cure for this malaise? Kuwait, the third-largest Arab oil producer, was the first to explore. It broke ranks with its GCC peers in May by allowing the dinar to float against a basket of currencies and in a range against the dollar. Will the UAE follow suit? But since the UAE, Saudi Arabia and Qatar have large reserves of dollars, it will be a tough call. Saudi policy is very clear. It was very categorical in Doha – “the dollar peg stays”. Saudi, which pumps out a massive 9.1 million bpd of oil, is fearful a revaluation would cut the riyal value of dollar-denominated oil revenue, which, according to Bloomberg News, is set to hit $163 billion this year, the most in more than two decades. Qatar has also affirmed its position to stay in line. So for the time being, maybe, the UAE, the second biggest Arab economy, which pumps out around 2.8 million bpd of oil, may have to plough a lone furrow.
On the other hand, Oman’s position is that the dollar’s travails are a short-term issue and that that the greenback will soon find its way to its rightful position. Though there are not much takers for this viewpoint in the region now, there is a western school of thought which is slowly veering to this view. They are pointing their fingers at the euro’s travails. The single currency’s rise is affecting European exporters ability to compete in the global market. The head of Airbus has already termed it ‘existential crisis’ and is pondering shifting production facilities to the US. The rise of the sterling has slowed down the UK economy and the Bank of England is eyeing cutting rates.
Therefore, according to a recent article in the Wall Street Journal, if economies outside the US start slowing down, money will start flowing into the US, which could see the greenback rising. Also, thanks to the sub prime crisis, troubled US financial firms may have to sell foreign currency-denominated assets to shore up their balance sheets before the year ends. And repatriating that money home means buying dollars, which could again boost the currency.
This could lead hedge funds and other such speculative funds, which have bet heavily against the dollar, to unwind their bets. That could see the dollar making a fierce rebound. Therefore, the greenback need not be a “worthless piece of paper”, as Mahmoud Ahmedinejad said recently. Uncle Sam’s currency may yet have the last laugh.

This article was published in Oman Tribune in December 2007