The WSJ has an article today on the possibility of the Gulf Nations ending their dollar ties. There’s nothing all that interesting about it, except that it points out this:
The countries of the Persian Gulf are struggling with the impact of their own good fortune as rising oil prices bring a windfall. Normally, when the price of a country’s major export rises, that pumps up the local currency, which helps restrain inflation.
Instead, much the opposite has happened. As the price of oil has skyrocketed in recent years, Gulf currencies tied to the dollar have fallen relative to other currencies such as the euro and British pound, making many of their imports more expensive.
The UAE and Qatar have suffered some of the worst inflation, as the oil gusher has triggered a building boom. In Qatar, inflation hit 11.8% last year, and the International Monetary Fund estimates it willaverage 12% this year. This week, officials in Doha, the capital, raised taxi fares by a third.
This is why I have long opposed currency unions – whether the proposed union of the US and Canadian dollar (something we hear a lot less about these days, but which was highly touted in the 90s) or the Euro. And tying your currency to another currency, in effect, is very similiar to currency union. Of course, it’s not identical, since you retain the ability to get rid of the peg.
When your currency is tied, you get currency feedback that is designed for, or caused by the other countries currency. It can be designed, as in Bernanke’s deliberate rate cuts, which are underming the dollar even more, and will lead to even more inflation; or it can be appropriate, in the sense that pressure is also on the dollar due to massive trade and balance of payment deficits. Either way, it’s a happy accident if it turns out to be appropriate to you, but it doesn’t have to be.
Of course, for the gulf nations, it often was. If America was in recession, well then, odds are so were they. If America was booming, then oil demand was up, and times were good. But that link has been broken for the time being.
Or so it seems. In fact, of course, it really hasn’t. If the US goes into a real demand driven recession (something I expect) then odds are that everyone will. China may be attempting to decouple, but it simply hasn’t happened yet and I don’t believe the Chinese consumer can take up the slack when America’s consumers falter in a credit crunch.
This is mitigated by the fact that we’re pushing right up against the supply envelope for oil. So if demand drops relatively speaking, will it drop enough to reduce oil prices significantly?
That depends on how bad the recesssion is, or if it turns into a depression.
But what the Gulf has to fear most is not that, but the possibility of substition. Many rich areas were destroyed economically when a substitute became available for their resource. And substitution away from oil is what the major oil consuming regions – whether China, or India, or the US, or the EU need to work on.
If there is a major financial wipeout and a reaction against that wipeout as there was in the thirties, paper games will dry up to a large extent. At that point the substitution away from oil will start to make sense. It may not pay the double digit returns you could get these last few years playing leverage games, but it will pay decent returns in an economy where those unproductive uses of money have been largely shut down.
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