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The Jehoshua Novels


The Saudis Call Bernanke's Bluff

Well, well, well… grab on to the gunwales ladies and gentlemen because Saudi Arabia has just reminded Bernanke what the consequences of damaging their holdings could be (hat tip Don):

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

This is a very dangerous situation for the dollar,” said Hans Redeker, currency chief at BNP Paribas.

“Saudi Arabia has $800bn (Â £400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States,” he said.

The Saudi central bank said today that it would take “appropriate measures” to halt huge capital inflows into the country, but analysts say this policy is unsustainable and will inevitably lead to the collapse of the dollar peg.

As a close ally of the US, Riyadh has so far tried to stick to the peg, but the link is now destabilising its own economy.

One of the more misguided things that people say about the economy is to look at any given segment and say “oh, it’s only x% of the economy, therefore it’s not a big deal.” Some money — hot money — matters a lot more than the amount involved. Saudi money, Saudi investments, are mostly “hot money”, they can be pulled out of the US relatively quickly. If tens of billions or hundreds of billions all moves out of security markets more or less at the same time the end result would be a crash much larger, with much larger effects, than the nominal amount in question (especially when you take into account unwinding leverage.)

This is the problem that Uncle Ben has — if he raises interest rates he’s going to send both the markets and the economy into a tailspin. If he doesn’t, foreign investors in dollar denominated securites are going to think that perhaps being in the dollar isn’t a good thing. Every percent the dollar depreciates against another currency is effectively a percent off your earnings (or more, thanks to leverage).

More After the Jump

This pattern is really familiar to me, because it’s where Canada was in the early nineties. We relied a lot on foreign funding of our debt, and the foreign holders were getting really twitchy about the debt ratios (far lower than the US’s, but then Canada isn’t a hegemonic power). The result was nearly a decade of relatively high interest rates and those interest rates hurt economic growth and kept unemployment relatively high compared to the US, even given methodological differences. Fortunately the government at the time weren’t tax cut zealots, and were lead by a very competent finance minister, who worked together with the Bank of Canada to get the debt and deficit under control. A lot of people laugh at Paul Martin, but Canadians actually owe him a big, er, debt of thanks.

Now what the US has had going with major foreign governments is what Stirling and I have called the “death bet.” That is to say — they bet that because the consequences of not propping up the dollar are so high for them, that they’ll just keep doing it. As a result the US can run its monetary and fiscal policy however it wants, because no one will have the guts to pull the carpet out from underneath them.

This is probably still true of Japan and China — not so much because of their dollar denominated assets — everyone knows those will eventually be worth a lot than their nominal value; but because both of them are getting to run their export industries — they lend the US consumers money, US consumers send it back. In the case of China, they send it back along with lots of jobs and lots of industry that China wants to move from the US to China. There’ll be a price for it, maybe even a huge one, but in exchange for industrialization it’s worth it. As for Japan, they’re in a bind — their economy is in the doldrums and they don’t want to send it into a depression.

Other than the money the Saudis have invested in the US, and perhaps for security concerns, the Kingdom isn’t in the same situation. They don’t export squat to the US except for oil, and it’s not like Americans can stop buying that, or that there aren’t plenty of other customers. So all they risk losing by pulling out is money that if they don’t pull out, because of the long term prospects for the dollar, they’re going to lose much of the value anyway.

If the US dollar is going to drop relative to other currencies, if keeping your money in the Kingdom is better than having it in the US, then why keep it there? The Saudis may want to stop a rout (though one wonders if they’re just saying that while they edge to the exit) but it could be rather hard to stop even if they’re serious.

But the real message to the US in this policy move is simpler: that the US can no longer act as if it is the only center of economic gravity. The House of Saud isn’t willing to just suck up the losses, and they have just made it crystal clear by not just making threats (like the Chinese did) but by a concrete action (or, as it were, non-action).

So Bernanke will now have to decide what to do: continue to ease to help the markets and the chances of Republican re-election, in an attempt to avoid a wipe-out at the polls — but by doing so risk a dollar run or even just an acceleration of the dollar’s decline; or tighten and send the economy and the markets into a tailspin.

The correct thing to do at this time is to tighten. No one wants to hear that, but that’s what needs to be done. At the same time, since rich people aren’t spending their money on generating useful economic activity, the fiscal authority should be taxing back money from the rich and from corporations which have made out like bandits, then taking that money and investing it in infrastructure and demand (energy, telecom, etc.).

But that’s not going to happen, because the US doesn’t have a functioning Congress; and if it did, they’d still have too many anti-tax zealots (against taxing rich people that is) to do what needs to be done on the fiscal side. Since Congress won’t do it, since they want the monetary authority to be responsible, Bernanke will have to choose.

What the Saudis have done is just make the choice both harder and more clear. Easing for domestic political reasons will not be acceptable to them.

Like any death bet the question is “who’s going to blink?” But it’s no longer a real death bet, because while it’ll hurt the Saudis, it’ll hurt the US a lot more — no matter what Bernanke chooses.

I wonder if Bernanke’s still glad he got the job? Sometimes there are not good answers.

If it were me, I’d look in the mirror and say “what would Volcker do?” Then I’d raise rates, become the most hated man in America, and tell the legislature and presidency that I’ve done my job, and now they can either do their jobs, or blame it on me and get voted out of office anyway.

That’s what you’d do if you were non-partisan, anyway.

What’ll Ben do? Well, we’ll see. We shall see.

27 comments to The Saudis Call Bernanke's Bluff

  • Peter C

    Good take on the looming Saudi dollar stash growing legs to head south. Could a sub-plot be to force the U.S. to attack the Persian’s using the threat of pulling the support of the dollar? Or to liquidate before the Cheney attack on Iran?

    “There are two types of folk music:
    quiet folk music and loud folk music.
    I play both.”

    Dave Alvin

  • mauberly

    the ability of Wall Street to compartmentalize risk with its sales pitch, as you suggest with ‘oh, it’s only x% of the economy, therefore it’s not a big deal’ will be over. Bernanke is trying to paper over the debt crisis. I don’t know how he is going to paper over a currency crisis.

    http://mauberly.blogspot.com/

  • nymole

    no rich people were harmed in making this recession for a take on Mr. B.


    1.”George Washington did not cross the Delaware for Capitalism,” -Shmuley Boteach.
    2.The Dems haven’t punished the GOP enough, so you’re going to reward the Republicans?

  • tjfxh

    The dollar going into free fall? And Big Ben was worried about the markets’ tanking.

  • Scotjen61

    If the dollar were at 2001 levels on the world market, the price of oil would probably be $40 per barrel.

    Remember, the stock market is not up, the dollar is down. The dollar is worth half its value from the high levels it had achieved around 2000. Down 50% over the course of Bush Jr.’s Administration. It is at record lows since – well, Bush Sr.’s Administration.

    We know one thing. They both like wars, they both like a weak dollar, and neither one can talk in sentences.

  • nymole

    The Saudis will cream us on the dollar if we don’t invade Iran for them and China wil cream us on the dollar if we do?


    1.”George Washington did not cross the Delaware for Capitalism,” -Shmuley Boteach.
    2.The Dems haven’t punished the GOP enough, so you’re going to reward the Republicans?

  • mauberly

    the dollar reached a max under Clinton and Bush 2. It began to decline against the Euro with the stock market recovery from the market troughs of 02-03.

    Much of the decline is a result of the Euro being a kind of default currency into which people have fled as the Asians debased their currencies for mercantilistic reasons, currencies that were in part pegged to the dollar.

    The other currencies that have rallied are resource-based such as the Canadian and Australian dollar. Canada’s and Australia’s rocks are hot and getting shipped to the Far East apace.

    If this global rally stalls, people will stall on the Euro and the A & C dollars. For the US dollar, it would be a good thing if it did.

    http://mauberly.blogspot.com/

  • Ian Welsh

    of the Canadian dollar rising. It’s doing us more harm than good.

  • nymole


    1.”George Washington did not cross the Delaware for Capitalism,” -Shmuley Boteach.
    2.The Dems haven’t punished the GOP enough, so you’re going to reward the Republicans?

  • Mark

    So in the words of Bob Barker, “Come on down!”


    “I despise idealogues masquerading as objective journalists.” – Bill O’Reilly, March 30, 2007

  • Takachi99

    is to understand who he works for and where his ultimate loyalties must lie. The Fed is not a government agency and is not beholden to the Federal government despite the fact the President appoints him.

    He is ultimately beholden to the owners of the Federal Reserve and that is the banks themselves. His charge is to save the banks that own the Fed and not the Saudis or the Chinese or the Japanese or the Russians or anyone else that hold Federal Reserve Notes. You note that the Russians and the Chinese are buying gold. Now what would that tell you they think is happening.

  • Ian Welsh

    and because of price stickiness consumer prices aren’t going down either.

  • LJ

    would that encourage the Chinese to de-link the Yuan and who would benefit from that? Just wondering if there is some deeper reason to trash the dollar so blatantly?

  • Tonsure Wimple

    Speaking of which, where is a resource on the actual ownership structure?

    Forget it, Jake – it’s AmnesiaTown

  • tjfxh

    According to the voodoo economists, a falling dollar will work to US advantage in the global marketplace. Talk to others, and that will point out that economies and militaries run on energy. When energy costs rise, either corporate profits take a hit if they absorb the difference, or more likely, they pass it on to the consumer. Moreover, wars are extremely expensive even when energy costs are cheap. Energy demand is now exceeding supply by several percentage points, and at the same time the dollar is buying less oil. This alone is spelling an end to the era of unlimited growth. In addition, the effects of global warming, which are going to be every expensive to adjust to, will further hobble growth. Add to that the enormous expense of both foreign wars and homeland security, and you get the picture. Debt is now maxed out, and the only recourse is to cut spending or raise taxes.

    If the Rethugs win, expect more tax cuts, more debt, military expansion, and the attempt to make draconian slashes in social programs, resulting in increased inflation/dollar depreciation. The dollar depreciation will be lauded as making the US more competitive in the global market place. This will spell the end of the dollar as the world’s reserve currency, and soon enough the US will no longer be able to print money to finance its debts. If the Dems win, look for rising taxes and the attempt to make some cuts in military spending as the US draws down. The combined effect of raising taxes and cutting military spending will provoke recession. There is no good solution on the horizon. Throw in the developing crises of US economic profligacy and military adventurism under the Bush/Cheney Administration, coupled with rapidly accelerating global warming, and things look much worse.

  • Escher Sketch

    And not the first time I’ve heard it asked.

    So who does own the Fed?


    “The best-informed man is not necessarily the wisest. Indeed there is a danger that precisely in the multiplicity of his knowledge he will lose sight of what is essential.”

    - Dietrich Bonhoeffer

  • Escher Sketch

    of a somewhat less than welcoming border now, and the openly-stated idea that only Americans inherently have rights in America. That chills the whole cross-border thing for some of us.

    I’ll admit to contemplating a substantial cross-border purchase at the moment, but that’s via mail.


    “The best-informed man is not necessarily the wisest. Indeed there is a danger that precisely in the multiplicity of his knowledge he will lose sight of what is essential.”

    - Dietrich Bonhoeffer

  • GordonMcMillan

    So down is up, (and black is white, and war is peace… Heck, Ghouliani just told people that in order to balance getting rid of the AMT, he’d make the Bush tax cuts permanent). Wheeeeeeeeee. Let’s all go to Tina’s and fall up her stairs!

  • GordonMcMillan

    check this out: Oil traders routinely order vastly more oil than needed, then cancel (or rollover) the excess. Just to keep the “demand” numbers high.

    No way a Rethug wins the election. A recession (or more) is coming. If our Congresscritters had a brain, they’d ensure it starts now so even the instant gratification voter knows where to place the blame.

  • Shaula Evans

    “No way a Rethug wins the election.”

    I would like to believe you are correct…but that you’ve echoed my own prediction from 2004.

    Also depends on if you define “win” as: “gets the most votes” or “winds up holding the office.”

    And when you look at Congress, they seem (as ever) to be working very hard to sully Brand Democrat to the point that they can still manage to seize defeat from the jaws of victory.

    You /should/ be right. And I hope you are. But I’ve given up on prognosticating myself.

  • GordonMcMillan

    …”the Math” on the 2006 elections. He was wrong. He had picked out a few dozen House races and a half dozen Senate races. He set the wheels in motion to disenfranchise voters, stick dangerous polling places with too few machines and jimmy some others with pre-recorded cards.

    Then he realized that the “swing” districts he had targeted weren’t really swing – they had turned solidly Dem, so he tried (without sufficient prep) to target the next set. It worked in places, but not enough to save his ass.

    2008 will have some stolen districts – no question. But quite a few D’s (and even some principled R’s, though there are very few left) have caught on. It will work in even fewer places, and they need vastly more places.

    Take the (by now) age old practice of gerrymandering. You reorganize 3 50-50 districts so they are 2 55-45 and one 40-60. You always win 2/3rds of the districts. Except when when your in-party approval rating drops more than 10 or 15%. Then you win nothing, guaranteed. It backfires. It’s called hubris, and these guys have it in spades.

    (With you on 2004, though. I bought a bunch of alcohol to celebrate the victory. I drank it all, and never even got a buzz.)

  • Tina


    US rate cut stirs debate over Gulf currency peg

    Published: Tuesday, 2 October, 2007, 02:13 AM Doha Time
    AFP
    KUWAIT CITY: The US interest rates cut has revived a fierce debate on whether the Gulf states should keep their currencies pegged to the dollar and bear the crunch of high inflation.

    The GCC states are experiencing high growth rates of between 4& and 8%, thanks to soaring oil revenues that boosted liquidity to new levels. But as a result, inflation has risen to double-digits in some Gulf states.

    Barring Kuwait, which in May dropped the dollar peg in favour of a basket of currencies to ward off imported inflation, the remaining five states, including oil powerhouse Saudi Arabia, have kept their currencies linked to the dollar.

    To preserve the value of their national currencies, Gulf states have in the past matched any movement in US interest rates, but this time most of them left their monetary policies almost unchanged.

    On one hand, a rate cut by Gulf states would further increase liquidity and spur the already high inflation rate.

    On the other hand, a decision not to cut rates would undermine the value of their currencies, which are linked to a sliding dollar, and huge assets. This dilemma has encouraged many economists to demand a change in the dollar peg regime.

    “I believe it is time that Gulf states adopt new monetary policies that are independent of the US Federal Reserve … We must take measures to control inflation,” said Ali al-Dakkak, head of Saudi Dakkak Economic Studies Centre.

    “The US and Gulf economies are now going in opposite directions … Losses incurred by Gulf economies will increase as long as their currencies continue to be pegged to the dollar,” Dakkak said.

    The US Fed rate cut was taken in the wake of the sub-prime mortgage crisis in a bid to spur economic growth after signs of a slowdown. On the contrary, Gulf economies remain hot, growing at a fast pace.

    Dubai-based EFG Hermes Investment Bank said in the long run, the best option is for Gulf states to peg their currencies to a trade-weighed basket of currencies, which means following Kuwait’s example.

    It said that the US rate cut has put Gulf central banks in a precarious situation because of rising inflationary pressures.

    Prices rose by 11.8% and 9.3% in 2006 in Qatar and the UAE, respectively, the two countries most affected by inflation, according to official figures.

    Inflation even hit 14.8% in March in Qatar before easing to 12.8% in June, and experts consider it is now well beyond 10% in the UAE.
    Inflation in the world’s leading oil exporter, Saudi Arabia, raced to 3.8% in July, a seven-year high, and is expected to reach four% by the year end, the highest level in 13 years.

    Inflation in Kuwait, Oman and Bahrain is also hovering at around 5%, although official figures show it at slightly above 3%.

    In light of their booming economies and high liquidity levels, the Gulf states would need to increase interest rates, rather than follow the US Fed cut, in a bid to control inflation.

    more

  • Tina


    Some 85 pct of Iran’s oil sold in currencies other than US dollar – minister

    Tue, Oct 2 2007, 09:21 GMT
    http://www.afxnews.com

    TEHRAN (Thomson Financial) – Some 85 pct of Iranian oil is sold in a currency other than the US dollar, the Iranian oil minister said, cited by the central agency of information on state television.

    Seyed Mohammad Khatibi, vice president of the National Iranian Oil Company (NIOC), said at present 65 pct of oil sales are made in euros and 20 pct in yen.

    “Only 15 pct of oil sales are made in dollars and we are progressively replacing this with more credible currencies,” he added.

    The value of the US dollar has fallen some 30-25 pct since 2004, he said, and “keeping capital in dollars means a significant fall in the value of our assets”.

    “We have therefore decided to replace the dollar with other currencies,” he said.

    Iran is the fourth-largest oil producer worldwide and the second-largest among OPEC members.

    found via kos

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