Wednesday, 13 June 2007

Break The Peg Before It Breaks Us

Over the past few years there have been numerous articles discussing the GCC currencies peg with the United States greenback. It seems unlikely that this Catholic marriage of a relationship will ever be broken. At least, not from our side. The bad news here is that unlike the GCC Common Market agreement we have no external pressures from the European Union to get our acts together and reach a collective accord. It all falls down to simple mathematics. We in the GCC do most of our trade with Europe and Asia, and yet we insist on giving them a leg up by artificially pegging our currencies to the weak and declining dollar. So they get to buy more from us for less money, and we have to pay them more to buy less, sounds fair?
To be just one must explore the positive aspects of this polygamous marriage (six currencies married to one Mr. Greenback). One factor is the lowering of currency risk. Second, the US, as the sole superpower, certainly appreciates this gesture from their oil producing allies especially at the time when their budget deficit is going from bad to worse, facing two wars with no end. If there was a currency divorce then there is a big chance that oil will just end up costing their consumers more to consume, something neither the Republicans nor the Democrats will appreciate.
We all have seen how the United States (rightly) reacts to countries that artificially peg their currencies to the US dollar when the tables are turned to their disadvantage. In China’s case, angry US Senators and Congressmen have demanded quicker action to de-peg the Yuan from the Dollar[1] and the US government even has threatened to resort to the World Trade Organisation to plead their case[2]. To the extent that a senior US finance official said that an inflexible Yuan ``complicates the use of monetary policy'' in bringing about a slowdown to China's ``booming economy”[3]. The message to China being that it should break the currency peg, allow the Yuan to appreciate therefore making it more expensive for Americans and the rest of the world to purchase Chinese goods, less expensive for the Chinese traders to buy from abroad than from their domestic market, and ultimately make America happy.
Even the US based IMF has called upon the GCC to reconsider the peg[4] that they have accused as being a factor contributing to the rising inflation in the GCC[5] saying that sticking to this policy will actually result in the GCC countries “importing inflation” (as opposed to the home grown sort). According to independent studies[6] the rate of inflation in the UAE is 15% in 2006, triple the Ministry of Economy’s estimate. Anyone who rents a flat or sends their children to school in the UAE can easily tell you that 15% is a very conservative figure.

A study commissioned by the Saudi Commerce and Economic Review [7] estimated that between January 2002 and December 2003 the US currency depreciated by a staggering 41.5 percent against the Euro, and more than 22 percent against the Yen and Sterling. And then the trip downhill (aka Iraq War) starts with the ever widening US budget deficit that leads to more government borrowing which leads to more pressure on the US dollar which leads to weaker GCC currencies.
The Kuwaitis who were the last ones to be hoodwinked into this seemingly unbreakable relationship had it right all along. Their Dinar was smartly attached to a basket of currencies that reflected their major trading partners currencies including the Yen, Euro and the US dollar. Their mistake came in January 2003 when they emigrated completely to a dollar peg, talk about bad timing. Only in 2006, the Dinar (and by extension all other GCC currencies) fell by 22% compared to the Euro, meaning if someone delayed purchasing a Mercedes Benz for 30,000 dinars in 2005 she would have to fork out an additional 6,600 (84,000 UAE Dirhams) for the very same car the following year. When the Central Bank of Kuwait allowed their currency just one percentage point flexibility in 2006 it appreciated to its highest level against the dollar since January 1992, stating that the move was in response to inflation[8].
What GCC nationals are not informed about is the secret behind this artificial peg that world bodies have called on to be annulled in addition to businessmen and downright common sense.
This is something that we will most probably never know. What we do know is that, as our American friends say, we got the short end of the stick.



secretdubai said...

One analyst I spoke to said that it is likely they will repeg within six months. However officially they will keep denying any such plans "for political reasons".

I guess they will just do it overnight, they'll have to pick a day when the US is distracted ;)

Sultan Al-Qassemi said...

I guess you're right Secret Dubai. We will never learn, please read what I wrote about media in the GCC, it will surely get me into trouble! :)

Meera said...

I understand the reasons to why de-pegging would be positive to the UAE's economy, but at the same time what are the negatives?
Dubai's economy is highly dependant on tourism and the large influx of expats into the region. Dubai has been growing at this rate because, our currency is considered 'cheap' to the europeans and other foreigners. If we de-peg, will our currency still be 'cheap'? I don't believe that we will continue to have tourists and foreigners moving into our UAE if our currency appreciates significantly. Therefore, we will be losing out on a big part of our economy.
Another factor to consider is that when the Euro was first established, no one was complaining on why the Dirham was pegged to the Dollar. Now, with the euro continuously appreciating, more and more of people are protesting. This is the way the world works!
There are much more dynamics to de-pegging than we think and we must address and study all the potential outcomes as a country before we act on something we might regret later. Also, i think it is unfair to pinpoint one person that is fronted to deal with such issues, and the general public { best translation i could think of for 3amat el sha3ab) must understand that is a joint federal decision.