Fed is a downer as gulf parties over $100 oil

Fed is a downer as gulf parties over $100 oil

Welcome to the greatest party on Earth.

It’s in West Asia, and it’s about $100 (Rs3,940) oil, though you wouldn’t really know it here in Dubai. It’s not just because oil is still a bit shy of $100 a barrel; it’s thatthis isn’t a public celebration. Gulf officials don’t want to appear ecstatic about trends threatening growth almost everywhere else.

Yet, it’s a party nonetheless as the fuel—literally and figuratively—propelling economic growth and raising the region’s global influence continues to rise in value.

This silent party is unique for another reason: the hangover may already be under way even before the merrymaking reaches a fever pitch. As petrodollars fill government coffers and create new billionaires, inflation is becoming a worrisome side effect.

Consider trends in the United Arab Emirates (UAE),where surging property prices drove inflation to a record 9.3% last year. Talk to locals here, and they will tell you that inflation, which is reported annually, feels higher than the official rate.

UAE officials have been slow to take an obvious step that would cool things down: revaluing the currency, the dirham. It’s pegged to the dollar, which has fallen 13% against the euro this year. Standard Chartered Plc. says the six Gulf Cooperation Council (GCC) nations need to raise the value of their currencies 20% to restore normalcy to economies.

They should do it immediately.

Scrapping dollar peg

A move is coming, and the markets are pushing for it. It’s hoped that a 3-4 December meeting of GCC leaders will result in plans for a regional currency revaluation pact at some point.

With investors such as Jim Rogers, chairman of New York- based Rogers Holdings and a former partner of George Soros, saying “the dollar peg is doomed", the news, as they say, is out. Merrill Lynch & Co. predicts either UAE or Qatar will cut the dollar peg within half a year.

Faced with today’s inflation rates—Qatar’s reached a record 14.8% in the first quarter—the region shouldn’t squander half a year mulling what’s both inevitable and logical.

“The economic argument is there," says Marios Maratheftis, head of research for Standard Chartered in West Asia.

At the moment, Gulf central banks can’t raise borrowing costs; they must follow the US Federal Reserve to maintain their pegs. Each time Fed chairman Ben Bernanke cuts rates, Gulf states have an even harder time clamping down on growth amid rising oil prices.

It’s a fait accompli. Why pump unnecessary doubt into markets? Just get it over with and move on to other issues. “De-pegging should address supply side factors that are feeding inflation, but tougher steps are also required to contain domestic demand," says Mushtaq Khan, an economist at Citigroup Inc.

In some ways, UAE is moving in the other direction. On20 November, it announced plans to boost federal spending by $1.8 billion next year, raising state workers’ pay by 70%. This would be one of those rare cases where economists John Maynard Keynes and Milton Friedman might have agreed on something. Is it really wise to deal with inflation by essentially loosening fiscal policy?

Scrapping the dollar peg is clearly a big decision. The region has never had an independent monetary policy and pegging the currencies to the dollar, or others such as the ones linked to the British pound before that, offered an element of stability. And change is always a bit scary.

Three positives

Among the more drastic changes would be scrapping the dollar and re-pegging to a basket of currencies. Yet, if that seems too radical, Gulf economies should at the very least re-peg currencies at a higher level against the dollar. Three immediate positives would come from such a step.

One, it would cool inflation. Two, it would improve the livelihoods of the many overseas workers who flock to cities such as Dubai and send wages home to support families. Three, it would force American consumers to conserve more. This third effect might not go down well with Gulf leaders enjoying high oil prices. Yet, abandoning the dollar peg would boost oil prices for Americans, the biggest oil consumers. The Bush administration isn’t pushing conservation; currency shifts in the Gulf could fill the void, helping lower global greenhouse gas emissions.

High on the list of arguments to tread carefully is the risk of precipitating a dollar crash. The problem is that the issue is too often discussed in conspiratorial tones.

Calls by Venezuelan President Hugo Chavez and Iranian President Mahmoud Ahmadinejad to scrap the dollar only fan such speculation. Clearly, President George W. Bush’s foreign policies haven’t won the US many friends in the Gulf either. Yet, this is more about business than grudges as the dollar slides.

Just because a financial arrangement has worked for decades doesn’t mean it makes sense forever. As economies boom and oil prices surge, Gulf leaders are faced with big decisions on the dollar. Big, but also inevitable.

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