Monday, December 03, 2007

Dollar hanging by unravelling thread

Dollar faces new sell-off if Gulf states end greenback pegs

Foreign exchange markets are on alert this week for the embattled dollar to face a further, severe sell-off after key talks between the Middle East’s Gulf states that could lead to them scrapping their currencies’ pegs to the greenback.

Rulers of the six nations of the Gulf Cooperation Council (GCC) meet today and tomorrow in the Qatari capital of Doha amid significant pressures to sever their currency ties to the falling dollar, which is fuelling record inflation in their countries.

Officially, the GCC states have insisted that the key currency issue is not on the agenda for the rulers’ summit talks. However, there is intense speculation that mounting economic and social strains inflicted by the currency pegs could see them scrapped, or the Gulf currencies revalued, either at the meetings or within weeks of them.

Any move by five of the six GCC countries to follow a lead set by Kuwait in May and abandon their long-standing dollar pegs would add to already severe stress on the American currency, whose overall value on its broad trade-weighted index has plunged by nearly 12 per cent over the past two years, raising inflationary anxieties for the United States.

A collective or individual decision to scrap the pegs by Saudi Arabia, the United Arab Emirates (UAE), Qatar, Bahrain or Oman could greatly fuel pressure on the dollar. It would further cut overseas demand for the greenback, since the Gulf states involved would no longer need to buy dollars to ensure that the value of their currencies is held to the pegged level.

Any shift would also be taken by markets as a “vote of no confidence” in the dollar’s value from countries that are large holders of American assets, and spark speculation that they might diversify their foreign exchange holdings out of dollars.

Gabriel Stein, of Lombard Street Research, said: “The real effect could be on the dollar. This would be seen as a further loss of confidence in the greenback, accelerating its rout.”

Economists and Middle East experts are split over whether the Gulf nations will opt to act this week, revaluing their currencies or scrapping the dollar pegs in favour of a link to a basket of foreign currencies.

Whether the nations are likely to act collectively or individually is also unclear. Analysts believe that the GCC states, which hope eventually to set up a single currency and may this week give further details of those plans, may well want to show unity.

However, they note that divisions between the countries, arising from the different economic and social pressures that they face, may make it hard to clinch agreement on any action.

Most experts do agree, however, that there is overwhelming pressure for change in GCC dollar-peg regimes. Inflation across the group’s members is surging as record oil prices stoke strong growth in their economies, while the sliding dollar drags down their currencies, sending the cost of imported goods up sharply.

The pressure is made worse as the US Federal Reserve cuts American interest rates, forcing GCC countries to follow suit to maintain their dollar pegs, at a time when they should raise them to quell inflation.

With inflation now at about 9 per cent in the UAE, and close to 12 per cent in Qatar, accelerating price rises are also igniting social and political tensions among migrant Asian workers who are seeing the real value of their wages eaten away.

Expectations that the GCC will move this week, or soon after, have been heightened by comments from Nasser al-Suweidi, Governor of the UAE’s central bank, who last month highlighted pressure for action.

Marios Maratheftis, of Standard Chartered, believes there is a strong chance of GCC moves within two months. He said: “Currency reform is both necessary and likely. We believe that the probabilities for a revaluation and a possible introduction of a currency basket have risen substantially.”

Original article posted here.

1 comment:

spooked said...

Oy, this is getting very scary.