Why GCC currencies need to stand up for themselves.
Over the past few years there have been numerous articles discussing the GCC currencies’ peg with the US 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 pressure from the EU to get our act together and reach a collective accord. It all comes 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 more to buy less. Does that sound 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 a time when their budget deficit is going from bad to worse and at a time when they’re facing two wars with no end. If there was a currency divorce, then there is a big chance that oil would just end up costing consumers more to consume, something neither the Republicans nor the Democrats would appreciate.
We all have seen how the US (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, and the US government has even threatened to resort to the WTO to plead their case. 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”. The message to China is that it should break the currency peg and allow the Yuan to appreciate, therefore making it more expensive for Americans and the rest of the world to purchase Chinese goods and less expensive for the Chinese traders to buy from abroad than from their domestic market, ultimately making the US happy.
Even the US based IMF has called upon the GCC to reconsider the peg that they have accused as being a factor contributing to the rising inflation in the GCC, saying that sticking to this policy will actually result in the GCC countries “importing inflation” (as opposed to the homegrown sort). According to independent studies, the rate of inflation in the UAE was 15 per cent 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 per cent 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 per cent against the euro and more than 22 per cent 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.
In 2006, the dinar (and by extension all other GCC currencies) fell by 22 per cent compared to the euro, meaning if someone delayed purchasing a Mercedes Benz for KWD30,000 in 2005, she would have to fork out an additional 6,600 (AED84,000) 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. A recent Deutsche Bank report indicated that should the de-pegging become a reality, the GCC currencies will appreciate anywhere between 10 and 30 per cent against the dollar.
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.
This article was originally published in MONEYworks on April 2007. (PDF Download)