Dollar’s fortunes

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Gulf states are still showing confidence in the dollar and in defending the peg. All GCC currencies are pegged to the greenback, bar the Kuwaiti dinar.

The battered US economy could signal the return of the weak dollar, sparking renewed calls for  GCC countries to depeg their currencies.

Remember the days when off-plan buying, rotating towers and refrigerated beaches all seemed like great ideas? It was only a year ago.

Though some things from 2008 have most likely been confined to history, one thing that could soon be making a comeback is the weak dollar.

Its safe haven status boosted the greenback when the world's financial system was shaken to the core by the collapse of Lehman Brothers in September last year. But this year has seen it easing against most other major currencies, and signs of a recovery in the US economy could accelerate the decline. Or it could give it a much-needed boost, depending on who you listen to.

US Federal Reserve chairman Ben Bernanke numbers among the US officials who have pledged to keep the dollar strong.

"The Fed supports the treasury's strong dollar policy. We think the dollar should be strong, and the best way to get a strong dollar is to have a strong economy," he told a forum with US public broadcaster PBS in July.

"When the economy is strong, then there is a lot of good investment opportunities, foreigners want to invest here, and that causes the dollar to rise. Our whole strategy right now is to get the economy out of the doldrums, and back into a growth path that will attract foreign funds and will get the [dollar] strong - and keep it strong."

During his recent visit to the Middle East, US treasury secretary Timothy Geithner also stressed his government's desire to maintain a strong dollar policy.

Governments and investors in the Gulf are estimated to hold around $400bn in US assets, and the US will need foreign investors to finance its budget deficit, which topped $1 trillion in the first nine months of fiscal 2009. Of course, in the long term, letting the dollar slide wouldn't necessarily be a bad thing for the US government since it would decrease the relative value of its debt.

Analysts point to a host of factors that could make traders sour on the currency in the year ahead. Many fear that America's ballooning fiscal deficit could force the government to raise taxes, which would stunt economic growth.

As the global economy begins to stabilise, the need for safe, zero-yielding assets will shrink, and currencies in faster-growing emerging economies could become more attractive.

There have also been calls by China and Russia earlier this year for the creation of a new currency that would replace the dollar as the world's main reserve currency. Central banks around the world currently hold more US dollars and securities than they do any other currency, but they are beginning to diversify their assets.

Chinese officials have expressed concern over the Fed's decision to buy $1.2 trillion of long-term government bonds and mortgage-related securities, an operation effectively being funded by printing money. Spiralling inflation in the world's largest economy could devalue the dollar and threaten the value of China's $1 trillion investment in American government debt.

"As more and more economies are adopting unconventional monetary policies, such as quantitative easing, major currencies' devaluation risks may rise," the People's Central Bank said in a report this year.

Mattias Pannhorst, a fixed income and FX strategist at Deutsche Bank in Frankfurt, believes the greenback will continue to depreciate against the euro over the next 12 months until it reaches around $1.50 per euro. That compares to a high of $1.60 last year.

"We have been negative on the US dollar for quite a while now," he says.

A prolonged period of dollar weakness could lead to a rethinking of the Gulf countries' dollar pegs, but only over the longer term, he adds.

All GCC currencies are pegged to the dollar except for the Kuwaiti dinar, which tracks a basket of currencies.

In addition to making imported goods more expensive, tracking the US interest rate means that Gulf states may end up with excess liquidity if their economies are growing at a faster pace than the US is. That could mean higher inflation and the formation of asset bubbles such as the one seen in Dubai.

Early last year, speculation grew that GCC states would revalue their currencies as growth in the US ground to a halt while oil exporting countries in the region kept growing at breakneck speed on the back of oil prices that reached $147 per barrel.

But although the economic prospects for the region have improved lately amid a surge in oil prices that should enable most Gulf countries to run current account and fiscal surpluses, growth is likely to be modest.

"Once the recovery gains steam inflation risks will again be a topic as the peg prevents local central banks from raising rates. Also, for a currency union preserving currency strength is paramount," Pannhorst says.

"So over the longer term, and if there really is a prolonged phase of dollar weakness, there could be a rethinking of the currency pegs or a revaluation, and a diversification away from the dollar is not unlikely in our view."

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READERS' COMMENTS

Wild guess
Posted by Munts on Friday 14 August 2009 at 09:20 UAE time


Heres a thought, just a wild guess that the AD leadership struck an agreement with Geithner last month to maintain support (buy T bonds and keep peg) in return for nuclear generation and military related initiatives.

The AD advisors are very astute and know there are many other methods of hedging against a deflating USD.

Just a guess, no inside information.

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