US Treasury green light for Gulf currency revaluation

The latest US Treasury report to Congress on International Exchange Rate Policies recognizes the inflationary pressures that the dollar-peg is putting on the Gulf States which some analysts see as a green light for revaluation in the oil-rich region.

This is a highly significant report because it is widely believed that US opposition to revaluation is the only reason that it has not happened this year. Gulf countries are all running double-digit inflation, and wholly inappropriate low interest rate regimes due to the dollar-peg.

‘The US recognizes significant appreciation pressures on the GCC countries,’ said Merrill Lynch. ‘From a fundamental standpoint we believe the US authorities have hinted that there is a need for more exchange rate flexibility.’

Merrill Lynch predicts a move to a currency basket within the next few months and a five per cent appreciation in Gulf currencies before the end of the year.

But this would not be the first time that Merrill Lynch has been overoptimistic and premature in its forecasts on revaluation. Recent statements from Gulf central bankers have declared trenchant support for the existing exchange rate regime, although who makes the real decisions on such matters of vital national importance is a matter of conjecture.

But perhaps Merrill is right to conclude: ‘This represents a modest change in focus but we believe it a big signal for the currencies of the GCC.’

Certainly from any commonsense standpoint the maintenance of the current exchange rate regime stands ultimately to damage Gulf economic interests by producing a boom-to-bust economic cycle of significant proportions. And almost anybody who has studied economics will draw the same conclusion.

For very high inflation levels distort investment into real estate and financial services, starving other sectors of resources, and then inflate prices to levels that are unsupportable in even the most minor setback. Then follows the crash!

Preemptive action by Gulf central bankers to keep this economic boom under some kind of control through revaluation and currency reform is therefore something most economists would welcome.