Should the UAE keep its dollar peg as Professor Rogoff says?

Posted on 01 July 2010 with 1 comment from readers

Taking advice on the US dollar peg from a US professor is a bit like asking a shop assistant if you look good in a garment that you are thinking of buying. The answer is going to be yes this is right for you!

But should we be so dismissive of Kenneth Rogoff, Professor of Public Policy and Economics at Harvard University, who made this recommendation yesterday to an audience in Abu Dhabi that included the Crown Prince General Sheikh Mohammed bin Zayed Al Nahyan?

No different this time

He spoke mainly on the theme of the 66 financial crises covered in his excellent book ‘This Time is Different’ (see the review here). Rogoff appeared to back track a little on the conclusions of his book, and now says ‘I don’t think we are going to have a second meltdown’.

However, he did warn that ‘we find that after a wave of international banking crises there’s a wave of sovereign debt crises’. And indeed it is true that the dollar has strengthened considerably over the past year as a percieved safe haven, as the eurozone has suffered waves of doubt over debts in Greece, Portugal and most recently Spain.

However, whether the UAE is correct in keeping all its eggs in the dollar basket is less clear, and the Central Bank is very heavily weighted towards dollar reserves and has no gold.

For the dollar is a flawed currency. The US deficits will most likely never come down but eventually be inflated away. That will mean the oil-rich UAE suffering again from higher levels of inflation due to its dollar peg. The UAE has a balance of payments surplus and will likely never have a deficit.

Indeed, Professor Rogoff agreed, saying: ‘High inflation is a risk (with the dollar). There’s a liklihood of the US raising taxes and having a slower rate of growth.

‘The US dollar is appreciating against other currencies because they are doing worse. But in five to 10 years the US will face problems due to its mounting debt.’

Oil priced in dollars

On the other hand, oil is priced in dollars so the UAE gets a lot of dollars whether it likes it or not. Most of its investments are also priced in dollars.

Professor Rogoff is right to point out that the euro is a mess and so rushing into a common currency with other Gulf Cooperation Council nations has limited appeal, although it too will more than likely be pegged to the US dollar.

But would it not make sense for the UAE to diversify its currency reserves more, or at least buy some gold. Saudi Arabia has just doubled its gold reserves as a hedge against a dollar devaluation. Surely the UAE is remiss not to do the same?