Friday, July 25, 2008

The peg precipice

You know all those countries (especially oil producers) who have their currencies "pegged" to the US dollar? Well, this is starting to be a problem for them:

Pegged exchanged rates prevent those countries from raising interest rates to keep inflation under control. Instead, to maintain the exchange rate, they have to match U.S. monetary policy. Interest rates in the United States are highly stimulative, however, designed for an American economy struggling to avoid a recession - not a Gulf country whose coffers overflow with oil money.

So emerging market demand continues unabated, even encouraged, further exacerbating the inflation problem that governments around the world are scrambling to contain. Qatar's inflation is running at about 14 per cent. Egypt is at 19 per cent.

The average for the region just two years ago was a mere 2 per cent.

From here. Furthermore, Saudi Arabia is experiencing serious inflation; depending on who you believe it is anywhere from 3.4 to 10.5%. I'm more inclined to believe the latter, myself. The thing is, if this starts really hurting the citizens of these countries, they might unpeg their currencies, in which case things could get very exciting indeed:

"If several dollar-pegged currencies were revalued, we could expect to see some panic selling in the U.S. dollar, further destabilizing the global economy," she said.

Such speculation has prompted politicians in the United States and the Gulf to frequently deny this would occur.

So what happens then? Well, I suspect that America's ability to buy oil would be severely compromised. It's not hard to guess what that would mean. It would get pretty awkward for us as well, given our dependence on the US market. Just how it would play out is anyone's guess (plenty of speculation happening here if that's your thing.

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