by Zuhair Ahmed
What do the currencies of Saudi Arabia, the United Arab Emirates, Oman, Qatar, and Bahrain all have in common? Despite their excessively colorful designs, all are pegged to the US Dollar. This was done to bring stability and a quick fix to some very volatile exchange rates to this group of extremely stagnant economies. It also made life easier as most of these nations soon began exporting a great deal of oil, which was, and still is, overwhelmingly sold in dollars. Today stagnation has become really hard to find amongst these (along with Kuwait) member states of the Gulf Cooperation Council (GCC). With a population of just 40 million, a third of who are expatriates, the GCC in 2007 had a nominal GDP of $800 billion, or about three quarters of India’s total. Coupled with the recent turmoil in the US housing markets and the rapid decline of the greenback, the time honored peg with the dollar is proving to being one of the greatest obstacles for further growth in the Gulf.
When a nation decides to a peg its money to another nation’s currency, usually the USD or the Euro, it relinquishes almost all control over its own monetary policy. More precisely, it can no longer change its own interest rates as it must be tied to its pegged nation’s interest rates in order for their currencies to stay in lock and key. Qatar, for instance, which has been suffering from some of the world’s highest inflation rates, is in desperate need of higher interest rates to curb such dramatic increases in prices; instead it is forced to cut them, which only further accelerates the devaluation of the Qatari Riyal. As of March 1, the Fed has cut the Fed Fund rate 5 times over the past 6 months, from 5.25% to 3% or a difference of 2.25%. Almost immediately after, the Qatar Central Bank has had to painfully follow suit every single time. As the US goes into a recession, if we are not in one already, there is going to be another full percentage point or two drop in the Fed Funds rate. This will push inflation in the Gulf to even more unbearable levels. It is important to keep in mind that while a moderate level of inflation may not seem so bad at face value, its affects do exacerbate quite considerably over time.
The inflationary pressure on the Persian Gulf steams from several major developments. The most profound being the surging demand for oil. China, India, and the Middle East have all begun to rapidly consume more and more oil which has really pushed the price of this black gold to near all time highs. In 2003 China surpassed Japan as the second largest consumer of oil, after the United States, and in 2007 accounted for 38% of the growth in the demand for oil alone consuming just shy of 7 billion barrels a day. All this has lead to the price of oil doubling from around $50 a barrel in February 2007 to over $100 today.
Unlike other commodities, when the price of oil spikes, it tends to have a very large impact on the cost of living. The costs of transportation, manufacturing, and, believe it or not, food all tend to rise as a result. In the past 6 months, the price of wheat has climbed by 35%, corn and soybeans have risen by an outstanding 50%. This has caused most of the staple foods in the world, such as bread and grains, to skyrocket. The Middle East has been especially hard hit due to the fact that for much of the region water is becoming increasingly hard to come by. As of February 2008, there are approximately 1.1 billion people in the world who have inadequate access to safe drinking water, most of which who are in the Middle East and Africa. Unless there are some drastic changes, this scarcity is only going to increase in the near future as water tables continue to fall. Hence, irrigation and the watering of crops have all become increasingly expensive which has sent food prices though the roof.
Quite frankly, this overdose of inflation is crippling the middle and poor classes of much of the Persian Gulf. Take for instance Dubai, the epicenter of this economic boom. This once small trading post is currently undergoing a rapid transformation in infrastructure, construction, and tourism, all of which are being built on the backs of foreign laborers. Currently the population of Dubai stands at 1.5 million, 75% of which who are migrant workers (the vast majority of which who are South Asian). Most come to work here as their salaries are significantly higher in Dubai than back at home, but in exchange, most have to toil in miserable conditions. Labor camps pack 10 to 15 grown men in small, poorly ventilated rooms, work is conducted in 10 to 12 hour shifts, and little if any medical care is available for those injured on the job. All this inflation has only made matters worse. Since almost all are paid on fixed wages, every month workers are being paid less and less for the same amount of work. This translates to less money they can send back home, less they can afford for themselves, and the further deterioration of already deplorable conditions.
There are rarely ever any easy solutions to such complex economic problems, but in this case, the benefits of removing the dollar peg clearly outweigh its drawbacks. In a recent report by Al-Jazeera, former Fed Chairman Alan Greenspan stated that “in the short term a free floating [currency] ... will not fully dissipate inflationary pressure, although it would significantly help to do so.” Kuwait took the initiative last year and finally did away with its peg to the dollar. It now keeps the Kuwaiti Dinar tied to a basket of currency which much more accurately reflects global trends. As a result, prices in Kuwait have stabilized. Yet, not a single other nation in the Gulf has decided to follow suit. This is primarily because the GCC nations are in hopes of forming an economic and monetary union, similar to the EU. All six countries hope to adopt a single currency, the Khaleeji, by 2010. However, before such a high level of economic integration can take place, each nation must have near identical monetary policies for the new currency to be adopted successfully. Oman has already announced it will not be ready to adopt the Khaleeji by the target date, and with Kuwait removing its peg to the dollar, this plan all of a sudden has becomes considerably more complex to the dismay of many in the region.
Most agree that the introduction of a new, major currency in the world would help to pump up the economic and political clout of the GCC and bring some much needed stability to the Middle East. Therefore it is critically important for these nations to one day reach this goal. However, in the short run, inflation is eating away much of the Gulf’s profits and putting a stranglehold on its economy. Right now the focus of the GCC should be on how to best handle this particular crisis. If this means putting off the adoption of the Khaleeji by a few more years, then so be it.
The rest of the GCC should follow in Kuwait’s footsteps and walk away from the dollar. This has to be done, if not for the investor, then for the benefit of its own people. Sure the United States is not going to be happy, as this move will almost certainly lead to the further weakening of the dollar. But then again, for the first time in over a half a century, what can the USA really do about it?
“Greenspan Tells Gulf to Drop Dollar”. Al-Jazeera English. 3 March 2008. <http://english.aljazeera.net/NR/exeres/FC515689-75CC-4121-BD37-2A84E5BF0C60.htm>.
“Inflation plague”. The Economist. 4 February 2008. <http://www.economist.com/agenda/displaystory.cfm?story_id=10635726>.
“Khaleeji Concerns”. Cooperation Council for the Arab States of the Gulf. 3 March 2008. <http://www.gcc-sg.org/index.php?action=News>.
Ranson, David. “Inflation May Be Worse Than We Think”. The Wall Street Journal. 27 February 2008. <http://online.wsj.com/article/SB120407506089695263.html?mod=opinion_main_commentaries>.
Simeon Kerr. “Kuwait Abandons Peg to Sliding US Dollar”. Financial Times. 21 May 2007. <http://www.ft.com/cms/s/0/d63eb12c-0737-11dc-93e1-000b5df10621.html>.
“Water Scarcity Update”. World Recourses Institute. 25 February 2008. <http://earthtrends.wri.org/updates/node/73>.