Mideast and the Dollar

A great post from last week from Interest Rate Roundup on the dollar's recent woes and the reaction by Mideats financial institutions:

a key source of weakness appears to be rumblings in the Middle East about dollar pegs. Many regional currencies, including the UAE dirham and the Qatari riyal, are pegged to the U.S. dollar at fixed exchange rates. The problem is, having a dollar peg in your country essentially links your monetary policy to the U.S.'s monetary policy. If the U.S. Fed cuts rates to stimulate the U.S. economy, your economy will be stimulated as well -- even if the LAST thing you need is an extra boost. And believe me, most economies in the Middle East don't need it -- after all, they're raking in billions and billions of dollars from oil sales.

The result of the Fed-provided stimulation ... on top of strong regional economic growth ... is a gigantic inflation problem in many Gulf countries. UAE inflation surged to a record high 9.8% last year, according to estimates, up from 9.3% a year earlier. The government is planning to cap certain food prices and considering building up a "strategic food reserve" in response. In Qatar, inflation is exploding higher at a 13.7% rate, prompting countermeasures such as rent caps.

Two days ago, Bloomberg did a story that UAE was keeping its dollar peg, but it came with considerable pressure. From the article:

U.S. Embassy officials last week told central bank Governor Sultan Bin Nasser al-Suwaidi of their concern about reports that the sheikhdom may drop the peg, the official said yesterday, speaking on condition of anonymity. Political leaders have stopped the bank from developing any plans to move toward another currency regime, the official said. U.S. Embassy spokesman Atalah Hoshan in Abu Dhabi wasn't immediately available for comment.

Abandoning the link would risk further weakening the dollar as the U.S. economy falters and the Federal Reserve battles a crisis of confidence in financial markets. The oil-rich Gulf states, including Saudi Arabia and the U.A.E., depend on the U.S. for political and military backing and are unlikely to abandon their closest ally at a time of financial turmoil, said Anoushka Marashlian, senior Middle East analyst at Global Insight in London.

``The U.S. has always been the guarantor of U.A.E. military security,'' Marashlian said. ``The U.A.E. wouldn't do anything to compromise that relationship.''

If a few more banks go under, things could change quickly. Stay tuned...