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Important to pick right side in the currency wars

The "currency wars" confrontation in South Korea this weekend will have long-term and serious implications for the world economy.

The "currency wars" confrontation looming in South Korea this weekend will have serious, long-term implications for the world economy.

Among them are: a possible (although unlikely) return to some form of gold standard; trade wars between the two principal protagonists, the US and China; and a negative impact on global economic growth just as the world is pulling out of the downturn.

These are the principal repercussions preoccupying policymakers if the leaders of the Group of 20 (G20) leading and emerging economies do not reach some kind of compromise this weekend, or at least in the near future, on the growing strains in world foreign exchange markets.

In the Middle East, the prospect of currency wars is once more feeding speculation that those GCC countries that are still pegged to the US dollar, of which the UAE is one, might be considering loosening that historic tie.

It is growing from a very low base, it must be admitted, because the official line from all GCC states, apart from Kuwait, which has already reduced dollar-dependency, is that the peg is here to stay. Nonetheless, the debate has kicked off again.

The pros and cons will be argued fiercely by economists and policymakers, but it is worth looking at the circumstances the last time we had the discussion. It was in late 2007 that GCC governments pondered whether to loosen the dollar tie, which has been in place for most states for some 30 years.

Then, the world's financial markets seemed to believe that a reordering of the dollar peg was on the cards, and flooded the region with capital designed to take advantage of the new regional order.

Some of this influx was speculative, aimed at making a quick buck by arbitraging the new situation, but some of it was genuine. International investors were apparently attracted to the long-term prospects of the Middle East if its currencies were more aligned with the realities of how GCC states did business in the world.

Of course, it came to nothing. Definitive denials by GCC governments in the summer of 2008 ended speculation that the peg would be rejigged, and there was a withdrawal of foreign cash on a grand scale.

That withdrawal coincided with the worsening of the global credit crunch (we had not yet begun calling it a credit crisis then) and was a significant response to the tightening financial requirements in investors' home markets.

It had the effect of pricking the "bubble" in regional asset values, especially in property and especially in Dubai, which in turn gave the emirate its own version of the financial crisis.

It's hard to say how much the collapse from September 2008 onwards in UAE financial markets was due to the withdrawal of foreign investment, and the result of the bursting of the country's very own asset bubble. Was the foreign exodus cause or effect?

The answer is probably only of interest to the policy wonks of the economics world, but here is the central point: before it all went wrong and they packed their money bags to leave, international markets rather liked the idea of de-pegged (or at least re-pegged) GCC currencies.

That's worth remembering in the very different circumstances of the currency debate this time around.

The UAE, and certainly Dubai, is going to have to work extra hard to attract foreign investment in the new post-crisis environment, and if a new currency arrangement helps it attract that overseas cash, that on its own might be a good reason to think again about the dollar.

There are other reasons, too. It's generally assumed that a rearrangement of the dollar peg would have a disinflationary effect, and the region's financial experts are again looking at the possibility of rising inflation.

This must not be overstated, and one of the leading regional economists, John Sfakianakis of Banque Saudi Fransi, reiterated the case for a sanguine view on regional inflation: the alarm bells are not ringing, he said, and no GCC country should fear double-digit inflation next year.

He also pointed out the circumstances now and in 2007-2008 are very different. The GCC and the US are on economic recovery paths, and their interests are much better synchronised than they were back then. These are sound arguments, likely to be met with nods of agreement in the GCC central banks.

But you get the feeling that this time round it might be different. We are witnessing the most radical realignment of global financial and economic power in nearly a century, since Britain lost its place as the world's financier to the US after the First World War.

Power is slipping eastwards, away from the US to the dynamic economies of Asia.

The Middle East has made much of its prime position on the "new silk road", and the facts confirm this: the UAE trades much more with four Asian countries, China, India, Japan and South Korea, than it does with the US.

It would be unwise to end up on the wrong side of a trade war between the Americans and the new Asian economies.

 

fkane@thenational.ae

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