The peg precipice

[nitroglycol]

Interesting:

OTTAWA — Inflation control measures in the Middle East are almost as rampant as inflation itself these days.Qatar just froze the price of steel and cement, and extended a diesel subsidy. Bahrain is spending more than a billion dollars a year to subsidize food and fuel. The mainly foreign construction workers in United Arab Emirates have launched strikes and riots as they watch the value of their savings erode.
Gulf countries are swimming in oil wealth but drowning in inflation - caused in large part by their own unrestrained consumer demand, and their insistence on hanging on to fixed exchange rates, analysts say.
Now, there's a growing fear among the world's opinion leaders that emerging market countries' last-ditch attempts to stifle inflation are akin to sticking a finger in the hole of a leaky dam.
Eleven years after the Asian financial crisis toppled currencies and wreaked havoc in Asia, Latin America, Russia and parts of the North American economy, analysts are again wondering whether the world is on the verge of another currency crisis - this time starting with the U.S. dollar.
The fear is that the inflation dam in emerging markets will break, prompting a quick abandonment of the U.S. dollar as a currency peg and reserve currency - an event that would be destabilizing at the best of times, but would be alarming in an era when the global economy is already dealing with soaring prices, a slowing U.S. economy and a credit crunch. "If you had a big shift in the Middle East, I think it would be a big deal because these countries are accumulating very sizable monthly excess revenues from oil sales. How they place that savings in terms of global currency markets is very important," said Jens Nordvig, senior global markets economist for Goldman Sachs.

From the Globe and Mail. The inflation rates in some of these places are huge:

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.

I suspect at some point some of these countries will have to cut loose from the dollar to maintain order at home; severe inflation in countries that already have extreme inequality in wealth is likely to make things difficult for the governments if they don't pull the plug on the greenback.



Another thing that stands out for me is that Saudi Arabia isn't mentioned once, and this says it's around 3.4%. Is their inflation rate actually that much lower, or is it measured differently?

[Rajiv]

Re: The peg precipice

It appears that Saudi Arabia's inflation rate is 10.45%

See Global Inflation Rates

However, even the web site you have referenced shows how much inflation has increased

Year	Inflation rate (consumer prices)	Rank	Percent Change	Date of Information
2003	1.00 %	190		2002
2004	.50 %	202	-50.00 %	2003 est.
2005	.80 %	15	60.00 %	2004 est.
2006	.40 %	14	-50.00 %	2005 est.
2007	1.90 %	38	375.00 %	2006 est.
2008	3.40 %	93	78.95 %	2007 est.

[nitroglycol]

Re: The peg precipice

Thanks for that link. Strangely, the source you quote shows Qatar's rate as 4.73%, rather than the 14% claimed in the Globe article.

[nathanhulick]

Re: The peg precipice

Its hard to intervene in the currency markets when you don't have any reserves. How exactly do they expect the US government to buy these dollars?

[phirang]

Re: The peg precipice

Its hard to intervene in the currency markets when you don't have any reserves. How exactly do they expect the US government to buy these dollars?

You don't: Japan and to a lesser extent China do so they can keep exporting to us and also ultimately finance the rope to hang ourselves with.

[mfyahya]

Re: The peg precipice

Interesting:
Another thing that stands out for me is that Saudi Arabia isn't mentioned once, and this says it's around 3.4%. Is their inflation rate actually that much lower, or is it measured differently?

I've seen Saudi inflation reported much higher than 3.4% in local newspapers. Here's one article:
"In the top oil exporter, Saudi Arabia, prices rose 10.5 per cent in April, their fastest pace in at least 30 years. Inflation in the UAE soared to a 20-year peak of 11.1 per cent last year."

Saudi Arabia has the highest subsidies among all the GCC countries, so the effect of inflation is lower. Gas is around US$0.50 per gallon for example.

These Arab governments are completely propped up the US and are completely dependent on them for defense. In the smaller countries such as UAE and Bahrain, there's not much dissent against the govt because, the citizens are a minority (around 18% for UAE) of the population. Unemployment is currently as high as 20% among this 18% citizen population, but it's not really an issue as they are well cared for by the rulers. These countries can continue to maintain their pegs without having political issues. The lower income population who suffer from inflation the most, are mostly expatriates and they're deported at the slightest sign of protest.

Saudi Arabia is very different, expatriates are a much smaller percentage of the population and the vast majority of the population would love to see their govt replaced, and stop the US from interfering in their country. It is common knowledge that the peg is maintained due to US pressure. Paulson and Co have been visited the region several times last year begging (demanding?) to maintain the peg. I don't know how long it can last. It's clearly unsustainable. I read somewhere that they have to increase money supply by over 20%. Even the religious establishment is speaking against it: http://www.telegraph.co.uk/money/mai...cnsaudi117.xml

[phirang]

Re: The peg precipice

I've seen Saudi inflation reported much higher than 3.4% in local newspapers. Here's one article:
"In the top oil exporter, Saudi Arabia, prices rose 10.5 per cent in April, their fastest pace in at least 30 years. Inflation in the UAE soared to a 20-year peak of 11.1 per cent last year."

Saudi Arabia has the highest subsidies among all the GCC countries, so the effect of inflation is lower. Gas is around US$0.50 per gallon for example.

These Arab governments are completely propped up the US and are completely dependent on them for defense. In the smaller countries such as UAE and Bahrain, there's not much dissent against the govt because, the citizens are a minority (around 18% for UAE) of the population. Unemployment is currently as high as 20% among this 18% citizen population, but it's not really an issue as they are well cared for by the rulers. These countries can continue to maintain their pegs without having political issues. The lower income population who suffer from inflation the most, are mostly expatriates and they're deported at the slightest sign of protest.

Saudi Arabia is very different, expatriates are a much smaller percentage of the population and the vast majority of the population would love to see their govt replaced, and stop the US from interfering in their country. It is common knowledge that the peg is maintained due to US pressure. Paulson and Co have been visited the region several times last year begging (demanding?) to maintain the peg. I don't know how long it can last. It's clearly unsustainable. I read somewhere that they have to increase money supply by over 20%. Even the religious establishment is speaking against it: http://www.telegraph.co.uk/money/mai...cnsaudi117.xml

If the gulf states were to drop the peg and I were the US president, I and my constituents would feel compelled to "liberate" the oil fields...

[don]

Re: The peg precipice

i believe you're referring to the Carter Doctrine.

[nathanhulick]

Re: The peg precipice

You don't: Japan and to a lesser extent China do so they can keep exporting to us and also ultimately finance the rope to hang ourselves with.

The article says that the United States will intervene to buy dollars, which we cannot do without reserves.

As for China and Japan, they are already intervening, which is why the dollar has not collapsed. Foreign Central banks are doing all the intervening they can, sooner or later they are going to realize its time to abandon ship.

[ASH]

Re: The peg precipice

If the gulf states were to drop the peg and I were the US president, I and my constituents would feel compelled to "liberate" the oil fields...

Conversely, if one wished to drop the dollar peg with minimal threat of repercussion, then it would seem ideal timing to do so when the American armed forces are overstretched and otherwise occupied (or should I say "occupying") -- and when American public support for expanded military operations is low.

Mind you, I don't buy the basic prediction as stated. If the United States were inclined to seize oil directly -- and if such a policy were politically realistic -- then we would have "liberated" Venezuela following the 2002 coup attempt. There, at least, was a (thin) pretext. I mean, Hugo Chavez is not exactly our favorite guy (nor we his), Venezuela is close to home, and we have a history of intervening against left-leaning governments in South America. Moreover, in 2002 -- before the whole Iraq fiasco -- the appetite of the American public for war was considerably higher. Frankly, such a thing (a full scale invasion, occupation, and seizure of oil fields) is politically impossible and out of line with our usual plan.

Our normal modus operandi is to build favorable relations with regimes like Saudi Arabia who are in a position to help us in the markets, and then wage wars to protect the status quo (although, amusingly, our assessment of what threatens the status quo can sometimes be at odds with the assessment of those who we think we are securing). I'm not claiming that we implement this strategy well; just that it's the strategy that we've followed so far. American governments are able to play this game because it is much easier to win public support for a war to defend an ally or liberate a friendly country than to invade a hostile country. The American public must be convinced it faces a serious external threat before it will support invading and occupying another country; economic motives alone won't cut it. True, the public can be misled, but having been stung so recently by the WMD issue in Iraq, the public is unlikely to support a fresh war requiring the deployment of ground troops without an extremely clear-cut casus belli involving the physical security of the United States.

If there were a revolution in Saudi Arabia, then yes -- we probably would intervene with at least air power in defense of the regime. We might even send troops, as long as it was clear we were helping re-install the house of Saud and weren't planning to stay and occupy. But if the present Saudi government decided that a dollar peg was no longer in their best interest, I doubt very much that we would invade the peninsula -- even if we had the spare capacity for such an operation. True, if the Saudis dropped the dollar peg, that would destroy the basis for our relationship with the Saudis, but we aren't in a position to fight to force a relationship -- only to defend existing ones. We are not a 19th century imperial power; we are our own type of (perhaps fading) imperial power.

[GRG55]

Re: The peg precipice

Conversely, if one wished to drop the dollar peg with minimal threat of repercussion, then it would seem ideal timing to do so when the American armed forces are overstretched and otherwise occupied (or should I say "occupying") -- and when American public support for expanded military operations is low.

Mind you, I don't buy the basic prediction as stated. If the United States were inclined to seize oil directly -- and if such a policy were politically realistic -- then we would have "liberated" Venezuela following the 2002 coup attempt. There, at least, was a (thin) pretext. I mean, Hugo Chavez is not exactly our favorite guy (nor we his), Venezuela is close to home, and we have a history of intervening against left-leaning governments in South America. Moreover, in 2002 -- before the whole Iraq fiasco -- the appetite of the American public for war was considerably higher. Frankly, such a thing (a full scale invasion, occupation, and seizure of oil fields) is politically impossible and out of line with our usual plan.

Our normal modus operandi is to build favorable relations with regimes like Saudi Arabia who are in a position to help us in the markets, and then wage wars to protect the status quo (although, amusingly, our assessment of what threatens the status quo can sometimes be at odds with the assessment of those who we think we are securing). I'm not claiming that we implement this strategy well; just that it's the strategy that we've followed so far. American governments are able to play this game because it is much easier to win public support for a war to defend an ally or liberate a friendly country than to invade a hostile country. The American public must be convinced it faces a serious external threat before it will support invading and occupying another country; economic motives alone won't cut it. True, the public can be misled, but having been stung so recently by the WMD issue in Iraq, the public is unlikely to support a fresh war requiring the deployment of ground troops without an extremely clear-cut casus belli involving the physical security of the United States.

If there were a revolution in Saudi Arabia, then yes -- we probably would intervene with at least air power in defense of the regime. We might even send troops, as long as it was clear we were helping re-install the house of Saud and weren't planning to stay and occupy. But if the present Saudi government decided that a dollar peg was no longer in their best interest, I doubt very much that we would invade the peninsula -- even if we had the spare capacity for such an operation. True, if the Saudis dropped the dollar peg, that would destroy the basis for our relationship with the Saudis, but we aren't in a position to fight to force a relationship -- only to defend existing ones. We are not a 19th century imperial power; we are our own type of (perhaps fading) imperial power.

Interesting that under similar circumstances 30 years ago, when oil was viewed as a finite, rapidly depleting resource, inflation was rampant, the US$ was weak, the US economy likewise, and there was a revolution in Iran, the US took no such action. Why would it be expected to do so today, given the Dems control both houses and may soon capture the White House?

[metalman]

Re: The peg precipice

Interesting that under similar circumstances 30 years ago, when oil was viewed as a finite, rapidly depleting resource, inflation was rampant, the US$ was weak, the US economy likewise, and there was a revolution in Iran, the US took no such action. Why would it be expected to do so today, given the Dems control both houses and may soon capture the White House?

the house of saud will never drop the dollar peg. it will fall right after the revolution but not before. to bet on a saudi dollar peg drop is to bet on revolution.

[ASH]

Re: The peg precipice

Interesting that under similar circumstances 30 years ago, when oil was viewed as a finite, rapidly depleting resource, inflation was rampant, the US$ was weak, the US economy likewise, and there was a revolution in Iran, the US took no such action. Why would it be expected to do so today, given the Dems control both houses and may soon capture the White House?

In my view, less was at stake with Iran in 1979 than would be at stake if Saudi Arabia faced revolution today. You are much better qualified than I to assess Saudi Arabia's significance in the oil market, but the received wisdom (from which I reason) is that Saudi Arabia is of prime importance. I am aware that their relative importance -- both in terms of total oil production and their capacity to act as a swing producer -- may be diminishing. However, I think a case could be made that they are categorically more important today than Iran was in 1979. There is also the dimension of prestige and the international order. "Everyone knows" that America props up the Saudi government in exchange for economic accommodation. If the United States failed to intervene, it would seriously undermine confidence in the "hegemony-light" system by which America attempts to wield international influence. If protection is all we have to sell, it doesn't help the brand to allow a major client to fall.

More importantly, our present challenges in Iraq and the associated tensions in American society are not of the same order of magnitude as our failure in Vietnam. Having just lived through Vietnam, the United States would not -- under any circumstances -- have signed up to overtly fight someone else's civil war in 1979. That has a good deal to do with why our meddling in Central America and Afghanistan in the 1980's had to be covert. Congress -- representing the will of the people -- even tried to prevent the stuff in Central America.

Propping up the house of Saud would be in keeping with institutional inertia -- it has been our policy for so long that it might be the instinctive response of the foreign policy establishment, regardless of their political alignment. Further, successful intervention in a hypothetical revolution would allow us to regain our influence over Saudi Arabia -- perhaps for a generation. For those of an imperial mindset, a successful intervention might be seen as an opportunity to restore confidence in American hegemony throughout the region.

Note, however, that I said "probably." We wouldn't make the attempt if we lacked the resources necessary to ensure success, and we don't really have much in the way of ground forces that could be committed. One might argue that any revolution capable of threatening the Saudi security apparatus would be beyond our present capacity to defeat. I also agree that we might not make the attempt even if we thought we could succeed, given the political considerations. It's not exactly 1979, but the American public is tired of war, and opinion of the Saudi government is not particularly friendly. The public case for intervention would have to be something to the effect of "what if the 'terrorists' get hold of the oil supply?" and even then it might be a near thing.

Anyway, that's what I think is different between 1979 and now... and even then, I don't think it's obvious what would happen. Ironically, the whole point of my post was that we were unlikely to go to war.

Maybe I should stick to writing about science, which is something I actually know about, instead of foreign policy -- which is merely something that I have opinions about.

[Guest]

Re: The peg precipice

ASH - I find your analysis of foreign affairs top notch. Good stuff, and very astute. Keep posting it!

[Verrocchio]

Re: The peg precipice

...the received wisdom (from which I reason) is that Saudi Arabia is of prime importance. I am aware that their relative importance -- both in terms of total oil production and their capacity to act as a swing producer -- may be diminishing. However, I think a case could be made that they are categorically more important today than Iran was in 1979. There is also the dimension of prestige and the international order. "Everyone knows" that America props up the Saudi government in exchange for economic accommodation. If the United States failed to intervene, it would seriously undermine confidence in the "hegemony-light" system by which America attempts to wield international influence. If protection is all we have to sell, it doesn't help the brand to allow a major client to fall.

Well reasoned, and well said, ASH. Your assessment of US ground forces available for deployment in another major engagement is spot on; however, these forces may well be freed up, if needed elsewhere, in 12 months time, or even less.

To the perceived basic motivation of US strategists to invade Iraq for control of her oil wealth, we may well imagine that a second reason was the establishment of bases for US ground forces that could be called upon to support the increasingly fragile Saudi regime. No other country in the Middle East is better located for this purpose than Iraq. Also, note the contiguous borders with Iran, Turkey, Syria, and Saudi Arabia and the not so subtle influence of US armed forces on their political decision-making.