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Now it's getting serious. With each passing day, the dollar seems to set new lows and oil prices new highs. Both trends are important for the Gulf region. Both are inflationary. And now they may be propelling each other.
As the dollar declines, those concerned to maintain purchasing power internationally, in non-dollar terms, are looking for higher dollar commodity prices. Oil goes up as a result. Moreover, because it is not just a physical commodity, but a traded financial asset, that movement can be exaggerated by speculative behaviour, rather than underlying market supply and demand fundamentals.
As oil prices climb, they reverberate around the global economy, both in respect of inflation and economic growth. Although the stagflationary mechanisms of decades ago appear to have been broken by globalisation - so that neither does inflation rise so much nor growth fall so much - still at current levels there is bound to be some impact among importing countries.
And then, because the US economy is already weak, and the Fed has signalled - somewhat strangely - that it is more concerned to avoid recession than to deal with inflation, it is the depressive effect on the economy that resonates more. The markets then believe that the Fed will be even more inclined to lower interest rates. The dollar goes down as a result.
It's not difficult to work out that this is a vicious circle. Particularly for the United States, but also for the Gulf states, their economies and their policies.
Remarking on the ominous relation between these markets in current circumstances, Jane Kinninmont, Middle East editor at the Economist Intelligence Unit, says "Maintaining such high oil prices could increase the risk of a US recession and thus put more downward pressure on the US, and Gulf, currencies."
There's more to it, as well. For instance, Hany Genena, Senior Economist at Gulf Finance House in Bahrain, talks in terms of ‘petrodollar monetisation' and the ‘money multiplier' as other, key contributory factors to the inflation momentum. All we need to know is that it's at least a four-wheel drive thundering up that statistical, economic dune.
The simpler proposition offered here seems bad enough.
The lower dollar not only translates into higher import prices, but motivates economic growth, which itself typically advances inflation anyway. As Abdullah Sharafi, a local economist and businessman, notes, "more investment is flowing in, and also tourists from the non-dollar countries [who] find this place a bargain".
Higher oil prices propel liquidity, income and growth. Because the region's governments do not typically react by curbing government expenditure or raising taxes - the so-called ‘orthodox' response to moderate the economic cycle - both growth and inflation are likely to escalate.
In fact, fiscal policy tends to be ‘pro-cyclical' rather than ‘counter-cyclical', since governments tend to compensate citizens for inflation by increasing wages. Unfortunately, that itself is inflationary, since it feeds demand relative to the supply of goods and services.
What's worse is that monetary policy cannot counteract either, since (as everyone knows to the point of tedium), regional interest rates are tied to those of the dollar, and are plainly too low for the booming economic environment we are witnessing.
Government may seek to intervene in other ways, on economic structures, hoping to rebalance the supply-demand equation. For instance, in the past week in the UAE on food (which is running at 30-40 per cent annual price growth, and contributes heavily to the overall consumer price index), by cancelling agency agreements allowing monopoly trading in foodstuffs.
Otherwise, central banks may try raising banking reserve requirements, or credit curbs. By such means, says Genena, they are "attempting to influence the private sector response to policy rather than changing policy itself". That's a reflection of the nature of the dilemma the authorities face, having to act on microeconomic features rather than through a conventional macroeconomic framework.
Market liberalisation policy has a chance of bringing benefit, since competition can drive prices down. But the other remedy for consumers mentioned this week – namely food subsidies – deals with inflationary symptoms rather than cause, and by promoting higher government spending may actually aggravate the basic condition.
These arguments are familiar to development economists. They are classic examples of the age-old debate between the IMF-type prescription (essentially sound money and market freedoms) and the alternative voice advocating various forms of government control and intervention.
So, if the dollar, oil and Gulf region economic policies are collectively and inherently inflationary, it would appear to be a dangerous state, unless structural policies to discipline cost-push mechanisms can overcome the demand-based effects of surging liquidity.
Other things can happen. Oil might tumble because world growth slips, or because the oil-exporting countries anticipate that retrenchment, so pump more, so that that too becomes self-fulfilling. Or the dollar could rebound because the market believes a different story: namely that the US will grow faster because of lower interest rates, rather than the dollar suffer from lower yield appeal. Or both. The behaviour of markets is a fickle thing.
In the meantime, the dangers for the UAE and other Gulf economies should be understood. As the dollar drops and oil climbs, with increasing tendency, inflationary pressure can rise according to the key policy parameters. Calls for currency depegging could become a clamour. Speculation would rise, although, as Abdullah Sharafi points out, floating individual currencies ahead of monetary union may invite rather than quell speculation.
The authorities know the problem and may be assumed to be working on solutions, although, according to Genena at Gulf Finance House, deploying interventionist measures reflects their current uncertainty.
There certainly seems to be an element of wait-and-see in the present policy stance. Foreign exchange markets may repeatedly position themselves for potential revaluations, notably in the UAE, but that prospect may depend on the dollar's future movement. "Gulf central bankers have emphasised that they want to avoid a kneejerk reaction," observes Kinninmont of EIU.
In any case, "revaluing the currency can only have a temporary effect, and would not solve the root of the problem," notes Sharafi. That's because it's a step-change in the exchange rate which still leaves the essential lever of interest rates in a bind.
In the medium term the policy mix would have to go beyond the monetary anyway. "Over the coming two to five years, we believe curbing fiscal excesses, encouraging capital outflows and undertaking deep, supply-side reforms will be by far the most effective anti-inflation tools the GCC should consider," argues Genena.
We're presuming that keeping inflation under control is considered an imperative. A recent report by the Dubai Chamber of Commerce and Industry confirmed this impression, and drew a startling conclusion.
With the overriding objective of forming monetary union in 2010, it claimed that the UAE Government will relinquish control of its exchange rate policy in favour of meeting the related criteria. "It is therefore most likely that the UAE Central Bank will revalue the dirham against the US dollar in line with other GCC currencies," it said.
With the dollar still on the slide, it becomes an increasingly plausible possibility. Last week Jason Goff, Head of Group Treasury and Market Sales at Emirates NBD, told Gulf News that, whereas technically 1.52/53 should be the imminent high point for the dollar/euro rate, any break through that level would suggest 1.60 as the next target. Meanwhile, the $120 barrel of oil is in the market's mind, according to Kate Dourian, Editor of Platts Middle East.
That all means that the uphill inflationary motor could well continue. A policy decision among the Gulf states on how to tackle this challenge might need to be taken. That would be better not done under pressure. Nobody wants to break down, mired in the sand.
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