It makes perfect sense for high growth countries to de-peg from the US dollar, since the Fed does not have the latitude to raise rates to fight inflation, and a monetary inflation is gripping most of the world, sourced by the US dollar as the world's reserve currency and its negative interest rates.
The US dollar peg could transmit a troublesome easing of monetary policy to those who peg to its currency since the US is in recession, but inflation is more of a problem in the growth countries like the BRIC and the Middle East, and to a lesser extent in Europe.
The postential downside is that this provides an all too convenient for government and economic demagogues to denounce countries that drop the peg as causing the US' problems, shifting blame from themselves and the reckless and irresponsible US banking system, its regulators, the Fed, and the corporations that have sprung up around them.
Gulf states urged to rethink dollar pegs
By James Drummond in Abu Dhabi
Sunday Jul 6 2008 14:45
The Financial Times
Abu Dhabi has reignited speculation that the United Arab Emirates may break its fixed peg to the US dollar. The UAE is one of the world's main holders of dollar-denominated assets.
In a report published at the weekend, the Abu Dhabi department of planning and economy floated the idea of tracking a basket of currencies in advance of formation of a currency union in the six-member Gulf Co-operation Council.
The department is answerable to the emirate of Abu Dhabi and is not a federal policymaking body. However, it reflects official thinking in the most wealthy of the seven statelets that comprise the UAE.
Inflation in the UAE runs at 11 per cent and is higher elsewhere in the Gulf. The dollar peg means Gulf central bankers have to match the interest rate moves of the US Federal Reserve and thus have only limited tools with which to curb inflation.
"Although the UAE has officially made it clear that it would not de-peg its currency from the flagging US dollar, international financial institutions as well as experts and analysts have maintained that the UAE would do well [to float] its currency as a means [of] curbing inflation," the report said.
Qatar and the UAE are usually thought to be the most likely states to quit the dollar peg. Speculation mounted last year that the UAE was about to break with the dollar after ambiguous comments by Sultan Bin Nasser Al Suwaidi, central bank governor, but the authorities acted to deny it.
Of the GCC states, only Kuwait manages a currency basket dominated by the dollar but it can decide its own interest rate policy. Inflation in Kuwait is lower than in the other GCC states.
"GCC states need to peg against a basket of world currencies, taking into account the latest trading patterns, which tend to be bent toward the eurozone and Asia," the Abu Dhabi department said.
"That the Gulf states continued to have fixed-dollar exchange rates, even as the dollar continues to decline, causes greater harm to the Gulf countries," it said.
Analysts did not believe a change in the UAE's currency administration was imminent, although the report clearly reflected a strand of thinking. Simon Williams, economist at HSBC in Dubai, said the report showed a preference for joint action over unilateral action.
"The case for reform of the GCC currency regimes is strong but we don't anticipate change taking place in the near-term. The report may indicate that debate is ongoing but I don't take it as a sign that change is nigh," Mr Williams said.
The UAE yesterday said that it was forgiving up to $7bn (€4.5bn, £3.5bn) in principal and arrears of Iraqi debt to help Baghdad with reconstruction. The announcement coincided with a visit to Abu Dhabi by Nouri al-Maliki, Iraqi prime minister, and with confirmation that the UAE will send an ambassador to Baghdad two years after one of its diplomats was kidnapped there.
