Raising the Costs of Pegging to the Dollar


Former Council of Economic Advisors Chairman Martin Feldstein pens a case in today’s Financial Times for Saudi Arabia to remove its currency’s peg from the dollar to ease their inflation problem. Inflation has raised political and economic risks for the region by stretching consumers’ household budgets with rising food prices and shrinking remittances sent back home by migrant workers, particularly from South Asia.
Though there may be an economic case for this, Saudi Arabia will not move on this in the near future — as Flynt Leverett and Hillary Mann wrote last Sunday in Abu Dhabi’s newest publication The National — as their peg to the dollar is more of a strategic calculation than a purely economic one. However Leverett and Mann point out that the costs incurred from this relationship by Saudi Arabia and the rest of the Gulf Cooperation Council (GCC) are rising and can only be sustained for so long before they overwhelm the strategic rationale of the dollar peg. They write:

On the strategic front, are GCC states prepared to use their financial support for the United States to influence the ways in which Washington exercises its military hegemony in the region? In private, Gulf Arab officials and elites complain about the consequences of US strategic initiatives in recent years, voicing concerns that US foreign policy may be creating more numerous and potent threats to the security of GCC states than those against which the US military protects them.
But, for all that GCC states complain about the invasion and occupation of Iraq, for example, they have effectively financed the whole operation by continuing to purchase US treasury securities and other dollar-denominated reserve assets. Will GCC states be so accommodating again — if, say, the United States initiated a military confrontation with Iran?

Attacking Iran would obviously change the equation but in a “geopolitical marketplace,” even the aggregate of minor provocations prod the GCC states to diversify away from their strategic ties with the US. Such a provocation could come in the form of the recent case being advanced by eleven US senators for the US Trade Representative’s Office to bring suit against eight OPEC states (including four GCC states) that are also WTO members.

This smacks of an effort to stoke populist sentiment with rising gas prices more than an actual weighing of the costs and benefits of such a political gambit.
Though OPEC is obviously a cartel, a principal justification for it is that in order to ensure massive front-end investments for certain commodities like oil production (particularly for secondary and tertiary drilling), there has to be an assurance mechanism for prices. OPEC allows countries that depend on production to sustain their economies to hedge against price collapses (like in the 1980s when many oil states defaulted on loans due to oil price collapses and were forced into economic structural adjustments programs by the IMF). The Canadian Wheat Board might be another example that has thus far escaped those 11 senators’ ire.
But the real issue here is the timing. If the conflict between OPEC and WTO was such a pressing concern to the Senators then it should have been brought up during the WTO accession talks for these countries, most recently when Saudi Arabia was admitted in 2005. But 2005 lacked the same political impetus as 2008 with the price of oil residing between $40-$70/barrel, not to mention Sen. Frank Lautenberg, the senator spearheading this effort, was not facing reelection at the time. (Speaking of provocations, Lautenberg has made incendiary remarks against other Arab countries in the past to play to populist, xenophobic domestic audiences).
Leverett and Mann conclude:

The next US president, whether John McCain or Barack Obama, will be challenged to put US policy in the Middle East on a course more productive for the interests of US allies in the region as well as the interests of the United States. For their part, GCC states will be challenged to manage their relations with the United States in ways that increase the chances Washington will actually find that more productive course. And that will mean being frank with US partners about what Gulf Arab states need from their alliances with the United States, what they are prepared to put on the table to make strategic co-operation more effective, and — just as importantly — what they are not prepared to pay for.

The GCC has more choices in the post-American world and the burden of refrianing from cheap political theatrics and instead articulating productive directions for the US relationship with allies in a critical region, falls not only on the Presidential candidates but all our national leaders.
–Sameer Lalwani


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