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


9 comments on “Raising the Costs of Pegging to the Dollar

  1. samuel burke says:

    ron paul speaks ..
    all war, but most particularly war funded by monetary inflation,
    bleeds a country in multiple ways. obviously, many of the young
    people who are in the military literally give their blood, and
    sometimes their lives, fighting in wars of this type. meanwhile,
    those who do not fight the war, but fund it, are forced to pay
    both the immediate costs, as well as seeing their long-term
    purchasing power erode, as the twin pillars of debt and inflation
    are foisted upon the backs of current taxpayers and future
    generations. neither conspiracy nor coincidence explains steep
    increases in the price of gas as the war drags on. no, this is
    simply a reality of the inflationary policies that, among other
    things, make this war possible.


  2. JohnH says:

    Washington refuses to sell arms to Venezuela. So Venezuela decided to buy some from Russia. The US government is puzzled, simply puzzled. I mean, why does Venezuela need to buy arms? Who would ever think of attacking them (and their humongous heavy oil reserves)? Hmmm. Maybe the country that has been conducting naval training exercises off Aruba, which just coincidentally happens to be right next door to Venezuela?
    This is another instance where the entire foreign policy establishment has been complicit in demonizing Venezuela. Once again they think it their “professional duty” to mislead the American people. Ya basta! Let the purge begin!


  3. Mr.Murder says:

    The largest reserves yet to be tapped belong to Venezuela.
    No wonder we want to isolate Chavez, so we can continue paying four a gallon for gas.


  4. JohnH says:

    Wigwag–Oil is thicker than blood. And I’m sure that those with the oil appreciate it just as much as the oil-have-nots, who suddenly have a newfound respect for it and desire only to respect it more perfectly. The Gulf states are certainly aware of this newfound covetousness and its implications for the standard of living they are coming to enjoy immensely. And Russia, another energy state, would be happy to sell them the means to defend themselves.


  5. WigWag says:

    JohnH, you might be right that strategically the Gulf countries and Iran might be better off banding together to pursue their mutual interests. Of course, to some extent that’s what OPEC is for. The animosity between Persians and Arabs is almost as ancient as the hostility between Arabs and Israelis. The liklihood that the Sunni Arab states and Iran will be making nice any time soon seems remote.
    As for your suggestion that the industrialized countries would love to steal middle eastern oil, I am reminded of a comment by the English social critic, GK Chesterton who famously remarked “Thieves respect property. They merely wish the property to become their property so that they may more perfectly respect it.”


  6. JohnH says:

    The one thing that everyone can agree on is that the industrialized world is desperate for oil. And the Persian Gulf has the biggest remaining reserves.
    Strategically, the threat to the region is from predatory industrialized countries. Iraq serves as a vivid, daily reminder of Western predation. Over time, the region has three choices: 1) build a credible deterrence capability, 2) surrender their energy assets voluntarily, or 3) end up like Iraq and lose their energy assets.
    Two of the three outcomes are disastrous for the region. So my guess is that they will find a way to bury the hatchet, band together for survival, and build a strategic deterrence. For all their dislike of Tehran, the Iranians are leading the way in this regard. This is the real Iranian threat.


  7. WigWag says:

    “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.”
    Are GCC countries really of one mind about what U.S. foreign policy should be? Isn’t it possible that some GCC countries support a more belligerant U.S. policy towards Iran, for example, than others.
    Here’s what Vali Nasr and Ray Takeyh have to say about the subject in the February, 2008 issue of Foreign Affairs.
    “The Bush administration’s strategy also fails to appreciate the diverse views of Arab states. Arab regimes are indeed worried about Iran, but they are not uniformly so. Saudi Arabia and Bahrain decry Iranian expansionism and fear Tehran’s interference in their internal affairs. But Egypt and Jordan worry mostly that Iran’s newfound importance is eroding their standing in the region. The stake for them is not territory or internal stability but influence over the Palestinian issue. Even within the Persian Gulf region, there is no anti-Iranian consensus. Unlike Bahrain, Kuwait, and Saudi Arabia, for example, Qatar and the United Arab Emirates do not suffer a Shiite minority problem and have enjoyed extensive economic relations with Tehran since the mid-1990s. Far from seeking confrontation with Iran, they fear the consequences of escalating tensions between it and the United States… A U.S. containment strategy that assumes broad Arab solidarity is unsound in theory.”
    It sounds like the GCC is just about as cohesive as most partnerships of of this type. In this regard, it’s quite reminiscent of the EU.


  8. JamesL says:

    >…(Saudi’s) peg to the dollar is more of a strategic calculation than a purely economic one.”
    A writer at Asia Times made the same statement about a year ago, regarding China. He wrote that Chinese leaders felt that the damage done to individual Chinese investors by a falling dollar was acceptable given the long term strategic benefits. The longer China could stick with the dollar, the greater the damage to the US, and the stronger China’s eventual position.
    ‘Strategic benefits’ may mean different things to China and Saudi Arabia, but if both writers are correct, the US under Bush/Cheney is stuck in a corner playing tactics under the guise of military strategy while other players are acting consistent with a longer term vision.
    Bush and Cheney have amputated some key appendages of traditional US strategy in favor of the manipulation of consent and military threats and actions. The next president will have to repair the damage to America’s strategic position and relational abilities. He will also soon discover that the US military is more of an economic and international relations liability, stuck in desert sands halfway around the world, than an asset.
    The few Americans still supporting Bush are very fond of “carrying a big stick” in international relations. But only if someone else pays for and carries it for them, whether it be the unknown grunt or the mercenary. No matter who it is, the person carrying the biggest, heaviest stick in unending circles through alien desert sands will be among the first to die of thirst. The notable exception to this rule is when the person carrying the load is walking on his own land, in the service of his own people.


  9. ... says:

    ot, but is steve going to do any coverage on the Senate Armed Services Committee hearing?? i think it is an issue that needs greater coverage… thanks..


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