Tuesday, December 18, 2007

Occam's Buck

What is the more believable explanation --- a call for higher real interest rates to reduce national inflation due to a comparatively weak currency, or a grand conspiracy to take down the United States through exchange rate manipulations independent of the US's current accout and trade deficit fundamentals. If you choose the first option, you're thinking like an economist. If you choose the second option, you have forgotten that the entire world does not revolve around your own pre-conceptions, as the Torygraph columinst Evans-Pritchard exhibited this morning:

To all intents and purposes, the Wahabi religious establishment of Saudi Arabia has just issued a fatwa against the US dollar. This bears watching.

A message issued by 26 leading clerics warns that inflation has reached intolerable levels in the Gulf kingdom.

While it does not vilify the dollar explicitly, the apparent political aim is to undermine the country’s dollar peg.

“The rulers should seek to try to remedy this crisis in a way that would ease people’s suffering.”

“We direct this message to the rulers and officials: we remind you of Prophet Mohammad’s words that you are shepherds who are responsible for your flock,” it said....

CPI inflation is 5.35pc in Saudi Arabia, the highest in over ten years. It has reached 10.1pc in the United Arab Emirates and 12.2pc in Qatar.

The dollar pegs – designed to anchor the currencies – are now forcing the Petrodollar economies to import US devaluation and monetary stimulus....

My own hunch is that the next al-Qaeda strike will not be a symbolic blow to a great building or city, but rather a carefully-timed economic blow: either by cutting – or trying to cut - the oil jugular, or by trying to precipitate a run on the dollar

It is not all about you. The surface explanation is a highly probable explanation and is consistent with similiar patterns of behavior of high current account surplus countries that are either dollarized, dollar pegged or dollar reserve dominated to shift their assets and income out of dollars. Kuwait broke their dollar peg in May f this year to avoid the inflationary impact of low US interest rates while their foreign trade in oil has continued to boom. The common currency discussion group for the GCC has talked about breaking the dollar peg; South Korea has been trying (unsuccessfully) repeatedly to get off the soft dollar peg cartel lead by Chinese central bank accumulations. OPEC as a whole is thinking about pricing some of their oil in Euros instead of dollars.

The motivations vary between countries but locking or banding around the dollar was supposed to provide some type of advantage compared to other options. For Saudi Arabia and other oil producing countries, the advantage was the removal of exchange rate risk and increased stability of income to allow for better access to foreign financial markets to finance imports. For that to work, the dollar has to be relatively stable and credible. The past couple of years has seen a stable downward trend in the dollar and an uncredible US government. The advantage just is not there, and the price to be paid for irresponsibility is inflation.

Much like anyone else, the Saudi clerics don't like paying for mistakes (even their own), but especially paying the consequences of someone elses' action. Removing the dollar peg is a way for the Saudis to avoid paying for US excesses. It is not a grand scheme or conspiracy, or a terrorist plot to create a momentary and unjustified domino run on the dollar. It is a reflection of reality.

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