Holding fort for the dollar peg

As vaudeville routines go, it made something of a contrast to the previous item on the programme.

Anyone in Abu Dhabi listening to US Treasury Secretary Henry Paulson might have been forgiven for wondering if he represented the same administration as President George W. Bush, who had recently visited the region to attempt to elbow Saudi Arabia into opening its taps.

With all the charm of a polished matinee idol, Paulson seemed to gloss over that little spat. He empathised - Gulf producers "can't alone alleviate" the price of oil. He flattered - the US would like to "benefit from sovereign wealth fund investments".

He even mildly cajoled - "we are urging all oil-producing countries to open markets to foreign investment, which would support faster and more efficient growth." In short, he did everything possible to avoid direct criticism of Gulf oil producers, in marked contrast to his employer and a rancorous Congress back home.

Talking it up

This was all entre'e to the main purpose of Paulson's visit though: persuading Gulf rulers to keep their currencies pegged to the dollar. "There's quite an awareness that the dollar peg does not influence inflation to a significant degree," Paulson told reporters. "Ending the peg is not the solution to the inflation problem," he added, demonstrating a politician's gift for syllogism.

Paulson's reward for his labours came on June 4, when after a meeting with Shaikh Mohammad Bin Rashid Al Maktoum, Vice-President and Prime Minister and Ruler of Dubai, the latter announced that the UAE would maintain its dollar peg for as long as it serves the interests of the economy. Paulson needn't have bothered. Had the US administration truly been under any anxiety that the leaders of the GCC might follow Kuwait in dumping the greenback, they need only have read the news.

On April 8, Sultan Bin Nasser Al Suwaidi, Governor of the UAE Central Bank, told the press the country had "no intention whatsoever to depart from the peg or revalue the currency in any way."

Even more emphatically, also in April, Qatari officials were reported as saying the GCC single currency, planned for 2010, would be dollar pegged. The dollar's position has not altered radically in the space of two months.

Truth be told, the GCC (excluding Kuwait) was always going to stay with the greenback - not out of any fondness for the currency, or even because it remains the best option, but because to drop the peg now would be to expose economies which are theoretically attempting to converge to unnecessary trauma. Moreover, the GCC is locked into the dollar, and even a revaluation would potentially do more harm than good - how much value would be wiped off GCC dollar-denominated assets if the market took this as a further sign of dollar retreat?

Bulging deficit

Hard pragmatism dictates economic policy in the GCC, just as it does in the US. Hank Paulson may say that the Bush administration would prefer a strong dollar, but everyone knows that kind of talk is for the birds. The US has a current account deficit approaching three-quarters of a trillion dollars, but by a stroke of luck it also has the keys to the printing press of the world's reserve currency.

No one is surprised it acts the way it does. Yet neither does it wish to lose the dollar's position as global reserve currency. This is, in effect, where the balance is struck. The strongest card the central bankers of the GCC have is the knowledge among men such as Paulson that their patience is finite.

- The writer is Middle East specialist and Oxford Business Group's regional editor in the GCC.