Worldy Wise: Dollar not likely to collapse

Consistency is the only sure bait when you're angling for sustainable growth. For the UAE, that has meant pegging the value of its currency to the dollar for the last three decades.

But as gold prices hit record highs — widely considered a sign of a lack of faith in the value of American money — important questions must be asked. For instance, is the dollar heading for a dangerous collapse and will this lead the UAE uncoupling from the US currency any time soon?

On both fronts the short answer is, "I don't think so". However, there are reasons why some support a switch in Emirati monetary policy.

Firstly — and this is for anybody that has been living under a rock for over the last year — an ominous pall hangs thick over the American economy.

Although things have improved, the dollar has still depreciated for the past six months, hitting its lowest point against a basket of currencies in 14 months in late October.

And because of the peg, as it declines in value, so too does the dirham. Moreover, oil revenues, which account for around 30 per cent of UAE GDP, are priced in the American currency. So when the dollar falls, the UAE suffers a loss of purchasing power relative to other currencies, such as the euro.

Secondly, on November 4 the Federal Reserve, the US central bank, announced that economic improvement would not be enough to justify a rate hike.

This "zero interest rate policy" set by US monetary experts, which essentially prices the cost of borrowing in the UAE too because of the coupling, could resurrect domestic inflationary pressures, especially if Emirati businesses register strong growth in 2010.

Monetary union

Finally, the UAE's reversal on GCC monetary union is another reason to delink. Emirati policymakers are no longer obliged to assess the impact their de-pegging would have on the proposed unified monetary system. Simply put, monetary experts are free to choose their own path.

Despite this, however, it is unlikely they will. The primary reason being the dollar's pre-eminence as a global currency. Most of the talk regarding its demise has been of the hot air variety.

Yes, the American currency has a lot on its plate, not least of all Washington's egregious public deficit. But neither the yuan nor the euro are in a position to take over as the world's reserve currency.

Also, what many Jeremiahs forget is that during the depths of the crisis in the US most investors rallied to the safety of Treasury bills.

As ill fated Lehman Bothers headed to its demise and the stock markets reached their nadir, the US dollar soared. Basically, investors saw the greenback as a secure option in times of financial disaster.

Since then, the dollar's decline has been systematic and in many ways is simply returning to levels similar to before the financial quagmire. Its depreciation may have caused a great flap but it is far from a crisis of confidence.

Policymakers in the UAE recognise this, as they have seen currency fluctuations before. They are also keen to point out that pegging the dirham to the dollar has, generally speaking, served them well over the years.

More to the point, a change in policy could actually be risky for the Emirates by discouraging foreign direct investment. After all, multinational investors are strategic by nature, so they would surely adopt a "wait and see" policy until they could judge the impact of a new exchange rate.

Perhaps even more importantly though, is the UAE's economic outlook. According to comments from the central bank late last month economic expansion could exceed 4.5 per cent in 2010, while inflation is not expected to be a problem. Against such a backdrop a shift in monetary policy seems unlikely.

In addition, the central bank in the UAE has a long history of adopting steady policies. So, something as significant as delinking the currency will not happen in a knee-jerk fashion due to market speculation.

Of course, that is not to say the authorities will not be monitoring the situation carefully. At this stage worries of a collapsing dollar are premature.

Nevertheless, if it continues to sink in value policymakers here are likely to be prudent. The orders given will probably be, "Don't jump ship — but do keep an eye on the life rafts".

Trevor McFarlane is editorial manager of Oxford Business Group, Abu Dhabi.