First with Financial Comment from Arabia

Arabian Gold: will the Gulf go for revaluation and a gold standard?

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gold_1004967cTalk about revaluation of the Gulf currencies is back on the agenda as rising inflation exerts pressure on the Gulf dollar pegs, while at the same time rumors of discussions about linking a new single currency to a gold standard have been so emphatically denied that skeptics wonder if there is some truth in it.

Over the past year Gulf States have seen inflation retreat from the double-digit levels of the oil boom years. But with oil prices having more than doubled since a low last December, those inflationary forces could be about to reassert themselves.

Dollar pegs

The problem for GCC countries is that with all but one of their currencies pegged to the dollar this means that US dollar weakness is automatically imported whatever the local conditions. In the boom period that meant artificially high inflation rates, also fueled by the associated direct link to US interest rates that stayed low for far longer than was healthy for Gulf economies.

Now that some semblance of recovery can be discerned in the global economy, and with the IMF forecasting better times ahead in 2010, the Gulf States might choose to learn from their recent experience and move to a different currency regime.

The time is ripe as four of the six GCC countries are committed to currency unification as early as next year, although this looks impossible to achieve in practice. This would seem a good period to contemplate a break with the dollar peg, perhaps following the Kuwaiti example of a basket of currencies rather than sticking with the peg as the Saudi Arabians appear to favor.

Broadening the Kuwaiti currency basket model to include gold is also worth serious consideration. Gold is a traditional anchor currency and appreciated for its fixed supply in an era of fiat money printing.

Dollar-denominated assets

However, the Gulf States keep a large proportion of their huge overseas assets in dollar denominated assets, and the danger of revaluation is that it undermines the value of these reserves in local currency terms. That has always been the argument from the UAE side for maintaining the status quo.

So it would be surprising if the Gulf States took the lead in revaluation and creating a new gold standard currency. Presently the six GCC countries are unable to agree on a new common currency, let alone a more radical shift like revaluation and a gold standard.

But if other nations like Russia and China took a lead in currency reform that might well put these ideas higher up the policy agenda.

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Written by Peter Cooper

October 21, 2009 at 8:25 am

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