Dollar slide: is the Gulf ready to cut loose? No doubt about it, the dollar is in trouble and things look set to get worse before they get better. With oil prices standing at $90+ a barrel, the coffers of oil-producing states are bulging, but in real terms the scenario is giving rise to serious and widespread concern

Middle East, The, Dec, 2007 by Pamela Ann Smith

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AS THE US dollar continued its sharp decline this autumn, investors around the world were waiting to see if the US Federal Reserve would act further to halt the slide and help curb the resulting big rises in the euro, sterling, Australian and Canadian dollars and other leading international currencies. While the fall in the value of the greenback has helped to push crude oil prices to record levels, many analysts feel that it has also fuelled a substantial rise in inflation in countries such as Saudi Arabia, Kuwait, Bahrain, the UAE and Qatar, whose riyals, dinars and dirhams are pegged to the US dollar. And that, in turn, has prompted increased pressure on Gulf governments to break their links with the US currency.

The dollar had already fallen to a record low of 1.43 against the euro in late October when the US treasury secretary, Hank Paulson, vetoed French, German and Italian plans to ask the G7 leading industrial nations to act together to halt the dollar's sharp decline. But by early November, after the US central bank had cut interest rates by a quarter of a percentage point to 4.5%, the currency was trading even lower, at more than 1.45 to the euro, setting yet another new record for the plunging greenback. Some analysts said it could fall still further, reaching 1.50 by the end of this year.

Sterling's intense climb against the dollar was stemmed by some unexpectedly weak news on the housing and manufacturing fronts, but was still trading in a range way above the psychological marker of two dollars to the pound, holding at around 2.08 in early November, near the 26-year high it had reached at the beginning of the month. Expectations of a possible rate cut by the Bank of England helped to keep it from climbing further, but few analysts were willing to rule out a renewed rise this year if the dollar's fall continued. The currencies of Australia, Canada and New Zealand, which have benefited from the worldwide rise in demand for wheat and foodstuffs, gold and other metals and minerals, as well as other commodities, also strengthened sharply in the autumn. The Australian dollar reached a 24-year high of 0.92 against its US counterpart even before the country's central bank met to consider a rise in interest rates, a move that would make the currency even more attractive to international investors. Canada's dollar also climbed dramatically, and surging oil prices gave it additional upward momentum even after it jumped 3% in one week alone to above 0.93 in early November.

While the renewed onslaught of the credit crunch in the US, which has also affected European banks such as Credit Suisse and UBS as well as Citicorp, Merrill Lynch, Goldman Sachs, Morgan Stanley and Bank of America of the US, was a major factor pushing both US share prices and the dollar downward, analysts also pointed out that the huge rise in crude oil prices was another factor. Because oil is traded internationally in US dollars, a fall in the currency means that the price of each barrel goes up in dollar terms regardless of the underlying supply and demand situation.

Fears of a US military confrontation with Iran, which would affect the vital oil tanker shipping lanes in the Straits of Hormuz, martial law in Pakistan and pipeline attacks in Yemen, along with rising demand from China and India, cuts in North Sea and Mexican production and inventory drawdowns in the US ahead of winter had already seen the price rise 35% from $71 at the beginning of July to $96 in early November. Talk of the $100 barrel, heard since this summer, was quickly overtaken in some financial circles by speculation that the price could reach $105 a barrel by the end of this year, before falling back sharply in the first quarter of next year.

"Market participants believe that the global decline in stocks in the third quarter will be followed by a further fall in the fourth quarter," commented Mike Wittner, global head of oil research at the French bank, Societe Generale. "Recent price action is choppy but clearly the momentum is upward."

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That would add still more revenue to the overflowing coffers of the GCC's exporting governments, given that the dollar price of crude has virtually quadrupled in the past four years. Even before the latest oil price rises, Saudi Arabia's Samba Financial Group had estimated that the Gulf states would accrue a surplus of more than $500bn this year. Another surge in revenue would intensify the need of the GCC's sovereign wealth funds to find suitable investments both regionally and internationally in which to place these escalating sums, particularly at a time when US bonds are weakening.

Which is why some OPEC ministers are reported to favour a more stable oil price of around $90 a barrel, or, as the organisation's president, Mohammed bin Dhaen Al Hamli, put it at the end of October, OPEC is "concerned about high oil prices". After a meeting scheduled for Riyadh in mid-November, OPEC ministers were due to confer again in Abu Dhabi early this month.