Echoes of 1967 as the Gulf prepares to dump the dollar

12 October 2007
In a sequence of disasters, Britain's Middle East empire disintegrated in the quarter century following the end of the Second World War. London reneged on its promises by withdrawing precipitately from Palestine in May 1948 and allowing almost 60 per cent of its non-Jewish population to be driven out in 12 months. In October 1956, it ganged up with France and Israel against Egypt and failed.
But the final blow to its Middle East prestige was delivered on 18 November 1967 when the UK devalued sterling against the dollar by 14 per cent. No one warned Abu Dhabi, Kuwait, Qatar and other Middle East members of the Sterling Area. They had their savings in pounds and lost

a fortune.

Gulf leaders were furious and reacted by abandoning the pound for the dollar. When the UAE launched the dirham in 1973, it was effectively linked to the US currency, not sterling.

History is about to repeat itself with the dwindling dollar in the same position as the pound was 40 years ago.

Sooner rather than later, the oil-rich countries of the Gulf are going to dump the US dollar for something better. The only substantial difference between then and now is that the alternative is not so obvious.

The economic arguments for ending the dollar connection are almost overwhelming.

The per capita productivity of oil-exporting Middle East nations has nearly doubled in the past five years mainly, though not exclusively, because of high oil prices and buoyant world

oil demand.

Over the same period, the GCC has recorded more than half a trillion dollars in balance of payments surpluses. In contrast, US debts and deficits have ballooned.

The Gulf and US economies are heading in opposite directions. The priority for Washington is fending off recession. For most of the GCC, it is containing inflation. That means currency divorce must inevitably come.

When it does, the turning point may well be seen as 18 September 2007, when the US Federal Reserve Board cut interest rates by half a percentage point, a move that precipitated a further decline in the value of the US currency. It was good for most Americans, at least in the short term. But for the GCC, which has accumulated record volumes of dollar-denominated assets, it was nothing less than a US tax on their savings to help pay for the consequences of the irresponsible behaviour

of US banks and borrowers.

It was a yet another slap in the face for the most loyal investors in the US economy.

But it is not just about economics. The US is organising a Middle East peace summit next month, but hopes of a breakthrough are fading.

The 2008 presidential campaign, already in full swing, will be dominated by candidates straining every fibre to win the pro-Israel vote. This is not a season for US politicians who are friends of the rest of the Middle East.

Since the Fed cut rates, there have been reports that Qatar has started shifting its assets out of the dollar. It is likely that other Gulf states are doing the same, but more gradually.

This is laying the groundwork for the five

GCC countries that have not ended the dollar peg to take the first step in that direction by revaluing their currencies. As surely as night follows day, the complete end of the dollar peg will then ensue.

Some are in a bigger hurry than others. Kuwait abandoned the peg in May, which may have contributed to a rise of almost 25 per cent in the Kuwait Stock Exchange (KSE) index since then.

The next candidates will be Qatar and the UAE. Revaluation will help temper inflationary pressures. Practically everyone in both countries will feel instantly richer.

Bahrain will move with Saudi Arabia, which has less to gain from revaluing the riyal immediately against the dollar. Oman's position is harder to place. It will tend to go with the GCC flow, but in its own time.

The Gulf's dollar era is not yet over. But a hi

A MEED Subscription...

Subscribe or upgrade your current package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications