A good omen for the region?

Barack Hussein Obama will probably find getting elected president of the United States easy in comparison to the uphill struggle he is going to face in dealing with the American economy as it enters a second year of recession.

Indeed, it is all too easy to forget that a regime change in the world's most important country is coming up this autumn, and that by January next year President George W Bush will have taken his place in history. US Treasury Secretary Henry Paulson's visit to the region this week is not exactly a farewell tour but he is shoring up support for an administration in its twilight months.

What is the face of things to come? We can be fairly confident that Barack Obama will secure the Democratic nomination, and that Americans will vote for a change rather than a continuation of the Bush administration's policies. But that does leave us at sea in terms of knowing how US economic policy will proceed as the past will no longer be a precedent for the future.

Usually Democratic politicians make a great many promises in their election campaigns that they either have no intention of fulfilling or no hope of doing so due to circumstances. So what kind of economy will President Obama inherit on his accession to the White House?

With house prices falling, consumer price inflation rising due to high oil prices and the financial sector in intensive care, the omens are not good for the First 100 Days or even the first couple of years for that matter. Wall Street is also currently pricing in a shallow recession and is liable to make a dramatic reassessment of the outlook for the new president, either just before or shortly after he is elected.

There is also the danger of exaggerated hopes that are the very muscle and sinew of a presidential election campaign. But which can rebound badly if those hopes are not quickly fulfilled, and the American population is not known for its patience. Bad news then if you are the living embodiment of national hopes and then disappoint.

In the Middle East, countries are enjoying an oil boom this year with record oil prices and revenues filling the national treasuries. It is a debatable point as to what has caused this oil price boom. But with no sign of oil actually being in short supply the finger must surely point at speculation driven by low interest rates – a deliberate policy by the US Federal Reserve to shore up the economy in an election year and protect against a collapse in the banking system.

At the same time the economic cost of high oil prices for the Middle East is that the same low interest rates are driving local inflation higher and higher. In Qatar and the UAE economists reckon inflation is now close to 20 per cent, and even Saudi Arabia has acknowledged double-digit inflation for the first time since the 1970s. The bedfellow of high consumer price inflation is a real estate boom with massive year-on-year price gains as supply struggles to keep up with demand.

A new US administration is not going to be able to wave a magic wand and change the economic environment it inherits overnight. Most experts do not expect US house prices to stop declining until the middle of next year at the earliest, as there is a huge unsold inventory depressing this market. Thus any notion that the US might hike interest rates quickly to curb inflation is probably false as the continuation of low interest rates will be essential to prevent a bad economic situation getting even worse. In truth, as the second half of 2008 pans out we are almost certainly going to see more and more consequences of the recent financial crisis in terms of weaker business and failure for non-financial and non-housing companies; again this will not be conducive to creating the sort of economic environment where the economy revives in 2009 and interest rates can be quickly raised.

For the Gulf states this means the misery of imported inflation is not about to go away with the election of a new president. Low interest rates will persist for far longer than generally expected, devaluing the dollar still further and inflicting wholly inappropriate interest rates on the region for another year or two. Local inflation will therefore increase again, and real estate prices will take another lurch upwards. It would not be surprising if pockets of local real estate become among the most highly valued in the world. The completion of the Burj Dubai in mid-2009 as the world's tallest building could mark a new high point in the real estate boom that has enveloped the region since the early 2000s.

One reason for the continuation of super low US interest rates is that the domestic economy will stay stuck in recession due to house price falls and the credit squeeze from the financial sector. This recession will to some extent dampen domestic inflationary pressures but only at the cost of squeezing corporate profit margins sharply, undermining the value of US stocks. Oil prices, on the other hand, will remain surprisingly high considering the recessionary impact on demand because prices will be supported by loose monetary policy and the availability of cheap money for speculation in commodity markets.

Is there anything a new US administration could do about this? Probably not much in the short term, although it could, of course, take decisions that would make the situation dramatically worse, such as suddenly cutting back public expenditure. But we should expect to see a whole raft of oil-substitution policies emerging from the White House that would have an impact over time, though not for a couple of years. Who knows some inspiring statements might also help stir the animal spirits of America into action.

However, the new president is also going to face foreign policy challenges that impact directly on the oil price, inflation levels and economic well-being. There will be the decision as to whether or how to exit Iraq, how to handle Iran's nuclear programme and the whole stalled Middle East peace process. It is here that one man could make a difference. Just as Tony Blair managed to bring peace in Northern Ireland after a generation of civil unrest, so it is not impossible that a fresh approach could work a miracle.

Let us end on this optimistic note. Could the next US president pacify the Middle East and bring a new era of peace and prosperity on the back of the current oil boom? Certainly if the barriers to investment came down and the divisions were healed then the economic impact would be similar to the ending of the partition of Europe in the 1990s. And there would be a great deal of business opportunities for US multinationals in the rebuilding and renaissance of the region.

This is a great deal of hope to pin on one individual to deliver, and the historical forces at play are probably too strong to overcome. But if leaders in the region decided to rally round a new US president to achieve a new status quo then anything is possible.

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