Greenspan gives green light to depeg

So what are we to make of Greenspan’s statements on his visit to the Gulf recently, when he appeared to give the blessing of the US economic establishment – of which he is still a leading member, despite the fact he no longer speaks officially for it as head of the Fed – to the proposition that it was time to de-peg the dollar from Gulf

currencies?

His remarks about clarity arose from his habit, while in office, of making delphic comments that had the power to move markets and transform economic policy in the space of a few words. The famous 1996 remark about “irrational exuberance” was the best example of such a remark – it set the tone for US monetary policy for the next few years, until the American market got carried away in the

His opinions on the dollar peg with GCC countries seemed clear enough. In Abu Dhabi he said: “Depegging is probably the most useful thing that can be done to stop the increasing influence of foreign assets on the monetary system and therefore the monetary base, which is basically the major force in inflationary pressures.”

He seemed to reinforce this message in another speech in Jeddah: “In the short term free-floating [of the Gulf dollar-pegged currencies] will not fully dissipate inflationary pressures, although it would significantly do so.”

Well, all that seems pretty clear to me. Unless Greenspan was engaging in some special version of doublespeak, it appears that he believes the Gulf currencies should be allowed to float freely against the dollar, and this would relieve inflationary pressures in the Gulf and around the world. Depegging could alter the global mathematics of inflation in two significant ways: first, it would remove the pressure on Gulf states to follow US monetary policy in cutting interests rates, generally assumed to be an inflation-importing factor in the UAE, Saudi Arabia and the other Gulf countries committed to the peg. (Kuwait and Qatar seem to have the strongest reservations at

Second – and there is no universal agreement among economics on this – depegging, accompanied by a rethink on the oil industry standard of setting crude prices in dollars, might also help to alleviate the faltering state of the US economy by setting a more realistic absolute value for the price of oil.

Free-floating could bring benefits for the industrial corporations worried about violent fluctuations in energy costs.

These are the assumptions behind Greenspan’s apparent conversion to the ranks of the depeggers. There are reservations and doubts, however. In the UAE, for example, rising property values are generally regarded as the main inflationary pressure, rather than the “imported” inflation, which results from Fed monetary policy.

And it is by no means certain free-floating Gulf currencies and oil priced in a “basket” of currencies rather than dollars would mean cheaper energy costs for the American economy.

But Greenspan’s comments have one further implication, which could just be the clincher for those in the Gulf who want some re-ordering of the dollar peg. The conclusive counter-argument to the depeggers has always been that foreign investment from and trade with the US would be damaged by any move to break free from the US currency. The fact that an American economist of Greenspan’s stature is now apparently giving it his blessing will only increase the pressure on the GCC Governments to break the link.