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CiteThey are also getting close to a record low v. the euro.
Yet oil is, well, still rather strong. Against the dollar. But also against the pound and euro. The euro and pound have gained significantly on the dollar over the past few years, but oil has gained even more.
A little while back I noted that the impact of China's depreciation against the euro (really Asia's depreciation against the euro, as most of Asia still tracks the dollar and the yen is rather weak) on trade and investment flows was an under-reported story (That may be changing: see Keith Bradsher's new story in the New York Times).
I also suspect the impact of inappropriate currency pegs – like the de facto currency union between the world's biggest oil importer and the world's biggest oil exporter – is an under-reported story.
Inflation is now rising throughout the Gulf. Quite significantly in some places. A weaker dollar (riyal, dinar, dirham) is the last thing the Gulf countries need now that they are really starting to spend their oil windfall.
The Kuwaitis seem to get this – even if they are (perhaps) constrained by the GCC’s commitment to peg to the dollar in advance of their planned (but increasingly unlikely) currency union. The Saudis, well, not so much.
John Sfakianakis of the Saudi Arabian British Bank just issued a long report arguing against a revaluation (hat tip, Mikka Pineda). A key argument: imported inflation from the dollar’s 12.5% slide v. the euro can not possibly explain a 40% increase in retail prices. (40%!) And since imported inflation is overstated, so too is the case for a revaluation. John Gamble of SAMBA — another Saudi Bank — went through the full range of possible inflation fighting tools in a recent report. He though rather cursorily dismissed a revaluation on the grounds that its wide ranging economic impact made it an inappropriate tool.
I wasn’t convinced. The dollar’s slide may not explain the rise Saudi inflation – which likely reflects a fall in “fiscal” sterilization as the Saudis have started to spend more of the windfall from the rise in oil prices. As more of the oil windfall converted into riyal and spent locally, money growth has picked up (Saudi m3 growth was close to 20% in 2006). That is the core reason for the pick-up in inflation.
But a weaker dollar certainly didn’t help. And the wide-ranging economic impact of a revaluation is precisely why it is an effective inflation-fighting tool.
The details reported in the Sfakianakis paper left me more convinced that the Saudi data – which shows a 3.5% y/y increase in prices – understates actual inflation. Some tidbits:
- The price of a schawarma sandwich is up 30% in the last 18 months.
- Fresh fruit prices are up between 50 and 80% (y/y), and vegetable prices are up 20-40%, according to an informal survey. It seems that higher paying construction jobs are pulling imported labor out of agriculture (cement factories are at 100% of capacity).
- Beef prices are up 15%, Fish prices are up 20-35% (all y/y).
- Rents in Riyadh are up 20-25% y/y
- Wages for high-end construction jobs are up 50% — and Saudi contractors are complaining of a shortage of imported labor at the low-end.
All in all, that doesn’t sound to me like an economy with 3.5% inflation, even if the price of a telephone call is falling. A cut in fuel prices (yes, a cut — nothing like sitting on a big pool of oil) in 2006 did help hold down 2006 inflation, but no further cuts are expected in 2007 …
According to the official data, the Saudi Riyal depreciated 20% in real terms from 2002 through 2005. The riyal even depreciated in real terms against the dollar – if you believe the data – as Saudi inflation was well under 1% a year during this period (SAMBA has the details), while US inflation was a lot higher.
I don’t believe the data. I suspect inflation was a bit higher in 2005 than reported – and a lot higher than reported in 2006, so the overall real depreciation is a lot smaller. And inflationary pressures have not disappeared.
Especially not if the Saudis insist on following the dollar down.
It would be kind of ironic if the dollar’s weakness – which at a minimum is adding to inflationary pressures in the Gulf – reflects petro-states shifting their investment portfolios toward euros and pounds. I don’t have a clue what SAMA (the Saudi Arabian Monetary Agency) is doing with its $200b plus of foreign assets, but some data Rachel Ziemba and I have pulled together suggests that the big Gulf investment funds do have a relatively low dollar share in their portfolio.
And we know the Russians have been shifting funds toward the euro and the pound. But the Russians peg to a basket – not just to the dollar!
Then again, I suspect some market analysts confuse the ongoing dollar sales oil funds – and central banks – need to make in order to keep the dollar share of their portfolio from rising (the oil states get paid in dollars, most central banks intervene in dollars) with diversification. There is a difference. Diversification means lowering your dollar share, not selling just enough of all the new dollars coming in to keep the dollar share of your portfolio from rising.
And the way dollars are flowing into central banks (the Russia's reserves rose by $7.6b in the first week in April), they have to sell a few dollars just to maintain their existing currency split.
The dollars the Russians sell “just to maintain their existing currency split” are only a fraction of the dollars they buy (via their customers) in global currency markets.
Example. If, say, Germany buys from Russia the oil equivalent of 100$, since oil is proced in $ Gernamy has first to buy 100$ (by selling Euros) –> This is dollar positive by 100$. Then it swaps 100$ to russians in exchange for oil –> this is dollar neutral. Then Russians will sell 50$ (suppose all against Euros) to diversify their curreny reserves –> This is dollar negative by 50$. This whole process of oil trade is $-supportive by 50$, not $-weakening.
So what happens in currency mkts when oil price goes up is dollar-positive!!.
To turn the overall effect of an oil shock on exchange rates from “$-positive” to broadly “neutral” (and sometimes even slightly negative), you need to add goods mkts. When, say, Russia swaps its currency reserves against goods & services via imports, assume, 100% from Europe, and they pay them with currency reserves that are 50% Euro and 50% $. Swapping the Euros for European goods does not cause any pressure on currency mkts, while swapping the remaining $-reserves for European goods causes a $ weakening (which in the example made compensates 1:1 the previous dollar buying, but if we change the exmple and insert the US oil imports, it could change the final balance of the exercise).
———
Oil countries are boosting their imports from China and Asia. That’s a change from previous oil shocks’ EU focus
What I mean is that this new (for the record) spending oil revenues in Asian goods is the other side of this oil-shock supporting the dollar (against major currencies). For if Asian gov.s peg to the dollar, the more oil exporters buy their stuff the more their CBs buy dollars.
Gheorghius –
oil shocks haven’t consistently been dollar positive. There is also a big shift of funds from the US to oil exporters pockets, and then on to european goods and assets. the EU isn’t all that energy intensive relative to the US, Norway supplies a decent chunk of its energy and Russia, as you note, buys lots of European goods.
the more important point though is that the gulf states’ peg to a weakening dollar isn’t helping their macroeconomic management at a time when they are really spending much more of the recent oil windfall.
Yes, I agree. As I wrote, if you also consider the US in the exercise (and not just Russia and Europe), the oil shock may be on the whole $-negative.
My point is that oil shocks ARE certainly $-positive until oil revenues are spent (even a 50% diversification of official reserves is not enough to change this). If you play a little with the US shares of oil imports and the $ shares of oil exporter’s reserves you’ll quickly come to this conclusion.
But when oil revenues start to be spent in a substantial way, since little of them are spent in the US, this becomes dolalr negative. And I suppose that the current dollar slide is not just caused by interest rates’ changing outlook, but also by these “real” flows.
My second point is that all these currencies $-pegging around the world keep the dollar up not just against pegging currencies (such as RMB, etc), but also against other major currencies (These pegs are Euro positive, if we consider only the financial side).
The overall effect, though, is uncertain, since a breackdown of the (say Chinese) $-peg would also distribute more evenly the burden of supporting the US adjustment process. (This would be Euro-negative).
I also agree on the rest of your post, an on the central point you make that the peg does not help the internal macro adjustment of Gulf (Asian) states. As I wrote in a previous post, I witness an acceleration in exrate movements (dollar slide against European currencies), and I feel that this is only the beginning of a broader change. It will end up pulling the Yen up, that in turn will generate a breackdown of most $-pegs.
We all know these imbalances cannot grow forever, the point is the timing of the inevitable change, and the shape it will take. You know my views on this.
Nice piece Brad,
Most of us are of course behind the curve (i.e. me) compared to you but it is interesting to follow this. I mean, one of the pillars of Bretton Woods II is getting seriously strained here. Of course, the official sources you cite suggest that it will linger for now but any kind of adjustment in the internal macroeconomic environment within the petroexporters’ societies must clearly also bring fourth the fundamental question of the dollar peg providing of course that the dollar continues its downward trajectory …
which brings me to …
The general question of diversification into Euros (especially) is a bit artificial I think. Of course it is already a reality (a post coming here perhaps Brad :p?) but at the end of the day the yield on which this diversification is based epitomized by the tightening bias by the ECB won’t go on forever and indeed if push came to shove in terms of a major currency correction I would expect the ECB to hit the brakes pretty quickly, how could they do otherwise?
Here, the pound seems a much safer bet for some juicy yield gains with the recent inflation data from the UK.
Are central banks big buyers of euros and pounds?
answer: yes. they bought at least $200b in 06, and with reserve growth running at $1 trillion in q1, i would bet they are big buyers now. $200b is large relative to the combined current account balance of the eurozone and the uk.
Are central banks diversifying, i.e. buying enough euros and pounds to bring down the dollar share of their rapidly growing portfolios?
A: Best I can tell, in aggregate, no. A few (RBI?/ BOK?/ BoR?) potentially may be diversifying (BoR clearly diversified in q2/q3 06, the question is whether it is doing more), but some can reduce their $ share if others (PBoC????, BCB) are increasing their dollar share.
Q: Are oil investment funds already fairly diversified?
A: Best I can tell, yes. They potentially added $50b to the eurozone/ pound flows in 06.
Thanks for that Brad …
buying, yes … diversifying, no.
I’m convinced that the Gulf currencies are a good buy. The question is — how to buy them? I wish there was a dinar/dirham/riyal ETF, but I can’t find such a thing. Does anyone have any ideas how one can put dollars into Gulf currencies, without jumping through too many hoops?