Brad Setser

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The Gulf’s inflationary monetary-fiscal-policy spiral ….

by Brad Setser
August 3, 2008

The Gulf has — by virtue of its peg to the dollar — entered into an era of “single digit interest rates and double digit inflation.” So writes the Global Financial House in its report on the Gulf’s economic outlook:

the region would have to “live with the paradox of single-digit interest rates and high double-digit inflation”, said Ala’a al-Yousuf, Chief Economist at GFH.

Moreover, loose monetary policy is generating pressure to loosen fiscal policy, as it is hard to explain why real wages for government workers are falling when oil revenue is soaring. That too will add to inflationary pressure:

So far, the government response to spiralling inflation has been in the form of higher wages, increased subsidies and other cash incentives, the report said, in the absence of any relief from the currency effect of the dollar peg.

“In our opinion, the GCC is entering a phase of loose monetary-fiscal policy spiral, which, together with a wage-inflation spiral, have trapped the region between two impossible trinities,” said Hany Genena, Senior Economist at GFH.

Government spending is set to rise 25% this year, reaching $300 billion. That is roughly half of the Gulf’s likely oil export revenues, assuming roughly 15 mbd of exports, an average oil price of around $120 for the year and $5 a barrel production costs. And that total leaves out — I think — a lot of government sponsored investment projects.

No wonder the region is booming. Monetary and fiscal policies are both wildly expansionary. This will, over time, help to reduce the oil exporters surplus and thus facilitate global adjustment. But it also risks laying the ground for big problems if the price of oil turns down.

Letting the exchange rate adjust up — and down — with the price of oil still seems to me to be a better way of managing commodity price volatility.

One thing though is clear: at current oil prices, the small Gulf states are once again fabulously wealthy.

Qatar’s per capita GDP is expected to top $100,000 soon. If Qatar’s GDP was calculated in way that excluded the income of the guest workers who live in Qatar but have no claim on the oil revenue, the per capita GDP of native-born Qataris would be far higher. So too the per capita GDP of the half a million or so residents of Abu Dhabi who get a cut of the emirate’s roughly $100 billion in current oil revenue. I think that works out to something like $200,000 a year in oil revenue per Abu Dhabian.

In a lot of ways, the immense current profits from oil production makes it harder to stop inflation. Everyone knows the money to pay higher salaries is there …


  • Posted by mark turner

    Gov’t policy sounds just like Venezuela, Brad (except that gov’t wages are staying in line with inflation).

    A thought: Does this lower the possibility of a downturn in oil prices (style of self-fulfilling prophecy)?

  • Posted by Dave Chiang

    Global Inflation may slow due to a deflationary credit bubble collapse led by the United States that is beginning to infect the rest of the world

    The national export machine, so recently invincible, is shuddering under the weight of America’s collapse in consumer confidence, while some look at the massive investment that has accompanied Beijing’s ultra-ambitious approach to the Olympic Games – $43bn (£22bn), according to official figures – and assume any such bubble must inevitably burst.

    Property prices are already falling, though notoriously unreliable statistics make it hard to say by how much. Even President Hu Jintao felt compelled to admit at a pre-Olympics press conference on Friday that tough times lay ahead.

    “Uncertainties and destabilising factors in the international environment are increasing,” he said. “China’s domestic economy is facing increasing challenges and difficulties”, stated President Hu Jintao.

  • Posted by AJ

    Since the Gulf states are in something of a defacto monetary union with the US their expansionary policies would seem to have something of a stabilizing effect on the dollar, ie. they’re trading dollars to buy Mercedes-Benz’s and Volvo industrial trucks, or whatever. It doesn’t seem to be the most prudent way of rebalancing, but it’s perhaps better than plowing the dollars into a new US credit bubble.

  • Posted by bsetser

    Mark — if the Gulf states had different politics (i.e. leftie … ) and weren’t generating tons of revenue for the world’s i-banks and PE firms, i suspect their current policy mix would be compared to Venezuela’s. There are a lot of similarities (including a link to the dollar).

    I suspect that the fiscal expansion in the gulf means that the states with market power will remove production from the market to support a higher price than in the past … and there large financial warchests give them the capacity to handle temporary dips in revenue from taking a bit of capacity offline.

    and yes, spending rather than saving does have the virtue of creating demand for germany goods rather than us financial assets, and thus works against the creation of a new bubble. but even if the Gulf is spending at a clip where its current account balances with $60 or $70 oil it would still be buying way more financial assets than ever before, just because of $125 a barrel oil

  • Posted by Rien Huizer

    I m still not convinced that we are looking at the right issue here. (1) there are three different country types here (1) Emirates, Qatar, Kuwait: small number of citizens, other residents have little security but of course if a forrced emigration became necessary, some non-citizens (mercenaries etc) would have to be loyal. The point is that these places do not need a population, except perhaps to symbolize tenancy We australians know the fly in fly out miner, Abu Dhabi could have fly in fly out citizens who would occasionally
    leave London or wherever to do citizen duty
    (2) Saudi: complicated. Many not so rich Saudi citizens, large number of potentially dangerous Yemenis, two stes of armed forced with non compatible armament. Too complicated to discuss here.
    (3) Bahrain and Dubai: little oil or gas but lots of offshore services, catering for Saudis and subcontinentals (in fact Dubai is probably to the former British India (what a waste that Britain withdrew much too early) what Singapore is
    to Indonesia etc. Bahrein and Dubai have ral, service economies and those economis may well be the most vulnerable in the current encironment.

    As far as I can see, for Abu Dhabi (sans Dubai) the exchnge rate i pretty unimportant. For Dubai it is important because the locals who depend on income from local sources are affected by the unintended effects of the peg. For Bahrain it is even more important because it is not in the Emirates.

    Saudi should have its own currency and also a domestic economy not entirely dependent on oil. However forty years of trying have has little effect. But this is really a difficult country with a variety of tribes, a kind of Vatican status within Islam, etc. Very understandable that US policymaking vs Saudi is so extraordinarily difficult to evaluate.

    Depending on further developments in Iraq and possibly Iran (all that wealth must have some effect there) Kuwait is different again, but it is no longer a dumb pegger. Itis also politically different from the others.

    All in all, not easy as always, only one clear case for change, Saudi. And that one should for the benefit of civilization as we know it (Western that is) change as little as possible. Anyway, their citizens are welcome in our cities.

  • Posted by Dave Chiang

    State-owned China Sinopec to buy British Imperial Energy for $2.2 billion in cash

    SHANGHAI, China (AP) — Independent oil and gas group Imperial Energy Corp. PLC confirmed Monday that it has received an approach regarding another “possible cash offer” for the company.

    London’s Sunday Telegraph reported over the weekend that Imperial had agreed to let Sinopec (SHI) begin due diligence on a possible offer for Imperial, valued at 1.1 billion pounds ($2.2 billion). The report did not give the source of the information.

    According to its Web site, Imperial Energy, founded in 2004, is an independent oil and gas exploration company with holdings mainly in western Siberia and Kazakhstan.

  • Posted by Rien Huizer

    DC, yr # 6 (that many may Follow). This is indeed highly relevant for our topic . When is Sinopec going to be more that 40% foreign -owned, like most US oil majors?
    Incidentally, one would wish he poor Sinopec mnagers luck with concessions in those areas. No doubt Imperial’s british shareholders will cheer when someone takes this merchandise off their hands.

  • Posted by bsetser

    Rien — I agree that Saudi is very different from the one tribe and 2 mbd of oil states (or in the case of Qatar, 1 mbd of oil and a lot of gas). But i would still think that these states would benefit from a currency that moved with oil rather than one that moved down when oil went up — i.e. all of these states are experiencing very negative real rates due to high inflation, which fuels a broad boom but creates risks, even in places that are phenomenally wealthy. And I would argue that Dubai is more to Pakistan (and Perhaps Iran) what Singapore is to Indonesia … and then it is also a place for westerns and locals alike to get a drink in a very dry region ..

  • Posted by Dave Chiang

    The situation in many developing nations is desperate in part because the International Monetary Fund, under the “ Washington consensus”.

    “As architects of the global economy, the World Bank and the IMF have enormous power and shape the conditions of peoples’ lives around the world. That power has been used to create a global economy friendly to the interests of the wealthy and multinational corporations, but devastating to the lives of hundreds of millions of impoverished people.

    “The IMF and World Bank, with the ‘structural adjustment programs’ (SAPs) they impose on indebted countries and their pro-corporate development projects, are the leading edge of oppressive globalization. The policies they have imposed in Africa, Latin America, and Asia have condemned people to stagnation, poverty, and death for twenty years, and those policies are now being adopted in the countries of Europe and North America too.” (Human Quest May/June 2001).

    Speaking of IMF’s directors and economists, Brutus writes:

    “Although some of them may have tricked themselves into believing that the neo-liberal economic model they defend is immutable, like a law of nature, most of them probably know that they are perpetrating a fraud of global proportions. Michael Camdessus, who retired after thirteen years as Managing Director of the IMF, told a group of U.S. religious leaders that he was willing to ‘sacrifice a generation’ in order to realize the so-called benefits of the macroeconomic model.”

  • Posted by Sam

    DC – we understand you abhor the Washington consensus of free trade, flexible currencies, and solid property rights. And further we understand that you espouse the Chinese model of currency micro-manipulation, dubious property rights, and industry favoritism. The macroeconomic trajectories of Brazil and Russia will be interesting from this vantage point. Anything of substance to add to inflationary policies in the Middle East? The building and investment-intensive growth model parallels that of China. Lots of office space and capacity to be filled. I know lots of very savvy short sellers are looking to short the banks that have financed the infrastructure boom in the Middle East and China. They could be wrong, but if they are right…

  • Posted by Twofish

    Sam: Chinese model of currency micro-manipulation, dubious property rights, and industry favoritism.

    Actually that isn’t the Chinese model at all. One problem with talking in terms of “pro/anti-Washington Consensus” is that China has accepted some parts of the WC and rejected others. This also makes it very difficult to do cross-national policy comparisons, because there isn’t one axis, there are about fifty.

    The problem with trying to look at the Gulf States in terms of the “Beijing model” of the “Washington Consensus” whatever that is, is that China has a huge number of people, and for the most part the Gulf States do not. One thing that is the case in China is that you have large numbers of people holding RMB, whereas I suspect that in the Gulf States, most people deal with dollars anyway so that no one really cares that much what happens to the local currency.

    Also unlike China where changing the RMB exchange rate does sharply change the balance of payments. I don’t see this happening with the Gulf States since they don’t have much in the way of local industry.

  • Posted by Dave Chiang

    Oh please Sam,

    If dubious property rights, and industry favoritism were such a problem in China, why is the Chinese economy the #1 recipient of Foreign Direct Investment in the world, surpassing the United States. Intel, Motorola, TSMC and NEC wouldn’t have invested in advanced semiconductor fabs across China that cost a billion dollar plus if the regulatory environment was so rotten. Fortune 500 corporations don’t so

  • Posted by bsetser

    I think Intel faced enormous pressure from the government of China to put a fab in China if it wanted to sell in CHina, and also i think agreed to terms that made the deal attractive. and even so i doubt intel is manufacturing its top end chips there. I don’t know the details, but my sense is that this was a decision that was shaped by government policy

  • Posted by bsetser

    even though I took DC’s bait, it would be great if we could focus on the gulf — there will be plenty of opportunities to debate china.

  • Posted by Twofish

    bsetser: even so i doubt intel is manufacturing its top end chips there

    It’s not because of US export controls. I’m sure that both Intel and the Chinese government would love to open some fabs in China with the latest technology, but in this case the stumbling block is the US government.

    This is a problem of looking at policies in detail. If you looks at policy in terms of “does the government intervene in industry or not” that turns out to be far too crude a lens to understand what is really going on.

  • Posted by Twofish

    The two basic questions about the Gulf is

    1) what are the domestic ramifications of Gulf currency policy?

    2) what are the global ramifications of Gulf currency policy?

    As far as 2) goes, I don’t see Gulf currency policy having much of an effect on things like balance of trade since I don’t see a mechanism by which changing the local/dollar exchange is going to change the balance of payments.

  • Posted by bsetser

    2fish — I don’t know for sure (and intel probably wouldn’t say this publicly) but my sense is that even indepedently of us export controls, intel would rather not put its latest technology in China out of concern that its proprietary skills would leak out …

    as for 2) a stronger currency would immediately increase the external purchasing power of all those paid in Gulf currencies, and likely lead to higher imports. there would be some impact, tho not a huge impact. Ordinary Saudis could afford European vacations — or nicer car. That kind of thing. As it is now, the adjustment mechanism is slower as it based on raising nominal salaries …

  • Posted by Dave Chiang

    The most hostile Americans that dislike the Chinese are the ones who have never even visited the country. The same holds true of Anmerican views of the Middle Easterners. Last night, I had a conversation with several individuals at my daughter’s swim meet. Let’s describe them as the typical American Joe6pack perspective on Muslims. The concern was Islam represented an equilvalent threat as the Soviet Union to Europeans. Nothing could be further from the truth. Compared to the former Soviet Union, the Armies of the Arabs are mostly disorganized and ragtagged. If the Armies of the Muslim Arab nations were so threatening to the world, how is it possible that little Israel with 7 million people can totally “kick the butts” of the Arabs in every conflict. And while Saudi Arabia and Iran practice conservative versions of Islam, Muslim Turkey and Dubai are relatively liberal societies. The seaside beach resorts in Southern Turkey have plenty of women walking around in bikini swimsuits.

    The problem with US foreign policy is that American perception of the rest of the world is entirely based on clichés. The US politicos play on these clichés with America’s Joe6Pack voter such as Obama’s comment that the US should boycott the Olympics or McCain’s comment that the US should isolate China from the rest of the world community. The incredibly biased US media reinforces these clichés due to the Cold War legacy against the Soviet Union. But China is nothing comparable to the former Soviet Union in culture, society, politics, or economy. Meanwhile the Fortune 500 US multinationals are moving “head over heals” to China with hundreds of billions of capital investment in new greenfield industrial development. Almost everyday, another multi-billion investment by some US multinational company is announced usually with a state-owned Chinese company. For instance, Sinopec and Exxon build joint venture refineries, Boeing and China AVIC build 747 freighter jet conversion kits, Airbus build A321 jets in Tianjin, GE builds gas turbines in Shanghai, Westinghouse builds reactors with China National Nuclear power, GM builds Diesel-Electric trains in Datung, etc.

    America’s Joe6pack brain is clueless about the rest of the world thanks to a biased US-centric newsmedia that spoon feeds BS cliches about the rest of the world.

  • Posted by Twofish

    bsetser: my sense is that even independently of us export controls, intel would rather not put its latest technology in China out of concern that its proprietary skills would leak out

    The critical bits of technology are going to leak out whether they are in China or Silicon Valley. Just by hiring someone that may (and probably will) later work in some other company, you are going to have some leakage.

  • Posted by Twofish

    bsetser: Ordinary Saudis could afford European vacations — or nicer car. That kind of thing.

    But if the source of their income ultimately is dollar/Euro and their savings are in dollar/Euro, then if you change the exchange rate, everyone is going to be back to what it was before.

    Also the big danger which Mexico and Latin America got in trouble with is large amounts of debt based on the expectation that oil prices would stay high.

  • Posted by Sam

    The most promising and viable ideas that I’ve heard as far as GCC monetary policy include a basket which reflects trade and capital accounts in accordance with FX weights. The winner here is obviously the Euro, in which GCC have significant assets and liabilities. I’ve also heard a crawling peg like Singapore in which the currency adjustment reflects monetary policy. This also makes sense to me given the importance of trade in their GDP. In mature economies like the US, UK, and EUR, rates play an integral role because financial markets are much more developed, capital flows supersede trade flows, and the asset/liability borrowings is all single currency. In GCC, it is virtually opposite so it makes sense for a currency to reflect trade flows and/or be managed in a crawling band to take monetary policy out of the hands of the FOMC. Many distortions in the global economy are attibutable to Fed policy that is way too easy for economies growing 15% in nominal terms, booming wages and money supply, etc. We have all seen the upside in these policies – modern, swanky hotels in Dubai and petrodollars buying up trophy properties. The dark side is yet to be seen and will only make itself evident once the proverbial music stops and the GCC Charles Princes’ are still dancing. We have already seen the downside of recycling excess dollars from trade surpluses in the bursting of the recent yield bubble: China’s insatiable appetite for anything with a yield above Treasuries, Russia’s not-so-pleasant fun in Agencies, and GCC’s purchases of overpriced NY and London real estate. You will really understand the downside when 50% of Dubai is uninhabited and Chinese banks implode under hundreds of billions of debt from zombie manufacturers. Again, the key to me as a market participant trying to figure out what the world will look like in 2 years and specifically ascertain who is financing all this infrastructure, hotel, and factory boom in emerging markets just as UBS and Merrill did for Florida and California real estate.

  • Posted by Twofish

    Sam: We have all seen the upside in these policies – modern, swanky hotels in Dubai and petrodollars buying up trophy properties. The dark side is yet to be seen and will only make itself evident once the proverbial music stops and the GCC Charles Princes’ are still dancing.

    The music is going to stop in at most twenty years when the Gulf oil reserve start running dry. But I’m not too worried, the Gulf states didn’t do too badly in the 1980’s when oil prices crashed. One reason is that because they have relatively low populations, they don’t get themselves into a situation were they were funding liabilities they couldn’t afford.

    Sam: You will really understand the downside when 50% of Dubai is uninhabited and Chinese banks implode under hundreds of billions of debt from zombie manufacturers.

    The problem isn’t spending money on stupid things. Suppose you are a Gulf sheik that makes a huge amount of money and then builds a building that sits half empty. No problem. You may have just lost $500 million, but if you have $2.5 billion, that’s not a problem.

    Now if you *borrow* money to build the building then you have a big problem, and so does the person you borrowed the money from.

    Sam: Chinese banks implode under hundreds of billions of debt from zombie manufacturers.

    Don’t think that is going to happen. There will be a crash in the real estate market, just like there is currently a crash in the stock market, but the different pieces are separate from each other so that I don’t think it is going to affect the banks.

  • Posted by Majorajam

    Excellent as ever Dr. Setser. If it weren’t for yourself and Marty Weitzman, I’d have a very low opinion of economists indeed. As a group, you have tremendous potential when you don’t wear your science like a straight jacket, which makes it unfortunate so many do.

  • Posted by Dave Chiang

    Sam: Chinese banks implode under hundreds of billions of debt from zombie manufacturers.

    I agree it won’t happen. There is one fundamental economic difference between China and the U.S. What Americans do differently is they don’t save any money with a zero percent or negative national savings rate. The savings rate in China is almost 40%.

    Writes the London Times on the global economic downturn impact in China,

    “People in Wenzhou are too innovative to allow their companies to go bust. The companies here have £44bn of cash, apart from their fixed assets, which they made during the good years. That money will help them to survive now,” he said.

    On a national level, $1.8 trillion of foreign exchanges reserves are a similarly healthy cushion.

  • Posted by Michael

    Most of the domestic implications for the Gulf Oil States fall well within the parameters of financial/political fluctuation that all the other wealthy (U.S.,UK, Europe, Japan, etc) nations endure without drastic crises. The international implication that really matters is the one Brad hints at: with lots of dollar reserves and huge income flows, why wouldn’t the Saudis cut production to maintain any crude price they so desire? Back in 2000 they were openly talking about price targets ($18-25$ barrel). If the Fed can have inflation and/or money supply targets (I wish!), they can have oil price targets. It’s the only enduring wealth they have, and they’d be fools not to manage it.

  • Posted by Rien Huizer

    Brad, Michael, Sam, Twofish.

    Seems that the Dutch Disease discourse will gain prominence. What I know about that subject gives me the feeling that if you replicate the conditions, you will find out that under those conditions there is hardly any policy space. The Dutch conditions were: (1) sudden, unexpected inflow of government revenue from abroad (2) country hardly recovered from WWII devastation and with a legacy of low cost-low tech labor intensive industry (shipbuilding, textiles, heavy machinery) next to world class electronics, chemicals and a strong service industry and an aircraft industry with a proud tradition but basically at the hobby scale (3) social democratic government not at all afraid of a growing employment ratio of Income-GDP, facing an electorate with lower consumption levels than neighbouring countries, due to financial income constraints caused by, principally, a low participation rate.

    There were three effects, not all malignant: (1) rapid wage rises due to over-employment caused by, i.a. high government spending, i.a. on public housing. Maintaining parity with the DM was a policy goal which disabled interest rate based monetary policy, which in turn led to a private housing boom (negative real after tax interest rates) (2) rapid rise in the standard of living to German levels (if corrected for the lower participation rate -which incidentally did not respond quickly to labor scarcity) (3) the most contested one at the time: the disappearance of all those labor intensive industries, or their conversion to efficient/value adding ones. The interesting thing is that these industries disappeared all over Europe or adopted focus strategies, after the failed attempt to keep costs down by importing migrant workers, and later moving factories abroad.
    So in essence, the Dutch disease was not all that bad, it cleaned out the dead wood and taught the public a lesson that social democrats cannot ignore markets, hence cannot improve their lot more than ordinary democrats would, and the public in Holland became thoroughly postmodern. Conservatives would say that the period facilitated the radical swing from austerity to hedonism, but that has no proven connection to ecpnomic policy, either forward or backward, as far as I know.

    What would have happened in Holland if it had “floated”, i.e. cut the link with the DM (there were some minor revluations later on)? Interest rates would have had to rise enormously, the government would have spent much more on debt service (in real terms), vulnerable industries would have died as well, and imports would have become cheaper, posibly shifting household expenditure away from non-tradables (housing, leisure) towards tradables. I might have mentioned another factor applying to Holland (and even more to the GCC) : extreme openness – cars, consumer durables, a little later furniture and clothing, tended to be imported. Any kind of currency regime other that maintaining parity with principal trading partners would have caused enormous turbulence. The methods ultimately used by the Duth gvt were increasingly strict fiscal dsicipline, taking the enormous stock of public housing off budget, quantitative credit controls (enforcable because of a de facto banking cartel and entry barriers to foreign competition) plus the simple forces of nature: the population began to age, married women wanted work and the labor market and its regulators responded with innovations, posr war investments in human capital (university education no longer for the happy few from the late 1950s) started to bear fruit, etc.

    I would say, there is little in the story of the Dutch economy from 1970 through the late 1980s that helps the GCCs; they are too different and too heterogenous. Currency policy would be fairly low on my list and basically impossible for some: Singapore and Malaysia (a bit like Dubai and Abu Dhabi) are in a situation where each can have its own approach to macro-economic policy, although they need to synchronize from time to time
    . Oneimportant facilitating condition for that is that they have separate currencies. As far as I can see, it does not matter a lot what currency Kuwait and Qatar use, as long as they keep the oil revenue out of their domestic economy, or outsource that economy to transients whose inputs and outputs could be priced in anything, as long as it was consisten (it is a bit like pricing in an MNC) and attracted sufficient labor. I think that the problem is that Dubai and Abu Dhabi, with totally different economies, (a Spore/Mal combination almost) have the same currency. Then in addition to that, Bahrain, without the “customer base” of Dubai, cannot move too far away from its much more developed neighbour. I guess this one is a little too difficult.

    Finally, I rarely hear arguments about optimal exchange rate policies for resource countries based on market power arguments. Virtually all oil exporters are price-takers for all their imports and have very little in the way of alternative exports, and even if they do those tend to be price-taking as well. All that a domestic curreny does in those circumstances, is to price the production and consumption of non-tradables,with private demand competing with the government sector for a scarce production capacity (if not made flexible by an effcient labor import regime) . It may be easier -given also that these countries have typically large transfers from the government to the private sector instead of the reverse as in normal economies- to develop credible fiscal policy than maintain an independent currency. This is entirely beside the point of if and to what extent the government should invst excess revenue in offshore markets, or leave the il in the ground.

  • Posted by Rien Huizer

    A not on the remark “interest rates would have had to rise enormously ..” early in the third paragraph: this assumes that floating would have started simultaneoulsy with the oil price increase, but because of the lag with which that would pss through to net exports, there would probably be a need to push the currency using interest rates. Floating by itself would not have changed the government ‘s expansionary budget policy, which ran ahead of gas export receipts.

  • Posted by Twofish

    One other thing that is important for economic policy is the long run time element. The oil is going to run out, and any plans on what the Gulf states should do with their money has to take that into account. Saudi Arabia is a particularly interesting case, because it has a population that is increasing quite rapidly and a state structure that absolutely depends on a large income to keep the masses pacified.

  • Posted by bsetser

    2fish —

    the oil will run out. but the gulf isn’t norway. its oil isn’t going to run out all that quickly — which in theory creates more space to spend now.

    note that the only fail safe strategy to protect against dutch disease is to save the entire oil windfall abroad (basically, the i-bankers get more of the money via fees on the investment than the population of the oil exporting state in the first instance). this has been close to the approach norway adopted (in the context of a floating rate). it was able to do so b/c of:

    a) a strong social consensus that the oil wasn’t something to spend just on the current generation
    b) norway was developed and wealthy before it found the north sea oil …

    I don’t think either condition exists in the Gulf — especially when it is clear that the princes are quite happy to spend the oil on their generation/ their social class.

    2fish — I think you understate the role the exchange rate can play even in states with little domestic production capacity/ a one-industry export sector that pays for the govenrment and finances imports.

    Suppose you peg to the dollar. And suppose you don’t increase nominal spending even as nominal oil revenue goes up.

    A one industry, most consumer goods are imported country would have seen the real value of existing wages fall — as the dollar fell against the currencies that the country buys goods from. Higher import prices and the same salary would imply falling real wages. And less consumption all around — as consumers cut back on other goods as they have to pay more for imports.

    Basically, the state has reduced its expenditures by making payments in a depreciating currency even as its real revenues have increased — the state (read the ruling family) has captured the entire windfall.

    Now suppose the currency appreciates along with the real price of the country’s exports. in local currency terms, the size of the export windfall falls — in euro terms, oil hasn’t gone up as much as in $ terms …

    However, real value of existing nominal salaries has been increased, so the real purchasing power of the country’s residents has increased. the price of imported goods has fallen, allowing more private savings or more spending on other goods. Basically, more of the windfall is automaticaly distributed to the population via higher real salaries as the external purchasing power of existing salaries rises.

    the residents are better off, the state’s windfall is smaller ….

    so why is this regime in the interest of the state/ the ruling family? well, oil prices go up as well as down, and the same mechanism also helps with adjustment on the downside.

    there are no magic bullets for managing natural resource wealth, especially resources with lots of price volatility. but i am pretty confident the existing regime is suboptimal.

  • Posted by Ekonomix

    I think UAE is the most prepared of the bunch for a crash in oil prices. Nevertheless, they are all going to face the same problems of 80s when this happens.

    Turkish Economy