A bloc of oil producing countries led by Saudi Arabia, Kuwait and others (not OPEC; for some reason they left out Dubai) reported preliminary steps to establish a regional currency: The “Gulfo,” in which to trade their oil in lieu of U.S. dollars. Is this a threat to the dollar hegemony?
Some would say yes, but I would say no. In fact I would go as far to say heck no.
This is a region of the world rife with tribal mistrust, border skirmishes, oil production quota breaking, and no institutionalized or constitutional outline for common defense. As the mess in Dubai shows, the region lacks a vibrant economic base and depth to support a common currency. The countries in question lack even the framework for regional trade agreements. Even if a move towards regional defense and cooperation did emerge, it would present more of a national security problem (for the U.S.) than an economic one.
And what would support a common Arab currency -- oil? If so, how would the reserves be audited, or would they? If the world dips deeper into recession and the demand for oil slides, how would the Gulfo be supported then? Would there be intervention in more Gulfos, or perhaps dollars or euros? Too many potential problems, and the world is unwilling and unprepared to adopt a new currency when the trade-weighted balance of payments in question is in the trillions. Plus, there are some who would argue we are already at or beyond peak oil production in the Middle East, suggesting that we are already beyond "peak Gulfo." That’s all we need, another currency in perpetual decline.
Notice the timing of this proposal. It didn't come out a year ago, when the U.S. dollar was strong -- it's coming out when the global sentiment towards the buck can be summarized in one word: disdain. The euro has been the darling and the dollar the pin cushion. "Goldman Sachs Group Inc. recommended its clients buy the euro versus the dollar, forecasting the common European currency will rise to $1.55 in three months amid an anemic U.S. economic recovery." -- Dec. 16, Bloomberg.
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But the Elliott Wave Principle tells us time and again that when things are at their worst and emotions run high, that’s when the contrarian viewpoint is most often properly employed. On December 17, Standard & Poor's put more than $2 trillion worth of European covered bonds on downgrade watch. Rather than just rating all these bonds triple-A as is typically the case, now banks will have to support the potential liabilities with substantial reserves. The potential bank exposure and decrease in pricing is leaving many to question the lofty value of the euro. Whoops. Seems not all is well in euro land.
Previously I wrote a column "In Defense of the Dollar," stating that its status as the reserve currency would persist over the foreseeable future because there are simply no good alternatives. We have our problems here in U.S. to be sure, but I would rather be standing here with a fistful of dollars than over there with a handful of sand -- and I don't think I'm alone in saying that.
Bill Fox is EWI's Senior Bonds Analyst and editor of EWI's intensive Interest Rates Specialty Service. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders around the globe.