Global Agenda: Kuwait can't wait

Within a few decades, at most, the dollar's dominance will be history.

May 24, 2007 20:43
3 minute read.
Global Agenda: Kuwait can't wait

global agenda 88. (photo credit: )

Last Friday, Kuwait announced that it was abandoning the "peg" linking the value of its currency, the dinar, to the US dollar, replacing it with a peg to a basket of currencies. Kuwait was the first country in the Middle East to make such a move, but it is unlikely to be the last. Why did Kuwait take this step and why are other countries expected to follow? The simple answer is that the fall in the value of the US dollar is pushing up the cost of Kuwaiti imports. In other words, being linked to the US dollar when the dollar is declining can create problems. If so, the Kuwaiti decision was perfectly rational and, indeed, should have come much earlier. The Kuwaitis are, in this respect, no different from apartment owners in Israel whose dollar-linked prices have been eroded by the dollar's fall against the shekel. Since the same logic applies to oil producers generally, because oil prices are quoted in dollars - it is hardly surprising that Kuwait is likely to start a fashion. But is there some deeper significance to this development? Probably - but just what depends on how you want to look at it. As noted, from a purely rational economic perspective, the only remarkable feature of the Kuwaiti decision is why it was so long in coming. No country that trades with all the main regions in the world should link its currency to one other currency; a basket approach is the most logical and the most theoretically correct. But rational economics is not the sole, or even main, criterion to be applied. There are those who use this seemingly technical event as a way of highlighting much deeper-seated trends. The dollar is in serious trouble, they believe, reflecting fundamental flaws in the US economy. Indeed, the dollar's status as global reserve currency is in danger - according to some, this status has already eroded beyond repair, so that Kuwait's move is just an example of how the dollar is doomed to remorseless decline. Within a few decades, at most, the dollar's dominance will be history, like that of the pound sterling before it. Heavy-duty gloomsters go further, suggesting that the demise of the dollar is a proxy for the coming decline of the US itself. If so, then the Kuwaitis are pretty smart to break their dollar link, since they are backing the wrong horse by keeping their currency in the dollar's sphere of influence. One step further in this analysis allows us to suggest that the Kuwaitis are not merely smart, but ruthless - people who don't let any sentiments stand in the way of their national interests. After all, if it wasn't for the US, there wouldn't be a Kuwait today, let alone a Kuwaiti dinar: barely 16 years ago, America led an international coalition to liberate Kuwait from the grip of the Iraqi dictator, Saddam Hussein. Is this the extent of Kuwaiti recognition of that effort, that at the first opportunity they ditch the greenback in order to ensure they get a better deal? However, before we get carried away with emotions, whether of admiration for Kuwaiti smarts or contempt for Kuwaiti opportunism, let's relate to some more facts. For instance, that the peg to the dollar was established not after the liberation, or even earlier, but only in 2003. This puts matters in an entirely different light. Kuwait succeeded in linking its currency to the dollar just when the US unit started losing value, and has held tight for four years through the dollar's decline. Given this display of anti-acumen by the Kuwaiti central bank, we can suggest a very different response to its latest move. Not only are these exchange rate decisions nothing to do with diplomacy, let alone showing gratitude or ingratitude toward the US, they may actually be the very opposite of smart. If Kuwait was so wrong in its timing of when to link to the dollar - just when it was beginning to slide - so, perhaps, it is equally wrong about its timing of when to unlink? As noted last week, there are those who believe - on the basis of both fundamental and technical analysis - that the dollar is done falling. At the most simplistic level, this is perfectly plausible, because the dollar's downtrend is now five years old and major trends in the currency markets don't usually last much longer than that. The fact that everyone thinks the dollar will continue to fall is very much a reflection of the duration of that major trend - "the trend is your friend" - and the Kuwaiti move is very much part of this approach. When "everyone" is convinced of some outcome, the most likely prospect is that the opposite will happen. [email protected]

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