Fears of dollar collapse as Saudis take fright

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.

"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.

The Saudi central bank said today that it would take "appropriate measures" to halt huge capital inflows into the country, but analysts say this policy is unsustainable and will inevitably lead to the collapse of the dollar peg.

As a close ally of the US, Riyadh has so far tried to stick to the peg, but the link is now destabilising its own economy.

advertisementThe Fed's dramatic half point cut to 4.75pc yesterday has already caused a plunge in the world dollar index to a fifteen year low, touching with weakest level ever against the mighty euro at just under $1.40.

There is now a growing danger that global investors will start to shun the US bond markets. The latest US government data on foreign holdings released this week show a collapse in purchases of US bonds from $97bn to just $19bn in July, with outright net sales of US Treasuries.

The danger is that this could now accelerate as the yield gap between the United States and the rest of the world narrows rapidly, leaving America starved of foreign capital flows needed to cover its current account deficit - expected to reach $850bn this year, or 6.5pc of GDP.

Mr Redeker said foreign investors have been gradually pulling out of the long-term US debt markets, leaving the dollar dependent on short-term funding. Foreigners have funded 25pc to 30pc of America's credit and short-term paper markets over the last two years.

"They were willing to provide the money when rates were paying nicely, but why bear the risk in these dramatically changed circumstances? We think that a fall in dollar to $1.50 against the euro is not out of the question at all by the first quarter of 2008," he said.

"This is nothing like the situation in 1998 when the crisis was in Asia, but the US was booming. This time the US itself is the problem," he said.

Mr Redeker said the biggest danger for the dollar is that falling US rates will at some point trigger a reversal yen "carry trade", causing massive flows from the US back to Japan.

Jim Rogers, the commodity king and former partner of George Soros, said the Federal Reserve was playing with fire by cutting rates so aggressively at a time when the dollar was already under pressure.

The risk is that flight from US bonds could push up the long-term yields that form the base price of credit for most mortgages, the driving the property market into even deeper crisis.

"If Ben Bernanke starts running those printing presses even faster than he's already doing, we are going to have a serious recession. The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems," he said.

The Federal Reserve, however, clearly calculates the risk of a sudden downturn is now so great that the it outweighs dangers of a dollar slide.

Former Fed chief Alan Greenspan said this week that house prices may fall by "double digits" as the subprime crisis bites harder, prompting households to cut back sharply on spending.

For Saudi Arabia, the dollar peg has clearly become a liability. Inflation has risen to 4pc and the M3 broad money supply is surging at 22pc.

The pressures are even worse in other parts of the Gulf. The United Arab Emirates now faces inflation of 9.3pc, a 20-year high. In Qatar it has reached 13pc.

Kuwait became the first of the oil sheikhdoms to break its dollar peg in May, a move that has begun to rein in rampant money supply growth.

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Ok hot shot, lets have at it.

Fact-USA is about 24% of the ENTIRE worlds GDP

Fact-USA is the worlds largest consumer of goods and services BY FAR.

Fact-The majority of the worlds trade is pegged to the dollar and the majority of the worlds cash reserves are held in dollars.

Fact-If the dollar collapses then the cost to Americans for the rest of the worlds output of goods and services becomes out of reach and we stop buying. Once the consumer stops buying the US economy tanks since the consumer is fully 2/3 of what makes it go. Once the economy tanks the countries producing what we were buying have no place to sell and either lower prices to dump their products or simply shut down. Either way they slide into recession or worse. This causes a domino effect and the entire world economy follows suit. It is not possible for ANY economy be it national or world wide to shrink 20+% and remain viable.

WE are the engine that pulls the economic train for this planet. Will that always be? I have no idea but it is the case at this time. Once the engine ceases to run the train stops. This is all simple economics, friend, and it is more then apparent you are clueless in this regard.

Whoa, easy on the rant bub. I’m impressed with your ability to regurgitate a few blurbs of trivia. What would really impress me is if you could construct a logical arguement with your trivia that proved your thesis. You know, something that showed cause/effect relationship. Give it a shot. Where your rant really falls apart logically is at your 4th alleged fact, because if the dollar declined significantly more than it has already, everything that we buy (e.g. oil)would become cheaper in all the other currencies making it possible for other consumers around the world to replace us.

How can you be so right on all the other FACTS about the economy, and then still spout the "we don't make anything in America anymore?" (#12)

FACT - US manufactures more per capita than any time in history, workers at highest efficiency ever....unemployment at all time low.

So if you wanna buy a sprinkler made-in-usa we should do what? Pull some design engineers out of silicon valley to build $3 sprinkler heads instead of designing $300 CPUs?

You guys shouldn’t get too carried away in economics arguments with the “If....then...and....then...” stuff.

In economics, you can stipulate first order effects, like increase price reduces demand.....that’s about it.

Only economists are dumb enough to then predict secondary and tertiary effects in global markets, which is as predictable as Texas weather during tornado season.

There is a cause effect to my arguments and there was no rant. You are unable to see it because your knowledge in the economic realm is insufficient.

Your claim that if the dollar collapses all the worlds goods and services would become cheaper to other world wide consumers is about the dumbest thing I've ever heard. The fact is we ARE 24% of the entire world economy and if you seriously believe that can be replaced without severe longtime pain then we have nothing more to discuss. Let’s just agree to disagree.

Rather then argue with you and cite the “figures lie and liars figure”quote, just do this. Google shrinking American manufacturing base.

Then come back to argue.

BTW, what exactly do we manufacture here in America?
TV’s, Appliances, telephones, clothing, automobiles (maybe some), pet food, fertilizer, what? For sure # of those EMPLOYED in the mfg end of things has gone straight down the tubes.

For sure # of those EMPLOYED in the mfg end of things has gone straight down the tubes.

So you're saying I should 'google' the same blogoshpheric hype that you've read as gleaned as accurate by the google web crawlers, and then as soon as I get on the same page as you, I can agree with you and be happy?

I work in the electronics manufacturing world. If you're interested, I can tell you how I went from a perspective in 2005 that is probably very similar to yours now, to a different opinion today after living in Asia for a few months, and working with engineers there, here and in Europe...

I don't doubt that a lot of sprinkler heads are manufactured in China now. But what I've learned is companies like Applied Materials building multi-million dollar capital equipment at 50% gross margins that is purchased in China to make semiconductors cheap enough to keep their 5% PC systems manufacturing lines afloat. Like the avionics industry, China simply does not have sufficient high-wage capability to manufacture this leading-edge capital equipment like the Americans and Germans can. It's not a matter of throwing more slaves at it.

So while the Chinese pay huge margins to support design and manufacturing jobs in Austin, TX at Applied, and the capital equipment is set up to depreciate immediately in Shanghai fabs, you can rightly say that America has "lost semiconductor jobs."

But I'd also be right to say that America (And Tokyo Electron) own the semiconductor capital equipment manufacturing jobs in high-wage Tokyo and California and Texas.

What I cannot get enyone to explain to me, and I hope you will, is if US unemployment is at an all-time low, then how are you going to get workers to manufacture sprinkler heads in America? Pull them off the semiconductor capital equipment assembly lines and train them to make garden hoses?

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