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Fears of dollar collapse as Saudis take fright
By Ambrose Evans-Pritchard, International Business Editor
09/20/07 "The Telegraph" -- -- 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.
The 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.
© Copyright of Telegraph Media Group Limited 2007.
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