Kuwait Ditches Dollar

Kuwait Ditches Dollar

Lionel Laurent, 05.23.07, 5:20 PM ET

Americans may not understand their central bankers' seemingly morbid fascination with the threat of inflation, but Kuwaiti officials do. After four years of pegging the dinar to the sliding American dollar, the governor of the oil-rich emirate’s central bank declared on Sunday that he would opt for a basket of currencies instead, citing “inflationary pressure.”

Sheikh Salem Abdul-Aziz Al Sabah told the official Kuwait News Agency that the dollar’s decline relative to other currencies had “contributed to the increase in local inflation rates.” After a 0.4% increase against the dollar on Sunday, the dinar held steady on Monday.

The U.S. Federal Reserve has also frequently fretted about inflation, even while holding interest rates at 5.25%. Chairman Ben Bernanke has had trouble convincing regular Americans: a Bloomberg/ Los Angeles Times survey released last month showed that 60% of those polled actually predict a recession in the coming year.

But in the Arabian Gulf, prices have outpaced U.S. monetary policy. Inflation in Kuwait hit 5% in the first quarter of 2007, up from 3.9% in December 2006. High oil prices and comparatively low U.S. interest rates have contributed to upward pressures in the region.

Kuwait’s ditching of the dollar is one of a series of signs that the greenback’s decline is affecting its international primacy. In 2004, India and Japan declared their interest in diversifying their foreign currency reserves, and the following year China and Malaysia opted out of dollar pegs.

But the result could in fact be healthy for the American economy, even if it casts into doubt the planned fiscal and monetary harmonization of the six Gulf Cooperation Council countries by 2010. Although Saudi Arabia, Oman, Qatar, Bahrain and the United Arab Emirates have all stuck with the dollar peg, a shift away from the greenback could dent the current account surplus that represents 30% of the bloc’s gross domestic product.

“A declining dollar is one ingredient in a longer-term stabilization and reduction in the size of the U.S. trade deficit,” said Nigel Gault, an economist with the market analysis firm Global Insight.

Kuwait’s decision won’t redress the trade imbalance just yet: although it last year ran a current account surplus of $37 billion, only about 10% of the emirate’s imports come from the United States. And the new basket of currencies is likely to give the dollar a weighting of up to 80%.

But as part of the larger picture, the move away from the greenback towards other currencies was one step towards redressing the balance of imports and exports.

“It’s half the story,” said Global Insight’s Gault. “The rest of the story is slower growth in US spending. And hopefully faster growth in the rest of the world.”