Oil currency hypocrisy
Does it make sense for United States Treasury Secretary Hank Paulson to be touring the Middle East supporting the region's hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their...
Does it make sense for United States Treasury Secretary Hank Paulson to be touring the Middle East supporting the region's hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their currencies appreciate faster against the dollar? Unfortunately, this blatant inconsistency stems from the US's continuing economic and financial vulnerability rather than reflecting any compelling economic logic. Instead of promoting dollar pegs, as Mr Paulson is, the US should be supporting the International Monetary Fund's behind-the-scenes efforts to promote de-linking of oil currencies and the dollar.
Perhaps the Bush administration worries that if oil countries abandoned the dollar standard, today's dollar weakness would turn into a rout. But the US should be far more worried about promoting faster adjustment of its still-gaping trade deficit, which in many ways lies at the root of the recent sub-prime mortgage crisis. The administration's multi-pronged effort to postpone pain to US consumers, only risks a greater crisis in the not-too-distant future. It is not at all hard to imagine the whole strategy boomeranging early next year, soon after the next US president takes office.
Of course, a strengthening of the oil currencies would not turn around the US trade balance overnight. But oil countries do account for a large share of the world's trade surpluses, and a weaker dollar would help promote US exports to some degree, even in the short run.
More importantly, it is imperative for US policies to be consistent across regions. How can the US Treasury, on the one hand, periodically flirt with labelling China a "currency manipulator" and, on the other hand, condone a similar strategy in oil-exporting countries?
Secretary Paulson has emphasised that the US is "open for business" from sovereign wealth funds. One can hope that his confidence is justified. There is no cause for the US to place any significant new restrictions on sovereign investments in the US beyond those that it already has on trade. Besides, the US needs these investments to help recapitalise its badly weakened financial system. However, even if we can agree on keeping the US open to sovereign wealth fund investments, that is no reason for promoting exchange-rate policies that exacerbate the very trade imbalances that are driving the whole sovereign wealth fund phenomenon in the first place.
Then again, perhaps the Bush administration is worried that if the oil currencies strengthen too much against the dollar, it will start becoming too expensive for the US to scale up its military operations in the Middle East. This, too, is wrong-headed. If a cheaper dollar leads to an invasion of US exports to the Middle East and rising living standards in the region, all parties will be far better served.
What about the interests of the oil countries themselves? Are they right to fear potentially catastrophic results from abandoning the dollar?
As with China, these concerns are overblown. Even with the prevalence of dollar indexation across the region, exchange-rate appreciation would still help promote cheaper imports and higher living standards. Moreover, as public confidence in the de-linked oil currencies increases over time, dollar indexation of private contracts will diminish, and currency movements will have a greater impact on overall prices.
More immediately, inflation across the oil states is soaring today, with CPI inflation in the Middle East averaging more than 6 per cent after years of relative stability. If this inflation is allowed to continue and deepen, it is likely to have effects easily as pernicious as the exchange-rate appreciation the region's leaders are striving so hard to avoid.
Perhaps the most important positive effect of exchange-rate appreciation would be to help promote the development of domestically-oriented industries such as health care, education and banking, thereby alleviating some of the region's mass under-employment.
To be sure, there are important differences between the oil exporters and the Asian economies. With world energy prices at record highs, it makes sense for oil economies to run surpluses, thereby saving for when oil supplies eventually peter out.
As for the US, it makes little sense to support dollar currency pegs in any large emerging market, at least until its trade balance normalises. This is no time for oil currency hypocrisy.
• Mr Rogoff is professor of economics and public policy at Harvard University, and was formerly chief economist at the IMF.
©Project Syndicate, 2008, www.project-syndicate.org
Perhaps the Bush administration worries that if oil countries abandoned the dollar standard, today's dollar weakness would turn into a rout. But the US should be far more worried about promoting faster adjustment of its still-gaping trade deficit, which in many ways lies at the root of the recent sub-prime mortgage crisis. The administration's multi-pronged effort to postpone pain to US consumers, only risks a greater crisis in the not-too-distant future. It is not at all hard to imagine the whole strategy boomeranging early next year, soon after the next US president takes office.
Of course, a strengthening of the oil currencies would not turn around the US trade balance overnight. But oil countries do account for a large share of the world's trade surpluses, and a weaker dollar would help promote US exports to some degree, even in the short run.
More importantly, it is imperative for US policies to be consistent across regions. How can the US Treasury, on the one hand, periodically flirt with labelling China a "currency manipulator" and, on the other hand, condone a similar strategy in oil-exporting countries?
Secretary Paulson has emphasised that the US is "open for business" from sovereign wealth funds. One can hope that his confidence is justified. There is no cause for the US to place any significant new restrictions on sovereign investments in the US beyond those that it already has on trade. Besides, the US needs these investments to help recapitalise its badly weakened financial system. However, even if we can agree on keeping the US open to sovereign wealth fund investments, that is no reason for promoting exchange-rate policies that exacerbate the very trade imbalances that are driving the whole sovereign wealth fund phenomenon in the first place.
Then again, perhaps the Bush administration is worried that if the oil currencies strengthen too much against the dollar, it will start becoming too expensive for the US to scale up its military operations in the Middle East. This, too, is wrong-headed. If a cheaper dollar leads to an invasion of US exports to the Middle East and rising living standards in the region, all parties will be far better served.
What about the interests of the oil countries themselves? Are they right to fear potentially catastrophic results from abandoning the dollar?
As with China, these concerns are overblown. Even with the prevalence of dollar indexation across the region, exchange-rate appreciation would still help promote cheaper imports and higher living standards. Moreover, as public confidence in the de-linked oil currencies increases over time, dollar indexation of private contracts will diminish, and currency movements will have a greater impact on overall prices.
More immediately, inflation across the oil states is soaring today, with CPI inflation in the Middle East averaging more than 6 per cent after years of relative stability. If this inflation is allowed to continue and deepen, it is likely to have effects easily as pernicious as the exchange-rate appreciation the region's leaders are striving so hard to avoid.
Perhaps the most important positive effect of exchange-rate appreciation would be to help promote the development of domestically-oriented industries such as health care, education and banking, thereby alleviating some of the region's mass under-employment.
To be sure, there are important differences between the oil exporters and the Asian economies. With world energy prices at record highs, it makes sense for oil economies to run surpluses, thereby saving for when oil supplies eventually peter out.
As for the US, it makes little sense to support dollar currency pegs in any large emerging market, at least until its trade balance normalises. This is no time for oil currency hypocrisy.
• Mr Rogoff is professor of economics and public policy at Harvard University, and was formerly chief economist at the IMF.
©Project Syndicate, 2008, www.project-syndicate.org