Revaluing the Riyal
Gulf states, including Saudi Arabia and the United Arab Emirates, may revalue their currencies while maintaining their pegs to the U.S. dollar, a person familiar with Saudi monetary policy said.The states may revalue by an unspecified amount in as soon as a month’s time, the person, who declined to be identified because the matter is confidential, said yesterday. No decision has been made on whether to revalue, he said.
Constistency between exchange rates is driven by arbitrage. Suppose USD1 = EUR1.4, USD1 = AUD0.85 and EUR1 = AUD0.65. What happens? People will use their US dollars to buy Australian dollars, use those to buy Euro, use those to buy US dollars and end up with more money than they started.
If USD1 = EUR1.4, and USD1 = AUD0.85, then, strictly speaking, EUR1 = 0.85 x 1.4 = 0.61 (ish). So If I start with USD100, I get AUD117.64. With AUD117.64, I get EUR76.47 and, with that, I get USD105.05.
What happened? EUR1 = AUD.61, if the other two exchange rates are to hold. As long as this disparity exists, I’ll make money. Within about, say, 40 seconds of trading opening, however, the price of Australian dollars, in terms of the Euro, will go down – because everyone will be in on this. So EUR1 = AUD.61 almost immediately.
Why is this relevant? The Riyal (amongst other OPEC currencies, but let’s simplify our analysis and do something very economist-y, like assume there’s only one oil-producing country, and that country has pegged its exchange rate to the dollar) is ‘pegged’ to the US dollar. This means there is a limited range within which the Saudi government lets it vary (the target is USD1 = RIY3.5). I.e. the Riyal will buy, in US dollars:
However, and as we know, the US dollar hasn’t been doing so well. Now we’ll extend our model to 3 countries: Saudi Arabia, the United States, and the EU. So the US will buy, in terms of Euro:
It’s not that big a deal: we could ditch them and just use Gold, without too much trouble. So: how many Euros, d’you think a Riyal will get you, lately?
Exactly. Now, suppose our Saudia Arabia facsimile doesn’t, say make much of its own ‘stuff’, but imports it. Practically all of it, paying with money it makes from exporting petroleum. Suppose it’s importing all of these goods and services from, say, Europe. Based on the chart above, what should happen?
Record levels of inflation. Nearly 5% last year: 9.3% in the UAE, and nearly 15% in Qatar. Meanwhile, income is steady, as oil is sold in dollars (although the price has been increasing – one can begin to see the advantage.
Which brings us to the story: a potential revaluation of the Riyal and other affected currencies. Still, it seems, a pegged exchange rate (although, with Saudi Arabia – and others – not following Bernanke’s second rate cut recently, it looked like they were going to accept a broader wobble in the peg, in order to buy at least a little slack with which to try and deal with inflation). The talk:
“It makes sense for them to do it,” said Jens Nordvig, senior global markets economist at Goldman Sachs Group Inc. in New York, in a phone interview. “Given the emerging inflation pressures, there are very good reasons for them to allow currency appreciation.”
“It’s unlikely they are going to move to a flexible system,” Nordvig said. “If they’re going to make an adjustment, they should make one that matters. Something in the 5 to 10 percent range seems like a range that would have some impact without being overly dramatic.”
That’s cool. If, in our over-simplified model, inflation is pulling 5%, and the Saudis revalued their currency 5%, they take a hit on their revenues – something amenable when oil’s spot price is marching onwards like a Christian bloody soldier – and ‘fix’ imported inflation that has landed on them thanks to the US economy (thanks, of course, also to their insistence on a pegged exchange rate, but that’s their prerogative too, I suppose). So, back at that first chart, we can see the market reacting already (Bernanke, Paulson: this is credibility); people are trying to get in on that arbitrage game: buy Riyals now, and make 5 to 10 percent (possibly?) on them in a month’s time.
What does that mean for the rest of us, though? There hasn’t been as much of a change. The Riyal only buys slightly more Australian dollars, for example:
I’m too lazy to look too broadly, but it looks like the big gamble is with US dollars (and why not, if they’re still expected to depreciate farther – don’t forget, the markets have also ignored Bernanke’s warning). It has bumped against the pound sterling, as well – but, again, not like it has against the dollar.
For “us”, the newly introduced 4th country (since I don’t care overmuch about Europe), this will have an impact on our exports to these countries – principally wheat, from what I’m aware. According to the CIA world factbook, though, we don’t even rate:
US 12.3%, Germany 8.6%, China 8%, Japan 7.3%, UK 4.9%, Italy 4.8%, South Korea 4.1% (2006)
We exchange one or two billion Australian dollars’ worth of stuff. So. Not a big deal, at least for them. We also send a fair amount (from our perspective) to the UAE, Qatar (famously, formerly, Iraq). We aren’t really relying upon our exports to keep our economy up, so it shouldn’t have too great an effect. Since these countries principally only export petroleum, they shouldn’t actively be generating inflationary pressure for us (or at least not moreso than our own demand). I would be interested, though, in what may happen with Germany, the US and Japan. Economies that are wobbly (or wobbled, in the case of the US), and more dependent on exporter earnings.
I shall follow this up sometime with more work looking at their exposure to the rest of the OPEC countries that are – according to these person familiar – considering the revaluation. Perhaps it could have a significant affect on their economies.