Thursday, June 07, 2007

Dollar weakness and oil producing countries

Stephen Roach of Morgan Stanley says:

"Oil producers in the Gulf not only price their one commodity (oil) in dollars, but their currencies for the most part are dollar-pegged and, largely as a result, their foreign exchange reserves are massively overweight dollars. In a high oil price environment, the more the United States relies on external lenders to fund its saving-short economy, the more the Gulf region fills the void – and increases its dollar-concentration risk accordingly. This outcome does not sit well with asset allocators in the Middle East. In fact, in my two most recent visits to the region in early 2007, I detected a growing unease with these concerns. The region worries increasingly about excessive exposure to a chronically weak dollar scenario as an unavoidable outgrowth of a prolonged US current account adjustment. Nor is this situation stable. The longer the US suppresses its domestic saving, the greater the risks the Gulf region may face as a levered play on the dollar. Kuwait’s just announced decision to end its dollar-pegged currency regime may well be the first step in a regional diversification strategy that attempts to temper such risks."

Moving some portion of oil revenues out of dollar-based investments and into other countries is a logical move at this point for oil exporters. However, the types of investments that are made with these funds is a key variable. Just putting the money into sovereign debt wouldn't be that productive. Finding projects in emerging markets that can generate decent rates of return is the core issue...

Update: Well, I have to back up and say that if the US yield curve returns to a meaningful upward slope as it might be on its way towards based on today's market activity, all of the above becomes somewhat less relevant. If long-dated Treasury yields jump up quite a bit, that will goose the value of the dollar upward as well, obviously. Then the oil producers' problem is solved. Recent Treasury auctions have been weak anyway...

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