International Politics
Will dollar devaluation limit oil production capacity and slow Middle Eastern economic growth? A large sum of the oil earnings of Middle Eastern oil producers is spent on imported goods and services. These countries receive dollars for their exported oil, and then they convert most of these dollars into other currencies to shop around the world for essential and luxury items. If the dollar is sailing high against other currencies, Middle Eastern countries sail with it, as long as they are going East and Northwest. They enjoy a higher purchasing power when they buy from Europe and Japan. In this case, goods from Europe and Japan are cheaper relative to dollar-denominated oil earnings. A grave concern arises when the U.S. dollar declines, imports from Europe and Japan become expensive, and oil earnings lose purchasing power. Historically, dollar depreciation forced OPEC to think about pricing oil in other currencies. With the Gulf countries constituting half of its members, OPEC thought about pricing its oil on the basis of a basket of currencies, but members relinquished this perplexed idea, due to fear of its political and economic repercussions. In fact, using a basket would not achieve the objective of stabilizing real oil revenues because of the dollar’s large weight in that basket. After the euro’s introduction, many experts thought of it as an alternative to the dollar, especially after the Iraqi government’s success in forcing the UN to sell Iraqi oil for euros. However, non-dollar pricing schemes may backfire and send oil prices lower. Studies show that the switch from dollar to non-dollar pricing would cause deterioration in the U.S. economy and lower its growth. Non-dollar pricing might cause a political backlash against the Gulf countries. In addition, a weaker U.S. economy reduces oil demand and forces oil prices to decline. It would wipe out all the benefits that can be reaped by the Gulf countries from using another currency, or even a basket of currencies.
Concerns about dollar devaluation and erosion of purchasing power were very common in the 1970s and early 1990s. The recent decline in the U.S. dollar against other currencies may bring back deliberations to the front burner. By the time this article was written, the U.S. dollar had fallen more than 7% against a weighted basket of six currencies. It is down more than 6% against the euro and 8% against the yen. Thus, the U.S. dollar was at its lowest level in 16 months against the euro, 30 months against the Swiss franc, seven months against the pound sterling, and six months against the yen. The dollar’s tumble came after six years of dominance and strength that benefited the oil-producing countries in the Middle East, especially Iran. Many analysts look at this recent trend as a more sustained situation, unlike the two short-lived declines since 2000. The oil-producing Middle Eastern countries are apprehensive about such trends. They lost about 10% of their purchasing power in 1992, due to a weak dollar during that period. A study published in the late 1970s found that dollar devaluation caused OPEC purchasing power to decline more than 16% between 1971 and 1977. A study by Philip Verleger in 1992 concluded that Saudi Arabia lost 9.6 % of its purchasing power because of a frail dollar. In addition, APS Review cited Abu Dhabi Chamber of Commerce Chairman Abdullah Muhairbi, who stated that OPEC lost more than 6.2% in purchasing power between April 1992 and mid-September 1992. Furthermore, the Gulf States lost $1.5 billion despite the rise in oil prices. Another study by that article’s author concludes that dollar oscillation caused the United Arab Emirates (UAE) to lose $2.7 billion between 1971 and 1994. This number is the "net" loss, because the UAE gained when the dollar appreciated in certain periods, especially between 1982 and 1985. As a general rule, dollar devaluation would not impact countries with large percentages of total imports from the U.S. as much as those nations that are buying goods and services from countries with appreciating currencies. Data from the IMF’s Direction of Trade publication indicate that imports from the U.S., as a percentage of total imports, are almost the same for Saudi Arabia, the UAE, Qatar, and Oman. However, they are much lower for Iran. Therefore, Iran stands to lose the most from dollar devaluation. Historically, dollar devaluation was associated with lower economic growth in the Gulf countries. For instance, despite constant increases in nominal oil prices, dollar devaluation of about 20% in 1977 and 1978 was associated with a 9% decline in real economic growth in Saudi Arabia, 8.5% in Kuwait, 18% in the UAE, 22% in Oman, 14% in Iran and 15% in Bahrain. Devaluation in 1992 was associated with a 5.6% decrease in economic growth in Saudi Arabia and declines in Iran, plus less-than-expected increases in the UAE, Qatar and Oman. Historical data indicate that under financial pressure, even Saudi Arabia neglected its additional oil production capacity, let alone other countries that were strapped for cash. A weaker dollar would lower the amount of funds available for these countries to maintain their production capacities, let alone increase them to meet future, ever-increasing demand. A further decline in the U.S. dollar would hurt everyone, since the only logical path for oil prices to follow when capacity declines is to go up, as was the case in 2000. In conclusion, dollar devaluation will reduce the purchasing power of the Gulf countries’ oil exports. In addition, it will erode their dollar-denominated investments in the West. Financial pressure will build up, budgets will be cut, public and private sectors will retrench, debt will mount, and economic growth will decline. Given the current sky-high unemployment levels in the Gulf and high population growth rates, one wonders what would happen if the U.S. dollar continues to wane. One may find comfort in the fact that the current percentage decline in the U.S. dollar is still low by historical standards, but the creeping trend is frightening.  Dr. A. F. Alhajji is an assistant professor of economics in the College of Business Administration at Ohio Northern University in Ada, Ohio, specializing in international and energy economics. Previously, he was an award-winning, visiting professor of economics at Colorado School of Mines. He is a regular contributor to this column. |
