from Follow the Money

Good question

May 20, 2008

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Michael Phillips in Monday’s Wall Street Journal:

If there’s one message the Bush administration has been trying to hammer home to Chinese leaders, it is this: A major country with a huge trade surplus and rising prices should let its currency strengthen with market forces. So why is the administration nearly silent about the fixed exchange rates of Saudi Arabia and other Persian Gulf oil fiefdoms? After all, like China, the big powers in the Gulf -- Saudi Arabia and the United Arab Emirates -- link their currencies to the U.S. dollar, export far more than they buy abroad, and now face inflation imported from overseas.

The US policy right now is that China shouldn’t peg to the dollar but the Gulf should. In reality, neither should. Kristin Forbes -- who I briefly worked for -- has this right.

"Given the huge current-account surpluses and reserve accumulation in the Gulf states, it’s getting harder and harder for the U.S. Treasury to justify putting pressure on China, but not the Gulf states, to have more exchange-rate flexibility," says Kristin Forbes, an economist at the Massachusetts Institute of Technology and former adviser to President Bush.

Dollars pegs are both inflationary and an impediment to effective balance of payments adjustment. The currencies of the countries with huge surpluses need to appreciate; the currency of a country with huge deficit not so much. And it is hard for say Chinese renminbi -- let alone the Saudi riyal -- to appreciate if it is tied to the US dollar.

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