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Monday, May 26, 2008

Uh-Oh! Gulf States May End Currency Peg to US Dollar

We hear from Bloomberg that both the United Arab Emirates and Qatar could abandon their currency pegs to the U.S. dollar in favor of a basket of currencies within months, and Saudi Arabia may follow the move late next year. They would all be following the lead of Kuwait, which last year broke from its neighbors and fixed its dinar to a basket of currencies.

Why are the Gulf States doing this? Thanks to surging energy prices, Gulf nations are experiencing an unprecedented boom, and an increasing inflation problem. Yet their currencies are depreciating and their central banks are under pressure to cut their nominal interest rates to match the Fed.

Plainly, the US Fed's easy money policy does not work for them. Even though many investors believe the US interest rate easing cycle is at an end -- futures on the Chicago Board of Trade showed traders saw a 92% likelihood the Fed will keep its target rate for overnight lending between banks at 2% on June 25, up from odds of 88% on May 21 -- it's too little, too late for the Gulf states.

What's more, Forbes quotes Deutsche Bank and others as saying that the Fed may NOT be through cutting rates, and may drop the benchmark from an already low 2%.

Continued cuts in the Fed benchmark rate could grease an already slippery slope for the US dollar. Since the Fed cut rates from 5.25% to 2% since last August, wholesale inflation has increased to 6.5% year over year and the price of oil has soared to over $130 from $70. A global supply/demand squeeze for distillates like diesel gets much of the credit, but the meteoric rise in oil prices wouldn't have happened without the Fed's help. If the value of the US dollar had just held steady since August, the price of oil would be under $90 a barrel.

And as bad as inflation is, it's probably much worse than the government admits. is a website that tracks the Consumer Price Index the same way it was before the Clinton administration started monkeying around with it. And according to ShadowStats, consumer price inflation is running at more than 3 full percentage points hotter than the government says. Would the government lie to you? Hahahahaha!

And this is my long-winded way of getting to my subject: Gold and silver prices. It seems that foreign governments, especially those in the Persian Gulf, are losing their faith in the almighty dollar and the policies of the US government. That undercuts the mighty greenback's standing as the world reserve currency. Now, that doesn't mean your dollars become worthless overnight. But the more its reputation gets chipped away, the faster its downward slide can become. I think this has the potential to heat up the fires under gold and silver quite a bit.

If paper money becomes devalued, people will put more faith in hard currencies. More and more Moms and Pops put a few gold and silver coins away "just in case," and the trickle we see in gold and silver coin investing now can become a flood. And thus we learn from the Wall Street Journal that d
emand is simply overwhelming the supply of US Silver Eagles. Why are so many "early movers" suddenly buying silver coins. What are they afraid of?

As the old saying goes, if you have to ask that question, you haven't been paying attention.

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