Random

A bit dry. You have been warned.

So the other day I wanted to change some Dinars into euros. I nearly got a heart attack.

Seriously, can anyone familiar with economics give me one good reason why the Dinar is yet to be revaluated against the dollar? Why don’t they up that damned fixed exchange rate?

We are in an unprecedented boom. The economy is flush with oil money going crazy bouncing up and down not knowing where to put itself. The economy is overheating. Prices have reached ridiculous proportions.

Now basic first year undergraduate economics would tell you that when your economy is overheating you as a government want to put up your interest rates. Make money and loans dearer and scarcer. That way some of that money flying around like a madman gets put and saved away while people stop taking out loans at ridiculously low rates.

Now because of that damned fixed exchange rate we basically have no control over interest rates. We have to take whatever is set in the U.S. But guess what? The U.S. has its own problems to deal with that are completely different than ours. The economy there is coughing and teetering on recession because of the credit (subprime) crisis. Defaults on mortgages are soaring, banks no longer want to give loans, new houses being built have dried up and people are poorer since house prices are not as valuable as before. For them (or so the Fed thinks), the best thing is to keep cutting interest rates so that credit doesn’t dry up and hence the economy is reinvigorated. They couldn’t give a damn that Bahrain would rather have higher interest rates.

At the same time the bloody dollar keeps sliding against every currency worth noting (except the yen). The bloody American trade deficit keeps widening and the dollar keeps sliding. What does this mean? Basically Americans are consuming way more than what they are producing. All those cheap chinese imports (among others) being gobbled up are way more than what America is selling to the rest of the world. So what can America do? It basically has to borrow to finance this over-consuming. How? By issueing government bonds with low interest rates that basically get bought up by China, Japan, the Far East and us gulf countries. Basically, we are financing the out of proportion consumerism of America by lending to them at ridiculously low interest rates.

And the dollar keeps sliding. Because interest rates are so low putting your money in America is not as attractive as it used to be. Why put your money in America and get 3% while you could put it in the UK and get 5.5%? This with the large trade deficit, which means America is borrowing more and more, makes the dollar unattractive and it keeps sliding.

But why should America care about the low dollar? Short of a massive run on the dollar (i.e. a crash in its value, which is probably unlikely), lower exchange rate makes American goods cheaper and increases their exports to the world. It helps offset that massive trade deficit. I remember when I was in the States I could not believe how cheap things were compared to Europe. It was ridiculous. Food was less than half price. This makes American goods attractive and more of them get sold abroad. That trade deficit would be much worse if the dollar was not so low.

And we in Bahrain get shafted in the process. No one needs to be told that Bahrain is completely dependent on imports. From our cars to our ACs to our labour (more on that in a bit), we import everything. Now given the Dinar is tied to the dollar, we cannot benefit from cheaper American imports due to the lower dollar as other countries do. We are fixed against it! No lower dollar for us! We cannot benefit from our exports increasing either due to the cheaper dollar (and by default the cheaper dinar), since we do not really have exports to speak off except oil and aluminum. Both of those are commodities controlled by world market prices. We do not make any cars or fridges to speak off so that we can export them.

At the same time, we keep suffering from more expensive imports from other countries. As the dollar falls agains the euro and the pounds, everything coming from Europe becomes more expensive. Just compare the price of an BMW M3 back when the euro was first launched and its price now.

Then we come to the most important import to Bahrain: Labour. We are completely dependant on expat Labour, particularly from the Indian subcontinent. They make 2/3 of our labour force. Now the Indian rupee has appreciated against the dollar by more than 20% this year alone. Guess what? That makes labour from abroad more expensive. When an expat last year could send 100 rupees back home, the same amount of dinars nowadays only lets him send 80 rupees. What they send back home have basically been cut by 20% in one year. Who wouldn’t get pissed off if their salary was cut by 20%, especially if you’ve been paid peanuts already and live in a country with rising prices? This is the immediate cause of the expat labour revolts that have happened recently (more on that later).

So imports have become more expensive due to the damned dollar falling. So has labour. Prices have soared. But this is not the whole story about prices.

Before we go into this prices story, let’s get one thing clear. This whole talk about how inflation in Bahrain is 4% is rubbish. It is a mistake at best, or a lie at worst. Only someone as naive, or beink bankrolled as Oxford Business Group (I’m not sure which one of the previous it is) would dare boast about how low inflation is in Bahrain. Every single evidence points otherwise. Use your informal judgement to begin with. House prices have sky rocketed over the last few years. So has food prices. In a country where food and accommodation spending make up so much how can we have 4% inflation? Add to this the rise in wages of both the locals in government jobs and the expat sector, and then as Ibrahim Sharif has rightly pointed out the increase in Broad Money (M2 and above) and there is no way in hell that the inflation is 4%. The fact that the government is fretting and has allocated 80 million dinars for spending on goods whose prices have soared just shows how ridiculous this number is.

So what caused these massive price hikes witnessed right throughout the gulf? Well, as we mentioned there is the lower exchange rates which made imports and expat labour more expensive. This is not all. There are some global causes which we cannot do much about. Import prices, particularly of food, have jumped up significantly due to higher fuel prices, the switch to biofuels and countries like India and China consuming more meat. What does this mean? Let’s start with biofuels. They are made out of maize (corn), so maize that was before used for food is now spent on biofuels. Less food is around so the prices go up. Then there is the fact that China and India have become richer, and hence eat more meat. Meat needs more input to produce (think of grass, water etc to feed the chicken and cows) and hence because of the extra resources going into this the price of the rest of food go up. So we end up with more expensive food.

Then there is the fact that our economy is booming and heating up. Demand and wages are pushed up and hence prices go up as well.

So there you have it, lower exchange rate, more expensive imports, pricier labour, food price jumps and an economy going overboard because of an oil boom has pushed our prices up.

Now in a modern capitalist society, what can you as a policy maker do to help control this price spike? Well, the obvious candidate is monetary policy. i.e. as we said before, increase the bloody interest rate. Now in Bahrain we can’t do that since we are tied to the dollar and we basically have to take American monetary policy. This, as we said, is doing the exact opposite and cutting interest rates. Crap.

Alright, well another indirect way is to increase our exchange rate against the U.S. dollar. Put the dinar up! This makes imports from the U.S. and also from other countries much cheaper, and so should help keep inflation down. No one is asking here that you completely break the link with the dollar, that is crazy talk of course. Just put the bloody exchange rate up! Instead we have our Central Bank Governor complaining that foreign exchange dealers are doing what any sane person does, which is buy dinars since they know at one point or another they will have to revalue the dinar (buy dinar is their message, you may stand to make a nice profit if it’s revalued against the dollar).

One of the last thing you want to do is throw even more money at the economy. This is unfortunately what the government is doing. It’s solution is to increase expenditure, commiting itself to more and more spending. More money gets spent, there is more money circulating in the economy, and guess what, that causes prices to soar. Other than the price hike, it also commits the government to the same level of spending in the future. It’ll be very hard politically to then cut down the spending. What will they do if the oil prices drop and they don’t have the revenues anymore to sustain their current expenditure?

This is all the more stark given that these price hikes bite the poor and middle class much more than the upper class. Most of the benefits of growth in the economy has been confined to the rich. The poor and the middle class, with their wages no where increasing as much as prices, have seen their purchasing power steadily get eroded. The basked they could buy 5 years ago is no longer affordable at current prices (just think of how pricy it’s now to buy a house).

So the economy is expanding, but most of this is confined to a small elite. At the same time prices have shot up. People can no longer afford stuff they used to buy. The government would ideally raise interest rates but it can’t since it’s tied to America, where the government has actually been cutting interest rates. At the same time it stubbornly refuses to revalue the exchange rate. Can someone tell me, for the sake and health of my accounts, why is this so?

……..

Talking about subprime crises, here is some comedy from the brilliant bird and fortune:

and how brilliant is this (but that is not how the arab mind works!):

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4 Responses to “Random”

  1. BuZain Says:

    WOW. This is too much economics for a single post. Very enriching though. Thanks for connecting some dots in my mind. Keep up the good work Nido.

  2. Anonymous Says:

    Great post! My input:

    I think there are three main reasons why the Gulf countries do not want to revalue. One is that their reserves are all held in dollars. If they revalue against the dollar the value of these reserves drop down. Second is that oil revenue is priced in dollars, while their expenditure is in local currency. If they revalue then their expenditure in Dinars will suddenly require more dollars to keep it at the same level. Finally, and probably most importantly, America does not want them to revalue against the dollar. America knows that a considerable amount of dollar reserves in the world are held in the gulf. If these countries revalue then that might cause other countries, when they see that even America’s most loyal servants have revalued, to reconsider their policy towards the dollar as well. A run on the dollar might then become a distinct possibility.

  3. Mariam Says:

    Thanks for the great post. Its interesting how all these events are linked together. I guess we’ll just have to brace ourselves for whats next!

  4. nido Says:

    You’re welcome Buzain. Thanks for stopping by!

    Anon:

    Very good points. I should’ve included them. The thing I don’t understand is that Bahrain is probably the least country the U.S. is worried about revaluing (very tiny), while other economically more important countries like UAE and Kuwait (practically) have already revalued. And in terms of their reserves losing value, that’s true but I think they have much more to lose by the higher import prices and inflation.

    Mariam:

    Thanks as always. Who knows what’ll be next. But if you’re a country supposedly going through a massive unprecedented boom and still most of your citizens are feeling squeezed, distgruntled and poorer then that’s a pretty strong sign that things aren’t going very well.

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