GCC currency pegs and the oil shock in 2016

The gcc currency pegs against the US dollar have the longest pedigree in the global foreign exchange market, with the exception of Hong Kong and Panama. After all, the GCC currency pegs survived the oil shocks of 1986 and 1999 when Brent plunged below $10 a barrel, the Plaza and Louvre Accords, the Iraqi invasion of Kuwait and Desert Storm, banking crises and stock market crashes in Wall Street, 9/11, the US wars in Afghanistan and Iran, the Arab Spring, China's hard landing and now the oil shock of 2015. The GCC pegs were the one macroeconomic constant amid almost four decades of war and peace, inflation and deflation, oil booms and oil busts, revolutions and unrest in parts of the Middle East.
The GCC dollar pegs make perfect sense since oil and gas sales are priced in US dollars. Yet they also expose GCC economies to periodic boom bust credit cycles since regional central banks are forced to shadow US monetary policy. In 2007, when the US dollar fell amid the credit bubble, inflation rates in the GCC soared as local real rates were negative, encouraging a daisy chain of leveraged property/stock market speculation that culminated in macroeconomic disaster in 2008.
In 2015, when the US Dollar Index soared 25 per cent in the past year, the GCC imports deflation via the oil shock and the rise in local money market rates as regional central banks are forced to tighten monetary policy in response to the Yellen Fed even as banking, property and assets markets are in stress. An ultra-strong dollar means a deflation shock for the GCC, as happened in the first term of Ronald Reagan (1981-85) and the second terms of Bill Clinton (1995-99) and George Bush (2008-09). The dollar's surge against the euro and the Russian rouble is also a disaster for tourism-oriented economies like Oman and Dubai, traditional winter hosts for hundreds of thousands of British and Russian tourists. In the language of macroeconomics, the US and GCC are not an "optimal currency area" in late 2015.
The US dollar is the world's dominant reserve currency. This enables the US to enjoy the benefits of Lord Leyne's "monetary seigniorage". This is the temptation for the nation with the world's reserve currency - the US dollar now, sterling a century ago, the Roman denari two millennia ago - to saddle its foreign trade creditors with periodic devaluations at will. This is exactly what the US Treasury and the Federal Reserve have done to creditors like the Germans, Japanese, Chinese and Gulf Arabs since the dawn of the Bretton Woods era in 1971. "Our currency, your problem", Nixon's treasury secretary (a Texan) boasted to the world and John Connolly was dead right.
Even though forward points have moved wildly in the Saudi riyal, Bahraini dinar and Omani riyal money markets, I do not believe the GCC will change the US dollar peg since it would mean a spike in local inflation rates, an exodus of offshore investors and slash the values of savings in the banking systems. GCC central banks, money and debt capital markets will be unable to manage the risk of freely floating currencies since their policies are all anchored to the US dollar peg. Geopolitics also makes a US dollar peg critical to the national security of the GCC. The GCC, with almost $4 trillion in central bank and sovereign wealth assets, is not Kazakhstan, which just devalued the tenge. The financial markets cannot and will not force a devaluation as even the Bahraini and Omani currencies can easily be supported by cross-GCC central bank swap lines.
Freely-floating currencies in the Gulf would invariably fluctuate with the price of crude, whose implied volatility is above 50 per cent. This will make macroeconomic stability impossible for GCC central banks, since no economy in the modern world, particularly those dependent on expatriate workers, thrive when its currency fluctuates by 50 per cent per annum.
The UAE has the highest sovereign wealth fund assets relative to public debt in the GCC. It has the stablest, best-capitalised banking system in the Arab world. The UAE inflation rate is 4.5 per cent, the highest since 2008. The last thing the UAE needs is a higher inflation rate when world trade is shrinking and global competitiveness is an economic threat. There will be no change in the UAE dirham dollar peg but a currency basket concept like the Kuwaiti dinar is an idea for the future.