(As mentioned in my previous post, this is a pending guest post from Peter Lavelle of PureFX and for the record, he has written this on 21 January 2013).
Will the UAE dirham gain value in 2013? This is what I want to look at in this post, which examines both what affects the dirham and what’s likely to happen.
US dollar peg
If you’re an expat in Dubai, you may already know that the UAE dirham isn’t what we call a “floated currency”, but is instead pegged to the US dollar. This means, instead of the dirham’s value being dependent on how much the financial markets will buy and sell it for, like the UK pound or euro, the UAE government keeps the dirham at a fixed rate to the US dollar. Specifically, since November 1997, 1 US dollar will buy you 3.6725 dirhams.
The reason the UAE does this so it can benefit from the United States’ monetary clout. After all, the US dollar is the world’s reserve currency, trusted by financial institutions worldwide, and used in countless transactions. In short, it’s our financial bedrock. For the UAE to peg the dirham to the dollar therefore allows it to “borrow” this authority, making Dubai’s economy more stable.
However, one side effect of this US dollar peg is that it means the value of the dirham doesn’t reflect the economic fundamentals of the United Arab Emirates. Unlike with the euro, for example, it isn’t the case that the dirham gets stronger if Dubai expands more quickly, or retail sales increase. Instead, because the dirham is pegged to the greenback, whether it gets stronger or weaker depends entirely on the performance of the US economy.
Given that, if we want to answer the question “How will the dirham perform in 2013?”, we don’t look to Dubai or the other Emirates, but the US.
US recovery signals strong dirham
Housing sales at 3-year high
So, how’s the US doing? Well, the good news is that it’s currently in its finest shape since the financial crash, in many respects. For instance, US homeowners bought 5.49m houses in the 12 months to December, the highest total since November 2009, according to Bloomberg. As Robert Dye, chief economist at Comerica Inc. in Dallas, tell us, this means “The housing market is coming back, gaining momentum.” And insofar as housing is one of the biggest parts of the US economy, it bodes well for a strong dirham too.
Initial unemployment claims at 4-year low
Elsewhere, we can also point to good news in the US job market. The number of people claiming unemployment benefits for the first time fell to a multi-year low last week, of just 335,000. That’s the lowest number since January 2008, and essentially means fewer people are losing their jobs, which of course points to a stronger economy.
Growth due to accelerate this year
Or, we can look to predictions that the US economy will expand at a faster pace this year. Speaking at the Asian Financial Forum in Hong Kong last Monday 14th, President of the Chicago Fed Charles Evans forecast that the United States will expand 2.5% in 2013, up from the 1.3% rate of expansion seen in the last three months of 2012. That’s acceleration, which signals a healthier US economy, and hence a rising dirham.
In short then, there are good reasons to think the dirham will become more valuable in 2013, based on US economic strength.
Debt ceiling and Fed stimulus
However, it’s not the case that the forecast for the US economy is all blue skies ahead. There are clouds too, which could impact both American prospects and the dirham too.
Without a doubt, the biggest threat to the American economy in 2013 is the debt ceiling. In case you don’t know, this is how much the US Treasury can borrow in order to pay its debts, be they bondholders’ interest, military salaries, or Medicare. The trouble is, at $16.4tn, some politicians believe the debt ceiling is already high enough, and won’t lift it until President Obama agrees to cut spending. Obama of course considers this blackmail, opening the way for a showdown that could bring the US to the edge of default, and hence terrible economic uncertainty. The debt ceiling deadline falls at the end of February.
What might happen? In all likelihood, the US will reach an agreement before it runs out of cash. To do otherwise would simply be highly irresponsible. However, given the sheer size of what’s at stake, fear could nonetheless do damage to the US economy before a deal is signed, reflecting in dirham weakness.
In addition, there’s also the fact that the Federal Reserve is engaging in a tremendous amount of stimulus at the moment (called quantitative easing), to the tune of $85bn a month. The idea of course is to help the US economy grow faster, which is a good thing. But the problem is, the more US dollars there are available, the less valuable they become as a result. To the extent that the US dollar falls as a result of this stimulus then, the dirham could fall too, because of its peg.
Risks broadly balanced
In short then, you can see that the risks for the dirham, like those for the US economy, are broadly balanced. On the plus side is the fact that the US is increasingly a healthy economy, with more people buying houses and less people losing their jobs. This is encouraging stuff, and should serve to lift the dirham. Yet equally, the political risks to the US economy, in the form of the debt ceiling, are pretty big. These could yet eat into business and consumer confidence, resulting in a weaker recovery and dirham. If you plan to exchange dirhams this year then, it’s worth keep a very close eye on what happens in the US.
About the writer: Peter is an economist at currency broker Pure FX. He’s worked in foreign exchange since 2010, and is a dedicated follower of global politics and economics. If you have any questions for him about the foreign exchange rates, he’d be delighted to help answer them.