GCC money supply surge guarantees high inflation, why no revaluation?

For anybody linked to the real estate business this matter not a jot, at least in the short to medium term. High inflation and low interest rates mean that the economy is effectively paying home owners to buy property through negative real interest rates.

The problem is that not everyone can become a home owner or work in the real estate sector or real estate finance. Those on fixed incomes will feel their disposable income squeezed by rising prices in the shops, petrol stations and by spiralling rents.

As Standard Chartered Bank comments: 'February numbers show that inflation in Bahrain reached 4.8% [as opposed to 4.6% in January], much [of it] attributed to rising food prices. In the last two years, inflation in Bahrain has exceeded 3%; something the small kingdom has not seen since 1997.

'The rise in food prices is directly linked to the US dollar peg and the weakening dollar given that Bahrain relies on imports for food. As the smallest Gulf economy, Bahrain is likely to follow the regional giants such as Saudi Arabia if it decides to proceed with any type of currency reform.'

No revaluation

Yet there seems little willingness on the part of GCC governments to contemplate revaluation at this moment in time. Any indication that even a study of this obvious and effective way to tackle inflation is underway is met with official denial.

The road is therefore open to much higher levels of inflation. The International Monetary Fund says that the UAE had inflation running at 11% last year, although other economists point to the high teens.

Money supply growth is a leading indicator so we can be sure that inflation will be higher in 2008 and unless we see a drastic fall in oil prices then 2009 will be the same story. A scenario with 15% official inflation and almost 30% in reality is far from impossible and may already be in the pipeline.

Boom-to-bust

The big risk is that inflationary boom-to-bust cycles are a feature of emerging market economies, and this has been seen again and again. Dollar-pegs in particular exaggerate this cycle as Hong Kong knows very well.

Will the GCC governments decide to take appropriate action before it is too late to avoid an inflationary bust? Judging from the continuous dithering and obfuscation it seems unlikely that anybody is going to want to grasp this nettle.

In the meantime, short to medium term investments in real estate and related shares will do exceptionally well, and those on fixed incomes will be paying for this through higher general prices.