US dollar, inflation, biggest business risks

The US dollar is a problem because all the leading currencies of the region are pegged to the US dollar, and for all practical purposes the US dollar is the regional currency. Thus when the dollar devalues that makes non-dollar imports more expensive in the Middle East.

This has an instant knock on effect in terms of inflation. Europe is the biggest exporter to the Middle East. Now when the euro is at USD1.30 plus that means prices of goods and services have to go up. So a German car will cost more, and so will a German power station.

Substitution can offset this process. However, it is not always possible to substitute European goods and services with US dollar zone goods and services.

Gulf supermarkets lead in this regard, and are increasingly buying from Asian and North American sources and not Europe. But this is not stopping small but gradual price rises for many products.

Indeed, the US dollar's decline adds to the kind of inflation that is normal for booming economies, and certainly the GCC States are enjoying an economic boom this year thanks to high oil prices. Accommodation, for example, has been soaring in price due to demand pressures which have little to do with the US dollar.

The next stage that business will face is pressure for higher salaries, already a factor in a booming economy with competition for the most skilled workers. Staff will not unreasonably feel that inflation is not caused by them and that the cost should be passed on to somebody else.

However, here we have the start of a wage-price spiral. It is easy to see that once this process starts it is hard to end it. Who is going to agree to a wage freeze to beat inflation?

Indeed, arguably the only way to stop inflation is through higher interest rates, and that is what the US Federal Reserve has already begun to inflict on us, and there will be more of the same. This is also a direct inflation of costs to business - or rather those with debts - that has to be taken into account by business planners.

In this new business environment planning a business in a booming economy like the Middle East becomes less straightforward. Inflation, the falling US dollar and higher interest rates can undermine even the strongest business if badly misjudged, and it maybe that we see some unexpected business crashes over the next few years because these factors have been ignored or misunderstood.