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Can Allah Help the Euro?

As the United States tries to tighten control on Middle East investments, will Arab investors turn to the euro?

December 31, 2001

As the United States tries to tighten control on Middle East investments, will Arab investors turn to the euro?

The trouble with that hopeful scenario is that, so far, it has turned out to be an empty wish. Europeans may have come to appreciate the euro as a tangible symbol of their newly found determination. Unfortunately, in the real world, currencies are measured against each other in the global foreign exchange market.

There, the euro has been slumping ever since it was introduced as an accounting unit at the start of 1999. At that point, the euro was worth about $1.16. Now, two years later, the euro hovers around $0.88. That is a loss in value of $0.28 and there is precious little evidence that the euro is about to strengthen.

The mere fact that as of January 1, 2002, it becomes a physical currency used for all cash transactions as well certainly won’t do the trick. No, for the euro to strengthen against the mighty U.S. dollar would require one of two things: either more demand for euros in global currency markets — or less interest in the dollar.

However, the odds are that the U.S. economy, despite the current U.S. recession, will be back in full swing well before the Europeans get their economy growing at a healthy clip. That would tend to foreshadow a further strengthening for the dollar, or at least not a weakening.

What, then, could bolster the euro? The current buzz among analysts is that Arab investors may ride to the rescue of the weaklish single European currency. Arab financiers have recycled their petrodollars in back accounts and investments around the world ever since the 1970s — and they are believed to hold as much as $700 billion in financial assets denominated in U.S. dollars.

Why does any of this matter? Well, in recent weeks, the Bush Administration has been tightening the noose around financial institutions around the world believed to support Islamic terrorists. In addition, the mere danger that the Saudi Arabian royal family could be overthrown by local Islamic radicals suggests that U.S. authorities will probably redouble their efforts to scrutinize the financial assets of Arab investors worldwide.

As a result, Muslim investors everywhere must fear that, with good reason or not, they too may be caught in the same anti-terrorism dragnet assembled by U.S. authorities. All of this may cause quite a bit of resentment — and is rumored to lead to substantial capital outflows from the United States.

And this is precisely where, according to some sharp minds, the euro enters into the equation. Indeed, what better way for Arab overseas investors to “stick” it to the Americans than to withdraw their investments from America — and place them in Europe instead? That would put downward pressure on the dollar and the U.S. economy as a whole.

In the past, such an action may have been short-sighted, especially considering the vast differences in returns on investment between Europe and the United States during the roaring 1990s. In other words, focusing their assets on Europe and European currencies would have hurt the self-interest of those investors.

But with Wall Street more down to earth now, these differing investment returns may not exist any longer. Besides, the political risk factor of engaging in — and with — the United States has increased significantly in the aftermath of the unprecedented terrorist attacks on its territory on September 11. In this climate, Arab investors are clearly facing an added worry about possible frozen assets in their U.S.-based accounts.

But in the end, all of this talk about Allah’s spirit indirectly strengthening the euro may just be another way for interested parties to talk down the U.S. dollar. In the ultimate analysis, this kind of conspiracy theory borne out by the foreign exchange markets, won’t add any real strength to the euro.

First of all, most international investors are not engaged in a narrowly defined domestic market of any one country, even one as big as the United States. Instead, they have their financial assets floating in the global financial market — loosely known as the offshore “eurodollar” market. It uses domestic financial markets merely as a place to park funds temporarily.

Moreover, even if they were to invest solely in Europe — and denominated in euros — Muslim investors stand little chance of avoiding scrutiny by U.S. law enforcement agencies. As a matter of fact, no international financial institution — whether in Europe or elsewhere — will be willing to defy the wishes of U.S. authorities. Doing so, would entail paying a steep price — being barred from doing business in the United States.

But the most important reason why Muslim investors will stick with the dollar has more to do with the global oil market — and the laws of finance that ultimately overshadow any political considerations. Oil is traded in dollars, which means that oil exporters’ revenues are dollar-based. While they may diversify portions of their assets into other currencies, the bulk will still remain in dollars. Any shift away from the greenback would cause oil producers more long-term pain than short-term gain.

How so? Well, Arab nations’ big-ticket spending items tend to be infrastructure investment projects and military hardware. Unless they keep their assets in dollars, they have heavy currency exposure. In addition, dumping dollars and driving down its exchange rate will be tantamount to an oil price cut.

True, over the past 30 years, there has been periodic talk of changing the way oil is priced — for instance, moving to another currency (such as the yen or a basket of international currencies). A change like this — if it ever occurred — could indeed undermine the dollar.

However, it didn’t happen even in the 1970s, when the greenback was weak — and OPEC’s political power was at its strongest. There is little chance of it happening now. And so the hope that the euro could be lifted by a bit of “divine” intervention from Allah is likely to remain little more than an enchanting pipedream.