Wednesday links and random thoughts

• US stocks plunged yesterday, led by a 28% drop in shares of Countrywide Financial Corp amid bankruptcy speculation. Merrill Lynch suggest that US recession is not a forecast but more a present day reality.

• Pimco Managing Director Bill Gross suggest strong pullback of aggregate lending amid subprime loses as thinly capitalized modern banking is vulnerable to the withdrawal of the deposits. Amid credit contraction Gross sees FED to cut rates to 3% by mid 2008


IMF has released article IV consultations with Qatar. Authorities’’ and IMF views on currency:

The authorities are committed to maintaining the peg to the U.S. dollar in the period leading up to GCC monetary union. They also view a pegged regime as likely to be in the interest of the GCC in the post-monetary union period. As regards the level of the exchange rate, the authorities agreed with the staff’s analysis and conclusion that the exchange rate is in line with fundamentals…

…A peg is appropriate in the period leading up to the proposed monetary union, but staff recommends a careful study for the period after the establishment of the monetary union.

That’s what I think:
Targeting an exchange rate and maintaining an independent monetary policy, with an open capital account is commonly called the impossible trinity. Only two objectives can be achieved at the same time. The peg to USD dollar broadly worked so long as the business cycle in those countries was well synchronised with the US economy. In other words the business cycle in these countries was synchronized with FED rates policy. Now the situation seems to be changing GCC countries are increasingly “decoupling” from the USD cycle as Asia is becoming significant consumer of energy. In other words GCC business cycle become increasingly connected to China’s business cycle which makes the “impossible trinity” more significant problem especially if decoupling story will continue. The USD-pegged central banks in the GCC region may be stressed further if the FED will cut rates aggressively and energy prices will not fall strongly.