Saudi Arabia's catch 22

http://www.ft.com/cms/s/0/b1cc3f16-824e-11dc-8a8f-0000779fd2ac.html?nclick_check=1

With a booming economy and inflation ticking higher, some speculators worry that Riyadh will de-peg its currency from the dollar. And they see such a step as having the effect of re-pricing oil in euros and yen. That’s because if Saudi Arabia de-pegs and does nothing else, it will be sitting on two rapidly depreciating assets: $20,000bn in oil reserves and $800bn in US dollar reserves.

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Dating back to the aftermath of the oil crisis of 1973, the US negotiated the original alliance with the Saudis to assure petrodollar recycling. As oil prices have risen this decade, economists including ourselves have argued that the re-investing of oil export revenues into the US by Saudi Arabia and its neighbours has contributed to keeping interest rates low and equity valuations high. Often referred to as the “central banker” of oil, the Kingdom has proven on multiple occasions that it is focused on protecting a buoyant outlook for the global economy, as much to assure itself of a buyer as to preserve its political alliance with the United States. That usually means supplying enough oil to the market and holding spare capacity for use in the event of a disruption. Today, however, given mushrooming dollar reserves and the weakening US economy, it also means that Saudi Arabia must hold off on reserve diversification or doing anything that would initiate an attack on the dollar.