There are many policymakers in the current White House who’ve silently supported a weaker dollar policy for the second term of the Bush Administration. This, the argument goes, helps support U.S. exports. True, but the downside risks today are percolating on many fronts. One can make a solid case that the common thread, which weaves through the financial markets today, is the weak dollar.

President George W. Bush was quick to criticize the 13 members of OPEC this week for not increasing oil output at their meeting in Vienna. That may be politically palatable but it seems to be short on economic realities. There is at most, as numerous leaders and analysts have outlined on our program, 500 thousand barrels of spare oil capacity within the cartel and that is not enough to drive prices down from their historic highs.

The culprit is the weak dollar. As a bet against dollar-based assets, global liquidity pools controlled by global fund managers have put money into the oil market. So the record prices we are seeing today are in part driven because these managers are looking for a more attractive return for their money.

A similar story is playing out with the hard commodities – gold, platinum, silver, iron ore. The $100 barrier for oil has been broken and gold appears to be on its way to the $1000 an ounce with its record run.

Don’t get me wrong; pressure from the developing world is intense. Countries within the broader Middle East are growing nicely and this is true from Dubai to Shanghai, from Kiev to Kuala Lumpur. As this band of growth from the Middle East to the Far East continues to expand, the pressure for the entire basket of commodities will continue to grow. But a strong dollar policy based on sound budget management in Washington would likely take out the top 20 percent of these record highs.

Keep tapping the wealth

There is a less obvious, sidebar story that has been a result of the soft dollar policy and that is the hunt for better returns by the giant and still growing sovereign wealth funds of the Gulf countries. When the dollar was solid, these funds were quite happy to park their money into the U.S. dollar and U.S. bonds. That is not the case anymore. With the coffers overflowing from $100 oil, they are re-deploying their assets around the globe, in U.S. and European equities, property deals and utility companies.

This had many crying foul, but the rhetoric this week toned down considerably. As European Commissioner Charlie McGreevy noted on our program, the debate changed a great deal in the last year. “From being looked upon as, I say 'pariahs' as it were, a year ago. I think people are now looking at it in a more balanced way and I think we've had a more balanced discussion now then we would have had one year ago.”

This is true in part because Europe and the U.S. actually need the funds as almost lenders of last resort. As a result, both the European Union and the U.S. Treasury are both talking about a voluntary code of conduct for sovereign wealth funds. The Gulf money managers I have spoken to scratch their heads and wonder out loud what that means in practice. But again, a whiff of cooperation seems to be in the air. The Chief Executive of Dubai International Capital Sameer Al Ansari said this week: “There’s little question that there needs to be more transparency.”

While a center ground is being found, the funds garnered a big vote of confidence from Warren Buffet who moved to the number one slot on the Forbes wealthiest people list. Buffet pointed the finger back to Washington: “This is our doing. Our trade equation guarantees massive foreign investment.”

As the Oracle of Omaha noted, the weak dollar may have helped sell goods abroad, but it has meant that, not only does the trade balance need to be financed, all the other products up for sale – especially banks and buildings – look like a bargain.

In a country that is not known for its openness, the port city of Jeddah provided a safe harbor for some frank discussion about the Kingdom’s future.

Regular visitors of Saudi Arabia know that Jeddah has for 1400 years served as a crossroads on the Silk Route. It has always been a merchant city where new ideas are brought into the agora and passed on.

This was in abundance at this week’s Jeddah Economic Forum, a meeting place for the past nine years and still able to bring in some heavyweight names. Capturing the most attention were the former Federal Reserve Chairman Alan Greenspan, Nobel Laureate Muhammad Yunus, and Saudi Labor Minister/ renowned author Ghazi Al-Gosaibi.

All three carried the show – the first sharing his insights on the pending recession in the United States. Greenspan said the U.S. economy was in “stall speed and the longer that goes on the greater the possibility of slipping into recession.” And the veteran of usually cautious phrases (trying to avoid the global limelight by restricting television cameras in an agreement with the organizers) said that de-pegging the Gulf currencies from the dollar would reduce pressure on inflation.

The idea was quickly rejected in the next speech by the Vice-Governor of the Saudi Arabian central bank Muhammed Al-Jasser. While he praised Greenspan for his wisdom and was a student of his works, he was bold enough to suggest that history has not proven his mentor in this case to be correct. It is a huge issue in the Gulf, with record oil prices also delivering record inflation.

It was the sort of candid give and take I was not expecting in Saudi Arabia. Time again, whether through questions from the floor on the panels I was chairing or through answers from electronic polling, participants were direct, probing and seeking solutions to the shortcomings they see in society.

Mind the Gap

What does this tell us about Saudi society today? With oil above $100 a barrel and revenues to Saudi Arabia alone predicted to top $200 billion dollars in 2008, the people want action and results. This is the biggest challenge. There is a huge gap right now between expectations and reality. Yes, Saudi Arabia plans to build seven new economic cities from scratch, with a budget of at least $100 billion. Twenty-eight billion dollars will be spent this year alone on primary and secondary schools. The aim is to develop human capital.

Skilled workers will be in demand in these new cities but they will need advanced degrees or, at the very minimum, quality technical training. The government was candid about the current problems. Both Saudi Royal Prince Turki Al-Faisal and Labor Minister Al-Gosaibi acknowledged that the reform process should have started 10 to 15 years ago. A big investment opportunity 30 years ago in Saudi Arabia was, many say, ill-conceived and now the new leader King Abdullah is acting like a man in a hurry. He should be.

Official unemployment of 12 percent downplays youth unemployment of more than double that. Fifty percent of the population is below the age of 20 and there are more on the way. They need jobs to avoid civil agitation.

The blueprint put forth by this government is ambitious -- probably the largest undertaken by a government since the rebuilding of Germany and Japan after World War II. But buildings alone, or the hardware, will be of little use if the people, the proper software, are not in place.

Perhaps this is why the participants at this year’s forum were yearning for simple solutions to their challenges, and why they afforded Nobel Laureate Yunus near rock-star status. He shared the work of Grameen Bank, lending without collateral for the poorest of the poor. It struck a chord with this audience who, despite record oil prices, feel they should have a wider swath of society enjoying the wealth. Yunus was swamped after his speech, surrounded by a pack of participants wanting to thank him for his inspiration to tackle poverty.

As I said, expectations are high in the Kingdom and the work has just begun.

It does not take much to rattle the commodity markets these days. Despite a dramatic slowdown in the United States and within Western Europe, there is certainly enough demand and enough speculation to have a new record close for oil this week above $100 dollars a barrel.

The trigger for the final close above that benchmark was a refinery explosion. Fingers were also pointed at the falling dollar, potential unrest in Nigeria and Hugo Chavez’s unpredictable nature as the overseer of Venezuelan crude.

With the strong growth underway in the Middle East region for this year and the mammoth construction boom, prices for everything from iron ore to make steel to Arabica coffee beans to make cappuccinos are at record highs.

There is a whole basket of so-called soft and hard commodities skyrocketing – and for good reason. Demand outside of the Group of Seven countries remains strong and minor “events” create reasons for speculators to drive prices higher.

Take Kenya and the prolonged negotiations over the power sharing talks with President Mwai Kibaki, and renewed fighting in Sri Lanka between the government and the Tamil Tigers in the north. Together those two countries represent 50 percent of tea exports. Tea demand is up 12 percent over the last year. Again, don’t look to the traditional tea houses in London for the answer, but places like India and China which cannot meet domestic demand.

Last week, prices for high quality Arabica coffee beans soared to a ten year high, after prices climbed 36 percent in 2007. Cocoa prices hit a 24 year high after surging 45 percent last year. Upcoming elections and civil unrest in the Ivory Coast provide plenty of “grist for the mill” (or reasons to speculate) if you are a trader of cocoa beans.
I don’t know if you are a daily scanner of the commodity section of your preferred newspaper, but right now they make for interesting reading beyond the daily staples of our diet. Platinum, iron ore and gold are all in record territory. We are seeing that major steelmakers are settling on contracts for raw supplies that are up more than 70 percent over last year. No doubt, the construction companies of the Middle East will be paying higher prices for steel plates and wire, only adding to the inflationary pressure we are seeing for real estate in the region.

The sum of all the parts is this: The rise across the board of this basket of commodities is not esoteric, “does not affect me” kind of stuff, but the real deal. While a slowdown in the West may slightly correct the imbalance of supply and demand near term, it will not solve the problem created by prosperity and a more globalized world. One thing I am not reading between the lines is the potential for the extra supplies coming onto the market to curb these prices. This applies to both quality coffee and quality crude.

Which leads me back to the recent rise of oil. Doing some quick math on Saudi Arabia, at roughly nine million barrels a day, the Kingdom brings in $6.3 billion a week in revenues from oil production; $325 billion a year. That is a great deal of money for a population of just 27 million. The government is in the midst of reallocating that money with a whole set of new economic cities, airports and universities. They don’t want to see a replay of the 1970s boom and bust scenario. There is an effort underway to build a foundation for future growth, beyond the barrel if you will.

We’ll take a closer look at that effort next week while on the ground for the Jeddah Economic Forum.

This weekend my family and I will travel to Rome for a visit linked to a mid-term school break. My wife’s family lives around the corner from the Pantheon. The Temple of the Gods dates back to 125 A.D. It is arguably one of the most impressive structures in the world.

When one walks into the Temple, the characteristics of grandeur and strength stand out. The pillars supporting the Pantheon are rock-solid, conveying stability, history, permanence. One gets the opposite feeling about today’s U.S. economy.

It is hard not to turn on the television, open a financial website or a leading newspaper without finding a banner or headline discussing the prolonged recession which may be awaiting America. While it may dominate the news, there is a tendency to use broad strokes to describe what is underway and what impact it will have outside the U.S.

Let’s tackle the first issue. Not every sector is experiencing a drop in demand. While sixteen pillars support the façade and portico of the Pantheon, two key pillars are showing signs of serious erosion in the U.S.: the housing sector and the banking sector. The White House signed into law a $170 billion stimulus package, which is designed to send a signal to both Wall Street and Main Street that Washington is responding to the challenge. As President George W. Bush declared, the U.S. can “absorb such shocks and emerge even stronger.” That is true and I witnessed that first hand in California during the 1990-91 recession. This is a case where having only 200 plus years of history versus 2000 years are a benefit. The economy takes a hit, sectors regroup and businesses move forward.

Right now we are in the evaluation phase. There is still talk within financial circles that the developing world can de-couple from the U.S. and grow strongly despite the turbulence elsewhere. The head of the International Monetary Fund, Dominique Strauss-Kahn poured cold water on that concept this week while in India, calling the theory a “very misleading idea.”

Hold on a second. The IMF cut its forecast for global growth from 4.4 percent this year to 4.1 percent. That is sizable but not catastrophic. Last year’s pace of 4.9 percent was not sustainable. Export-dependent China will slow to 9.6 percent, hardly a panic. Even in London, the Bank of England is balancing interest rate cuts against the threat of higher inflation. Investors are moaning about house price inflation rising only four percent this year; that is not a fall of 10 to 20 percent that we are witnessing in some American cities.

This is where the Middle East comes in. Enemy number one right now is inflation. You see it in wages, housing, clothing and food. It will likely lead to a de-coupling of the five remaining Gulf currencies from the dollar. But during my constant visits to the region, no one is talking about recession. Look at the price of oil. If there was a real global recession, I would expect a $20 drop in crude, not the $2 we have seen over the past month. We can comfortably expect the region to produce growth of six percent in 2008. Not bad and one would say “de-coupled” from the U.S.

What I think we are witnessing right now is not a crisis of growth but a crisis in leadership. During the recent World Economic Forum, I chaired the 2008 Economic Brainstorming Session, featuring a handful of leading economists, a handful of leading CEOs and a handful of finance ministers from the developing world.

In an electronic poll which followed a good 90 minute debate, two items led the survey of the greatest concerns. Over 18 percent signalled a lack of coordinated response and leadership to the current economic crisis as the biggest threat today. Another 18 percent pointed to mismanagement of the crisis, i.e. incorrect decision making. That is pretty alarming. In a globalized world where we are more dependent than ever on each other, those on the frontline don’t believe government and central bankers will deliver the right medicine.

In fairness, the world is more complex than ever. It means central bankers and leaders in the Middle East have to respond quickly to the challenges in front of them and not through the rear view mirror. The dependence on the dollar and skyrocketing real estate prices are good places to start. Initiatives have been put forward and acted upon. More are probably around the corner.
But as the Romans convey through their ever-lasting structures, let’s not overreact to the headlines. While two pillars of weakness are cause for concern, they are not yet a cause for alarm.