Currency wars will stretch the sinews of global business

We are living in the era of the 'clash of currencies' in which economies are fighting a war according to the denomination of their national money.

Forget the "clash of civilisations" so beloved of US right-wing politicians; we are living in the era of the "clash of currencies" in which the world's big economies are fighting a war according to the denomination of their national money. It's the dollar versus the yuan versus the euro versus the yen. British sterling is also likely to be dragged into the conflict and the regional currencies of the GCC will inevitably be affected by the global financial turmoil.

Who says we are on the verge of a new and dangerous phase of the geo-financial conflict? Well, Guido Mantega, the finance minister of Brazil, for one. His currency, the Brazilian real, and his economy could be one of the big losers from the conflict. He warned last week of the dangers of "currency wars" for the global economy, struggling to recover from the financial crisis. The Brazilian currency has always been vulnerable. On a trip to Rio some years ago, I wanted to change 500 deutschemarks into local currency. In exchange for my crisp DM note, I was handed back a carrier bag full of rolled-up bundles of reals.

The Institute for International Finance (IIF) is another harbinger of currency conflict. On Monday, this body, which speaks for the world's leading banks and financial institutions, warned of the dangers of global protectionism if the leading nations did not get their currency acts together. The IIF, while calling for a truce, is in no doubt that hostilities have already begun. What we are seeing is the beginning of the medium-term fall-out from the financial convulsions of 2008 and last year. In macroeconomic terms, the big loser from the financial crisis was the US and the dollar, which has acted as the global reserve currency since the post-Second World War settlement.

The process of diminution of dollar power was under way in any case, as China's economic growth pulled financial muscle away from the West and towards the dynamic economies of Asia. The financial crisis accelerated this trend and has now brought us to the opening of currency hostilities. China took advantage of the weakening of US financial power to increase its stock of reserve dollars. It now holds about US$2.45 trillion (Dh8.99tn) worth of currency reserves, of which about 65 per cent is in dollars, and shows no sign of wanting to reduce that stock. China's hoarding of dollars accounted for more than half the total increase in all reserves held between the beginning of 2008 and last June.

You might think the Americans would be grateful there is a buyer of last resort in the market to snap up dollars - and the sovereign debt they represented - that were in danger of depreciating as the frailties of the US financial system were made apparent. But it does not work like that, for two reasons. First, US politicians are becoming increasingly alarmed at the power this dollar and debt hoard gives to China. The authorities in Beijing have always said they were long-term holders of the currency of the world's biggest economy but US politicians (and they are not all right-wing xenophobes) fear the day when it is no longer in China's interests to hold dollars. Dumping them would be a declaration of financial war against the US and the effects on its economy would be cataclysmic.

The other reason Americans are concerned is what they regard as the intentional weakness of China's currency, the yuan. They believe Beijing is keeping this artificially low as a subsidy to Chinese exporters who already have a commanding position in world trade by reason of their huge cost advantages, mainly cheap labour. In normal times, this would not have been such an issue. Americans would have been happy to buy the goods produced by the Chinese and add to their dollar reserves. The problem now is that the US also wants to export. The cure to the economic recession that followed the financial crisis was seen as an export-led recovery but this would be stymied by an appreciating dollar. Perversely, it is now in interests of the US for the dollar to be comparatively weaker, certainly against the yuan but also against most other currencies in the world.

We seem to be approaching some kind of crisis point in the currency wars, or at least the end of an opening phase. It is obvious that not every currency can appreciate at the same time but there are now just too many of the biggest ones heading northwards when their national governments, also seeking export-led recovery, would prefer the opposite. The yen and the British pound have both been relatively strong and even the economic crises in Europe's peripheral countries including Greece, Ireland and Portugal has not stopped the rise of the euro over recent months. Something has to give.

The situation presents significant challenges and perhaps a unique opportunity for the Gulf countries. The challenges lie in the fact that the region is a remittance centre for many in Asia and Africa - even to Europe. Currency chaos would significantly disrupt this valuable trade. The ties between many regional currencies and the dollar also presents obvious dangers, chiefly the unwelcome volatility that big swings in dollar value would cause for the economies of the UAE and other dollar-pegged currencies.

Amid this uncertainty now may not be the right time to reconsider the GCC common currency. But, longer term, the logic of a regional currency, with a more representative weighting towards the big global players (apart from the dollar) and backed by petro-wealth, might become persuasive.