HARDLY a week goes by without a new reason to be gloomy about the dollar. The latest scare is that members of the oil-rich Gulf Co-operation Council (GCC) might loosen their links to the greenback, depriving the foreign-exchange markets of a reliable buyer of the troubled currency.

The United Arab Emirates (UAE), through its central bank governor, recently hinted that it would like to free itself from the dollar peg, but would prefer to do it in concert with the other GCC members—Saudi Arabia, Kuwait, Qatar, Oman and Bahrain. Last May Kuwait broke ranks and decided to track a basket of currencies. Since then, the Kuwaiti dinar has risen by nearly 5% against the dollar.

Now others might follow Kuwait's lead. Someone close to the GCC says that some members are advocating a substantial revaluation—perhaps by as much as 20-30%—if the dollar's slide continues. Another option being talked about would be to link the Gulf currencies to euros as well as dollars, with up to half the basket in the European currency. Further discussions will take place at a council summit on December 3rd and 4th. Futures markets are already pricing in a slight loosening of the dollar peg—though the UAE's central bank sought to quell speculation on November 22nd by cutting short-term interest rates.

The immediate problem for the Gulf states is that the inflationary effects of the oil-price boom are being amplified by their yoke to a weakening currency. Inflation, which until 2003 was rarely above 3% in the Gulf, is now around double-digit rates in Qatar and the UAE (see chart). Even in Saudi Arabia, where inflation has been more muted, it picked up to nearly 5% in September. Much of the pressure is from rising world food prices, which are a bulky item in consumer-price indices.

A revaluation would help cap inflation by making imported food cheaper. But housing costs are the biggest contributor to inflation in the UAE and Qatar, say Gerard Lyons and Marios Maratheftis, economists at Standard Chartered Bank. Spurred by strong oil revenues, these two economies have been growing at an annual rate of 8-10%, drawing in more workers from overseas and pushing up rents.

The rigidity of the exchange-rate regime gets in the way of policies that might temper these forces. Countries with pegs to the dollar have to mimic the policy of the Federal Reserve. If a GCC state tried to tighten its monetary policy when, as now, the Fed is easing, it would push its currency above the dollar peg.

The trouble is, a policy setting that is right for recession-threatened America is wrong for the GCC, especially at a time when oil prices are reaching record highs, as they briefly did on November 21st, of $99.29 a barrel. The pressures are made worse by speculative deposits, in anticipation of a revaluation, that drive down interest rates and add more fuel to the boom. The broad-money supply grew last year at an annual rate of 15-40% in GCC countries, according to Standard Chartered.

If, as seems likely, some GCC members let go of their existing dollar pegs, what might they put in their place? The simplest gambit would be a one-off revaluation: keep the link with the dollar but at a higher exchange rate. That would cap import prices and soak up the speculative hot money that has added to liquidity. It should also take the steam out of asset markets—and perhaps housing costs—by making investments more expensive for foreigners, including imported workers.

Yet a revaluation would not address the problem of policy inflexibility; the GCC would still be yoked to the Fed. A bolder course would be to follow Kuwait's lead and peg to a basket of currencies. Mr Lyons reckons that the dollar accounts for around 70% of the Kuwaiti basket, the rest made up of the euro and other currencies. Fuzziness about the precise make-up of the currency weighting allows Kuwait some discretion on interest rates—a “great benefit,” says Mr Lyons.

But even this is not ideal. Benchmarking to any rich-world interest rate is unlikely to suit the Gulf, since high crude prices depress income for oil importers but boost it for oil exporters. Brad Setser of the Council on Foreign Relations suggests one way around this problem is to have oil as one of the prices targeted in the basket.

A revaluation has costs. The huge stock of dollar assets held in the GCC would be worth less in terms of the home currencies. But unchecked inflation would also erode the domestic value of foreign assets and in a more damaging way.

A shift towards a looser peg in the GCC would undoubtedly hurt the greenback. At the very least, dollars would be purchased at a slower rate—leading to what Mr Lyons calls “passive diversification”. At worst, the policy might encourage others to follow, sparking panic sales of American assets. That is the main reason why Saudi Arabia is reluctant to move now, when dollar sentiment is so precarious. But given the inflation problem elsewhere in the GCC, the odds are that one or two more members will follow Kuwait.