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Revaluation sooner than expected?

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1 Revaluation sooner than expected? on Tue Aug 04, 2009 11:06 pm

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Revaluation sooner than expected?

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REVALUATION SOONER THAN EXPECTED?

In economics the inevitable always happens, and while the Gulf States have definitely rejected the idea of unilateral revaluation by individual countries, there is now almost a universal sentiment that revaluation is going to be a natural part of the currency union. It seems that the 2010 currency union, in some form at least, is really going to happen.

The sudden plunge in the US dollar’s fortunes over the past year, with a reverse of the previous bear market rally, just underlines the importance of revaluing Gulf currencies as a part of the change to a single currency.

Basket of currencies

This is indeed what the central banks now appear to be working on with the Gulf States moving to a currency valued against a basket of currencies, of course dominated by the US dollar but also including the euro, and perhaps even gold and silver. Mexico is working on plans for a new currency that include silver, while the idea of a Gold Dinar for the GCC has been around for years.

As a timely report from the Dubai International Financial Centre’s economics department concluded that the new GCC currency is likely to be in great demand as a global reserve currency, given that it will effectively be backed by the hydrocarbon assets, oil and gas revenues and sovereign wealth of the Gulf States.

The DIFC report concentrates mainly on the mechanisms that might be used in the running of the new Gulf Central Bank which are clearly important but not the main interest for the public and business in the region.

The attention is bound to focus on two issues: how much of a revaluation will the new currency include (if it does)? And how much will interest rates rise (or fall) as a consequence of the introduction of the new currency and central bank?

Big questions

These are not easy questions to answer, and the finest minds of economics are going to be occupied over the next months in debating the answers. It would be a little inflated of a humble local business columnist to attempt a definitive solution to such a complex matter.

However, let me put a few thoughts onto the table. If the US dollar weakens suddenly and severely over the next few months – and the $2 euro has been suggested in this column before, and it does not look so unlikely today with the ongoing US financial crisis – the new currency presents a generational opportunity to break with the US dollar.

We all know that having the GCC currencies, pegged to the US dollar has been a source of stability in the past. But it no longer seems appropriate to follow the fiscal and monetary policies of a failing US economy in the booming oil states.

This mismatch of interest rates alone is overheating local economies while the falling dollar is boosting imported inflation.

Now the Gulf States will have to consider very carefully how the mandate of the Gulf Central Bank is framed. If it is to target inflation then interest rate rises will need to be cleverly phased so as not to suddenly deflate booming local economies or be overly attractive to foreign investors.

However, a well managed currency will hold its value as a new reserve currency of the world. You also have to wonder if the idea of a currency basket will not be just a prelude to a free floating currency, effectively valued against every other free moving currency in the world, and on a par with the dollar and euro.

Why should the Gulf single currency be a proxy for other currencies? It ought to stand as a currency on its own given the population size and economic importance of the region.

Opportunities

At the same time the opportunity for local and global financial institutions to develop a far more sophisticated and diverse regional financial system around the new currency is obvious. There will be far more demand for sukuks and equities issued in the new currency, and these markets will have greater depth and liquidity.

For a single currency is also a demonstration of political will and confidence in the future. It says that the Gulf States are serious about economic growth and prosperity and creating a modern financial infrastructure. This will not go unnoticed among global business and finance, and it will tend to be a self-fulfilling prophesy about the future.

The single currency is a great project and recent unity among the main actors suggests that the reality that is coming may be a pleasant surprise to us all.

http://articlesofinterest-kelley.blo...come-with.html

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