Is monetary union an elusive dream?
BY Arthur Macdonald, Posted on » Monday, June 22, 2009
BY Arthur Macdonald, Posted on » Monday, June 22, 2009
On the face of it you would have thought that setting up a single currency in the GCC should have been a pretty easy prospect. But with the likelihood that there will be no single currency for at least three years it appears that there is some structural problem that has seen the member states fail to agree on very much since they first set off on this monetary union and common market route. I read somewhere recently that the prospects for the deal took a step forward recently when Oman announced it may join the new currency at some time in the future. That is what the UK said when the euro came into being in 2000 and almost a decade down the road there is no likelihood in the near future that that is going to change. So I would take the positive noises about Oman's participation with a very large pinch of salt. As far as I can see the possibilities on monetary union are now less likely than when the member states first took the decision for closer economic collaboration. There were positive signs early on when Kuwait agreed to abandon its basket of currency peg and come back into the US dollar fold. But that was one step forward then one step back as it returned to its own basket a couple of years ago. The project was further set back when Oman walked away from the idea, and then, things just seemed to get worse and worse. When the US began to aggressively cut interest rates to boost its economy and fend off a coming recession, which eventually arrived with a vengeance, this caused major problems for the region. Spiralling inflation can only be dealt with properly by a raise in interest rates. But as prices went through the roof in the UAE and Qatar both were under pressure to cut rates to maintain the peg. And for the citizens of both countries that proved a bit of an expensive disaster as prices continued to rise. The sensible thing to have done in this situation would have been for some, if not all of the GCC economies to either revalue their currencies or break from the dollar peg. But neither of these things ever happened. The idea that the UAE and Qatar were contemplating some move saw billions of US dollars flood into their economies as speculators tried to take advantage of a possible strengthening in their currencies when they finally took action. And when the credit crisis hit the West and the hot money went home, Qatar suffered and Dubai began to sink as its property industry went into an unprecedented freefall. Now one of the reasons speculators thought the UAE and Qatar would take action was that ultimately, had there not been a global financial collapse back in the US, then that is probably the road they would have gone down. But there is nothing like a global financial crisis to take the steam out of an economy and as the West suffered so did the UAE and Qatar as credit dried up and the oil price went into freefall. The problem here is that these problems are not going to go away as long as Saudi Arabia remains committed to the US dollar peg. In the longer term it is not in the economic interest of any of the GCC countries to remain resolutely pegged to a currency that in real terms has been weakening for almost three decades. It may have bounced back from earlier lows, but the vast majority of economists believe that the US currency will continue to head south as the US, while remaining the most powerful economy in the world, will nonetheless represent a declining percentage of its share of the global gross domestic product. All other things being equal, as economists like to say to cover their position, the exact opposite is going to happen in the GCC. All of the economies, to a greater of lesser degree, are diversifying and, while we may not see the levels of economic growth posted over the past decade, we can expect far higher levels of growth here than in the US, and indeed in most of the developed world. Again, the price of oil, in real terms, may not hit the dizzying heights of $150 again, but the oil price has already bounced back strongly in a period where most of the global economy is still in recession. In the medium to long term oil demand will increase rather than fall and it does not take a genius to work out that that factor alone will continue to strengthen the market for the region's largest export. And that liquidity will further boost growth and potentially fuel inflation. The bottom line is that the dollar peg may suit Saudi Arabia, and possibly even Bahrain. But for the other GCC states it will be bad news in the future. The decision by the UAE to walk away from monetary union earlier this year may be seen as a bargaining counter against Saudi Arabia. It may also be seen as sour grapes that it did not get to host the GCC central bank. But it is more likely that the country took the view that if Saudi Arabia was to have so much influence at this time then it would have even more when the currency is up and running. And in that instance you can see why the rulers down there take the view that the exercise may not be worth a candle. A single currency would be a good thing for the region, but to be properly effective it has to be one that, in the short term weakens the dollar peg and in the long term looks to free float on its own right. In the meantime it should be looking to peg to a basket of its trading partners, of whom the US is no longer such a big player. The problem at the moment is that with only four countries signed up for monetary union, one of which may be loath to go back onto the dollar peg, is there really any point? The euro is significant in global markets because it is now the largest currency in the world, having overtaken the dollar a couple of years ago. A single GCC currency would be an important advantage for the region, but only if all the players are committed. With only three or four states taking part, what's the point? My other doubt about the GCC economic union is that this should, if it is to work, allow the free flow of labour goods and services across borders. For numerous reasons I can't see Saudi Arabia abandoning security checks for traffic from the fleshpots of the UAE. |