A GCC Currency: Brief Discourse on the Virtues and Pitfalls of a Single Gulf Currency

Let me start by saying that I think, in general, currency union for the Gulf is ultimately a good thing.

However, it is quite difficult to reach full currency status, by which I mean that the currency would ultimately be traded in financial markets, without political union. It is not at all clear that political union in the Gulf is desired or desirable.

What benefits may come from a unified currency? For business the most obvious benefit is the reduction in foreign exchange costs. The Gulf countries quite rightly wish to expedite the ease of trade between the nations.

A single currency reduces the cost of foreign exchange. However, the benefits gained from the advent of the Euro, for example, included not only lower foreign exchange trading costs, but also the elimination of currency value risk. This issue is not part of the GCC benefit since the Gulf currencies are fixed to the dollar.

Under the coming Union, as has been posited, the new currency will, as well, be fixed to the United States dollar. The virtues of fixing the currency to the dollar include the fact that the key instruments of wealth generation in the Gulf (oil and natural gas) are priced in dollars and the tying of the currency to the dollar makes it insurable for non-Gulf and non-US businesses around the world. That is, they can hedge their Gulf exposure with US dollar contracts.

A far less radical benefit is the economies of scale that may be generated from reducing the number of Central Banks in the region. It is also likely that Union could draw the Gulf closer to the development of full currency status; something I believe is quite desirable.

Unfortunately, the road to monetary union and full currency status is fraught with difficulties.

First from a practical point of view the decision of the UAE and Oman not to join the monetary union, as it now stands, substantially reduces the benefit of that union. I would implore the GCC to work out its differences and to develop an accommodating model.

Second, note that while the fixed currency situation, to a large degree, eliminates discretionary monetary policy power there can still be policy applications that help one country compared to another country. While the Gulf countries have relatively high correlation in economic performance, it can still be true that monetary policies that are best for one nation may not be the best for another. Further, if full currency status is reached this problem will become even greater.

Why is full currency status desirable? Despite China’s reticence to join the “full currency status club”, moving currency to full status allows for monetary policy freedom. Under the proposed regime, fixing the new currency to the dollar will continue to make the Gulf countries dependent on US monetary policy. “As goes the dollar so goes the new currency”. In my view then the ultimate goal should be to reach full currency trade status.

The GCC’s combined GDP (including the UAE and Oman) is large enough to float the currency, and the current financial strength of the Gulf countries, all of whom rank in the top 40 in the world in per capita income, should lead to a desire to trade the currency. However, like China, it is not at all clear that Gulf country Central Banks are independent of their executive branches of government.

Currencies trade well when participants believe that monetary policy will respond to economic circumstances and not be overly influenced by the wants of the executive branch.

The view here is that ultimately a freely traded currency would be the best thing for the GCC block. The region already has the talent necessary to manage a world class central bank. A freely traded currency allocates full monetary policy authority to the region. However, in going in that direction the issues of political economy become acute.

First, the combined income of Bahrain, Kuwait, Oman, Qatar, and the United Arab Emirates is slightly below that of Saudi Arabia alone. It is clearly the fear of the UAE and Oman, as a minimum, is that Saudi Arabia will attempt to dominate policy.

The insistence by the Kingdom that the central bank be housed in Riyadh is an example of that phenomenon. In fact, to the extent that the Saudi Arabian economy might face different problems than that of other Gulf countries, there is a question about where monetary policy actions will be directed.

This problem is also faced in Europe. The United States also has regional issues, but has been able to overcome them by developing a Washington centric Central Bank and by having a unified central government.

We then prescribe that from day one the ultimate goal should be to develop a freely traded currency. Compromise should be reached on the location and management of the Central Bank. A Board of Governors needs to be created that will work impartially to maximise the Regions economic welfare The UAE and Oman need to be full members.

The Policy objectives of the Central Bank need to protect the welfare of all the member countries.

The Central Bank should be independent enough to make decisions that economically are to the benefit of the entire region and should be free from pressure around the short-term political wants of the individual executive branches of government.

Such a policy is not meant to diminish the status or power of the leaders of the Gulf countries, but rather to strengthen the overall economy of the Gulf.

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