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The Gulf Common Currency: Implications for the U.S. Dollar
The Gulf Common Currency: Implications for the U.S. Dollar By John J. Phillips IV Seeking Alpha: !~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~! Amidst the US Dollar’s recent depreciation in the global marketplace the looming adoption of a common currency by the Gulf Cooperation Council has weighed down on the minds of many economists and market participants alike. With the adoption of the common currency tentatively scheduled for 2010 it is worth examining both the motivations for a common currency, and its implications in the global marketplace. To begin with let us examine a few of the basic reasons behind the inception of the common currency as well as a few of the steps taken towards its creation. While majority of the GCC countries are highly dependent upon oil exports the GCC is trying to diversify member economies. The GCC ultimately seeks to increase private sector participation in interregional economic development. The GCC expects that the adoption of a single currency will yield a number of economic benefits. Namely, adopting a single currency will eliminate interregional currency conversion costs, which is expected to boost interregional trade. Increased interregional trade and investment will lead to increased economic diversification in the GCC, and, in turn, will lead to increased private sector participation due to increased interregional demand for non-oil related goods. The elimination of conversion costs is therefore expected to contribute to development in areas outside of the oil sector and to economic growth as a whole. In December of 2001 GCC authorities developed a timetable for the common currency. The timetable required member countries to establish a customs union by 2003. Member nations were also required to integrate their exchange rates by 2003 as well. An agreement upon the criteria for convergence was to be reached by 2005, and the adoption of the new common currency was scheduled for 2010. There has since been some speculation that perhaps the new currency will not be launched until 2012 or later. Keep in mind that the Euro was initially supposed to be launched before 1999, but was hindered by the UK’s rupture in 1992. As per the GCC’s common currency timetable, exchange rate integration required GCC countries to officially peg their currencies the US Dollar in order to maintain cross exchange rate stability. The GCC chose the US Dollar because it is the intervention currency of all the GCC countries, majority of their foreign currency reserves are held in dollars, and most of the GCC member’s currencies had already been effectively pegged to the US dollar. While the official convergence criteria has not in fact been set in stone it has been developed in theory. The common currency has come thus far. We are now awaiting the finalization of convergence criteria followed by a consolidation of the member currencies. With this brief history of the GCC’s common currency in mind let us examine some of the reasons why the development of this common currency is important outside of the Middle East. Initially the general expectation was that the Gulf common currency would be pegged to the US Dollar considering that member nations had already pegged their respective currencies to the dollar for the interim period. Despite this the option to peg the new currency to special drawing rights [SDR] or a special basket of currencies also remains an option. While GCC authorities will have to decide how the new currency will be valued sometime before it’s tentatively scheduled launch, many question if the member nations will maintain their dollar currency pegs through then in the face of the Dollar’s recent depreciation. If the new currency were to be pegged to another currency or a basket that excluded the dollar it is possible that oil will also be priced by some means other than the Dollar. If that were the case the US could be hit with a double wave of inflation if oil prices are on the rise, and the value of the Dollar is declining against whatever currency or currencies that oil is priced in. If the common currency were pegged to a basket that included the Dollar inflationary risks would be less extreme. In the event that the common currency is pegged to the Dollar it will help to maintain Dollar demand, something that the US can certainly use right now. It is possible that the GCC members will move to revalue against, or de-peg from the Dollar before the launch of the common currency. The IMF’s Strauss-Kahn recently argued that, a 20% revaluation against the Dollar would lead to a $400B loss on external assets if all of these assets were Dollar-denominated. The GCC is estimated to hold some $2.0T in assets abroad, most of which are thought to be Dollar denominated. While the GCC states continually deny any plans to de-peg from the Dollar, it remains within the realm of possibilities and could damage Dollar demand. Some of the GCC members have already began conducting studies on taking such action. On a separate note the management of a singular currency could prove to be quite burdensome. The current state of the Euro is a perfect example. Germany, the growth engine of the Euro-Zone, is not currently having any problems coping with the strong Euro as its economy continues to expand. France, the second biggest economy in the Euro-Zone, has voiced its concern about the impact of current Euro levels on its economy many times over. In short a singularized monetary policy may not fly in the GCC, and, in the long run, is likely to hit a few bumps in the road. As it is will the Euro now, the question then will be can a one speed monetary policy fit all? In conclusion, it remains to be determined when exactly the GCC’s common currency will be launched. At the going rate it looks like the GCC could miss the initial 2010 deadline by at least two years. The implications of the common currency for the US Dollar are mixed. On one hand, if the GCC pegs the common currency to the Dollar, the common currency could generate Dollar demand, and held to restore faith in the Dollar. On the other hand, if the GCC moves away from the Dollar the implications for the Dollar in the global marketplace will be much less than favorable. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ [url]http://seekingalpha.com/article/71592-the-gulf-common-currency-implications-for-the-u-s-dollar[/url]