It was suggested here some while ago that the Gulf states should probably be revisiting the issue of the US dollar peg, particularly now that the Federal Reserve has announced its intention to maintain extraordinarily low interest rates for years ahead, which poses an inflationary threat for linked economies whose recoveries are already well under way, but which face structurally different issues.
The date attached to that promise has already drifted out from 2014 to 2015. Who’s to say that it won’t be extended to 2020 — that metaphor for perfect vision — given the absence of alternative thinking?
By that time, cynics might suggest that the error of this unbridled stimulus strategy will be plain to see, and the responding refrain will be that hindsight is a wonderful thing, as if nobody is flying warning flags now.
Just as there were those (still ignored) who advised 20 years ago that the euro was a fundamentally wrong-headed idea, politically motivated rather than economically sound, so there were commentators, such as the Bank for International Settlements, who anticipated the global credit crisis — and it may now be that the reflationary danger for the Gulf region is likewise predictable.
It is as well to seek out the learned voices who can substantiate this supposition, and only a matter of weeks ago, one such source had a useful message to impart at a regional forum.
Syed Basher, research economist at the Qatar Central Bank, made a presentation to a symposium conducted by the International Institute for Strategic Studies on how the GCC might take the initiative on this matter.
Apart from identifying the key lesson of the European experience — that monetary union requires the creation of a fiscal union as well — his paper poignantly notes a curious lack of attention to one key aspect of current arrangements.
Stony silence
By comparison with the chatter about China, its payments surpluses and the level of the yuan renminbi, there has been “a stony silence on the undervalued Gulf currencies”, it says, although preparations for a regional dinar have been extensively covered.
As to that prospect, the bulk of the analytical background finds a favourable economic basis for the venture, but still it “faces significant headwinds” in terms of low intra-regional trade, lack of supranational political institutions and limitations in research capacity.
Total trade flows within the region, as at 2010, represented only 6.5 per cent of the total with the rest of the world. Financial integration has been faster, but still investment into regional industry from collective resources has been lacking, Basher states.
Moreover, corporate governance still leaves much to be desired, notably as to privileged information in stock markets.
Yet, the benefits of monetary union in terms of transaction costs, price transparencies and increased purchasing power over imports would not only be worth having, they might be accompanied by a “much-needed new economic paradigm” for the growth and development of the GCC as this century unfolds.
Tying currencies together, however, is not the crucial element for success. If the resulting currency were free-floating rather than fixed, stability would be enhanced as well, it seems.
Flexible exchange rate regime
“A flexible exchange rate regime will permit the GCC to absorb large swings in commodity [oil and food] prices,” argues Basher, “and would allow them to devise their own monetary policy to address domestic conditions”.
There is a reason why that is truer now than in the past, relating almost inevitably to oil. In a nutshell, the fundamental shift of global growth from the OECD countries to emerging economies has produced a disconnect between oil prices and both the US Federal funds rate and US dollar.
Whereas the oil price reverted to its mean trend during 1973-2000, since 2001, its path has been decisively upward. The fact that it has moved in the opposite direction to the other two variables has important implications.
In particular, the Fed has set interest rate policies increasingly to support growth rather than restrain inflation, entrenching an easy policy for the US, which the Gulf has followed while actually requiring a much tougher stance for the local economies.
A counterpart policy decoupling is advisable. Of course, it’s not rocket science, but repeating the truth doesn’t become less relevant for being obvious, as the recent history of Europe, an erstwhile potential model for the GCC, has demonstrated only too well.
Limited space here defeats further exposition, and there is plenty to discuss even once the basic principle is accepted.
Awkward issues still present themselves. For instance, isn’t fiscal union realistically a euphemism for political union? And surely it is not just that differences between the states make asymmetric shocks destabilising, but that differing productivity rates will not disappear, and compensating transfer payments may escalate over time?
Those and other sticking points have been reviewed, and can be shared with readers next week.
