Not long ago people were discussing the prospect of a GCC currency union based along the lines of the euro. But now that the very future of the Eurozone looks uncertain should a common currency for the GCC be abandoned completely?
To answer this question we need to define the perceived benefits of a common currency and then look at what went wrong with Europe and whether it was avoidable.
There are two main benefits of sharing a currency: the first is political and the second is economic. If a group of countries share a currency then you can assume those countries won't go to war with each other. Having the same notes and coins thus has a diplomatic advantage. It also stream lines some codes of law and regional regulation, which should, in theory make it easier to do business within a currency bloc that shares the same values, laws and justice system.
The chief economic benefit is trade. If a group of countries all share the same currency then it should boost intra-regional trade since there won't be any negative effects from movements in foreign exchange markets.
In theory a currency union sounds like a great idea: get all of the trade and labour market benefits without having to bail out nations that are in trouble. Wait a minute; isn't that exactly what Germany, France and the other Northern European nations have to do for Greece, Ireland and Portugal?
Therein lies the fault at the heart of the Eurozone. There can be no benefits from a currency union without financial support for a member that is in trouble. Take the United States of America as an example. Its 52 states share a currency - the dollar - but the Federal Government in Washington has central control. States in the US have defaulted plenty of times, just look at Louisiana, but each time the richer nations come to the rescue. The way the US works is that if a nation gets into financial difficulties then they pay less to the central government. Sure, the richer states have to pay more, but on average the financial position is the same: the richer states balance out the poor.
This has been a success; the US has essentially had the same system of government since the 18th Century.
The problem with the Eurozone is that its one size fits all approach doesn't work. As the US found out, there are poor states like Louisiana that can never catch up with big cosmopolitan powerhouses like New York.
Europe is just figuring this out now. Since the 2001 introduction of the euro some countries' saw their economies grow so fast that bubbles were created that duly burst come the financial meltdown in 2008. This happened in Ireland, Spain and Greece because interest rates were too low. However, for most of the last decade Germany (Europe's largest economy) needed low rates because its economy was much more sluggish.
The peripheral economies went on an enormous spending binge, which boosted trade within the Eurozone. That sounds like a positive, however the chief beneficiary was Germany since it produced the most goods - the other economies, bar Ireland, had limited exports that were of low value.
So the good times had to end and they shuddered to a halt 18 months ago for Greece. The consequences were immediate. For most of the last decade, investors didn't differentiate between whether they bought German or Greek debt, and lending rates for the two countries were roughly the same. However, when the music stopped playing this position reversed. Investors lost faith in the southern European economy and recently its two-year borrowing costs have shot up to nearly 40 per cent.
Now we are left to debate the solution to the Eurozone's crisis. Consensus is forming around greater integration and "fiscal transfers" so that the rich nations help up out those in financial difficulties. This works for the US and it seems like it's the only way to get the Eurozone back on track.
All of this should be a great learning experience for the GCC: firstly, currency unions take many years to get right and secondly the closer the economic integration at the beginning the more likely the chance of success.
At this stage the authorities in the Middle East should see how Europe resolves its crisis, now is not the right time to contemplate a common currency for the GCC.
© Forex.com 2011
