Gulf states agreement to enter currency union seen as dollar threat

The last I had heard about a prospective Gulf currency union came yesterday morning in a note by Marc Chandler who is the Chief Strategist at Brown Brothers Harriman’s FX group.  He indicated that he was more optimistic about a Gulf currency union on the than a Latin American one on the eve of a big Gulf leaders summit – although he noted several obstacles.

I woke up this morning to news that the currency union is going to happen and this has caused the U.S. dollar to weaken as it reduces U.S. dollar hegemony as a currency of trade.  Ambrose Evans-Pritchard reports:

The move will give the hyper-rich club of oil exporters a petro-currency of their own, greatly increasing their influence in the global exchange and capital markets and potentially displacing the US dollar as the pricing currency for oil contracts. Between them they amount to regional superpower with a GDP of $1.2 trillion (£739bn), some 40pc of the world’s proven oil reserves, and financial clout equal to that of China.

Saudi Arabia, Kuwait, Bahrain, and Qatar are to launch the first phase next year, creating a Gulf Monetary Council that will evolve quickly into a full-fledged central bank.

The Emirates are staying out for now – irked that the bank will be located in Riyadh at the insistence of Saudi King Abdullah rather than in Abu Dhabi. They are expected join later, along with Oman.

The Gulf states remain divided over the wisdom of anchoring their economies to the US dollar. The Gulf currency – dubbed “Gulfo” – is likely to track a global exchange basket and may ultimately float as a regional reserve currency in its own right. “The US dollar has failed. We need to delink,” said Nahed Taher, chief executive of Bahrain’s Gulf One Investment Bank.

The project is inspired by Europe’s monetary union, seen as a huge success in the Arab world. But there are concerns that the region is trying to run before it can walk.

Given recent events in Europe concerning Greece, Ireland and Austria, one might think the desire to initiate currency unions has weakened.  But it has not.  The disruption caused by this financial crisis has buffeted smaller countries with sovereign currencies because of a lack of currency controls and the destabilizing effects of ‘hot money.’ Iceland, which suffered the worst fate of small nations, has now been fast tracked for EU membership. Latvia has allowed its economy to suffer depression in order to maintain a peg to the Euro in the hopes of escaping the downside of small country monetary independence. And Brazil has attempted to deal with this by instituting currency controls, which some are heralding as a necessary measure. Other nations like Nigeria have also revived exchange controls in the wake of crisis.

The Gulf nations have obviously chosen currency union as a mechanism to protect their economies from excessive volatility.  This is a project that has been bandied about since 2001. It is unclear whether the recent problems in Dubai had anything to do with their calculation to spurn the U.A.E. as the currency’s center. 

The fact that the GCC (Gulf Co-operation council) also agreed to deploy a rapid intervention force to deter outside actors intervening in their internal affairs leads me to believe these actions could be a direct response to the U.S. and the U.S. dollar.  I am sure the GCC will point to Yemeni terrorists in Saudi Arabia as the target but the currency and military decisions may just as easily point to the United States.