Infrequently Asked Questions on the Monetary Union of the Countries of the Gulf Co-Operation Council

Infrequently Asked Questions on the Monetary Union of the Countries of the Gulf Co-Operation Council Jerry Mushin Victoria University of Wellington New Zealand Abstract: This article places the monetary union of the countries of the GCC, which is to be established in 2010, in the context of their recent monetary history and in the context of other monetary unions. It shows that the decision to join (or withdraw from, or re-join) a monetary union is both an economic and a political matter. The principal conclusion is that this new currency arrangement in the GCC countries, although of great importance, is not as dramatic a change as it might appear and, especially, that it is significantly different from the euro zone. Keywords: monetary unions, fixed exchange rates, Gulf Co-operation Council The six members of the Gulf Strasky, Adolf, and Peschel (2008). It is Co-operation Council [GCC] have generally accepted that, in appropriate decided to introduce a common economic conditions, a monetary union currency, pegged to the United States can increase efficiency by decreasing dollar, in 2010. The probable transactions costs and decreasing risk. advantages and disadvantages of this Integration of goods markets and of new arrangement have been discussed financial markets is likely to lead to by Abed, Erbas, and Guerami (2003), by economies of scale. There might also be Abdul-Qader and Shotar (2006), by a decreased risk premium on financial Creane, Goyal, Mobarak, and Sab assets. The principal disadvantage is the (2004), by Fasano and Iqbal (2003), by loss of monetary sovereignty. A member Fasano and Schaechter (2003), by Jbili of a monetary union can operate and Kramarenko (2003), by Sturm, neither an independent monetary policy Economics & Business Journal: Inquiries & Perspectives 1 Volume 3 Number 1 October 2010 Monetary Union Mushin nor an independent exchange-rate separately from the currencies of the policy. Its macroeconomic policy must remaining members. The loss of use fiscal instruments and other means. monetary independence is a necessary There are also costs that are incurred, consequence of joining a monetary by governments and in the private union. Mushin (2002(a), 2002(b), sector, when a monetary union is 2009(b)) has compared the established. macroeconomic effects of fixed and It is also generally accepted that floating exchange rates. Cohen (2008) the economies of Bahrain, Kuwait, has explained the nature and recent Oman, Qatar, Saudi Arabia, and United experience of monetary unions. Arab Emirates are sufficiently similar Using data published by the that it is probable that a monetary International Monetary Fund [IMF], union would be of substantial benefit to Mushin (2004, 2008(b)) has described all of its members. The purpose of this the recent distribution of exchange-rate article is not to repeat this analysis but systems. Most major countries now to provide the answers to nine have floating exchange rates. The important questions that are not members of the GCC are among the frequently asked but that are relevant significant countries that have fixed to the understanding of this issue. The exchange rates. first four questions deal with the nature and recent experience of monetary 2. Do Other Monetary Unions Exist? unions. The remaining five questions place the imminent monetary union of Because of its recent formation, the countries of the GCC in the context its importance in international trade, of their recent monetary history. and the large number and diversity of its members, the monetary union that is 1. How Does A Monetary Union most widely known is probably the euro Compare With Other Exchange-Rate zone. At its inception in 1999, the euro Systems? was adopted by eleven countries. The euro zone now consists of sixteen A monetary union can be regarded countries1. The development of the euro as an extreme type of fixed zone, and of earlier attempts at exchange-rate system. Like countries monetary integration in western Europe who join a monetary union, a country since the early 1970s, have been that adopts a fixed exchange rate analyzed by Mushin (2009(a)). surrenders, in exchange for lower Other examples of monetary transactions costs and lower risks for unions are the Eastern Caribbean businesses, its right to choose its own Currency Union, which has eight monetary policy. Of course, fixed members2, the Communauté Financière exchange rate systems are not all the Africaine [CFA], which has fourteen same. Some are more fixed than others. members3, and the Comptoirs Français A monetary union, however, does not du Pacifique, which has three allow the currencies of any of its members4. members to be devalued or revalued Political unions usually lead to Economics & Business Journal: Inquiries & Perspectives 2 Volume 3 Number 1 October 2010 Monetary Union Mushin monetary unions. Recent examples of currency of an external country. such political unions, which both The currency of the euro zone was occurred in 1990, are the expansion of introduced in 1999. The other monetary the German Federal Republic to unions use currencies with longer incorporate the former German histories. Democratic Republic and the merger of the former People’s Democratic 4. Have Other Countries The Same Republic of Yemen (Aden) and the Reasons For Forming Monetary former Yemen Arab Republic (Sana’a) to Unions As The GCC Countries? form the Republic of Yemen. However, a political union does not necessarily lead Choosing a fixed exchange rate, or to a monetary union. For example, membership of a monetary union, is a Egypt and Syria did not introduce a complex decision. There is no common currency when they merged in commonality between the countries 1958 to form the United Arab Republic. (and groups of countries) that have This political union ended in 1961, but chosen this type of policy. Such the absence of a monetary union was countries are of many sizes, have many not the reason for this. levels of development, have many types Dollarization, in which a country of industry, may be important or uses another country’s currency, is unimportant in world trade, may be another type of monetary union. For economically integrated with their example, the United States currency is neighbors or not, may be net importers the sole legal tender in seven other or net exporters of capital, and have countries5. Dollarization can involve a many types of government. Despite this, currency other than the US dollar6. The the number of reasons why countries unofficial use of currencies, especially choose a fixed exchange rate (or the US dollar, outside their countries of membership of a monetary union) is less issue, which occurs in many countries, is than the number of countries that make not the same as dollarization and is not this decision. within the scope of this article. Mushin (2001, 2008(a)) identified eight reasons for countries to adopt a 3. Does The Establishment Of A fixed exchange rate (or to join a Monetary Union Necessarily Involve monetary union): The Creation Of A New Currency? (i) Small economy Fixed exchange rates are often The establishment, in 1999, of the chosen by very small countries that are euro zone involved the creation of the (to a significant extent) economically euro, a new currency that did not integrated with a dominant neighbor. previously exist. However, not all newly They may even use the neighbor’s established monetary unions use a currency. Examples are the use of the newly created currency. A monetary Swiss franc in Liechtenstein, the union might decide to use the existing Indian-rupee pegs that are operated in currency of one of its members or it Bhutan and in Nepal, and the use of the might decide to use the existing New Zealand dollar in Niue. Economics & Business Journal: Inquiries & Perspectives 3 Volume 3 Number 1 October 2010 Monetary Union Mushin (ii) Historical and institutional membership of a monetary union. For connections example, the UK is a member of the A small economy might also fix its European Union but is not a member of exchange rate in terms of the currency the euro zone. of the country with which it has (vi) Perceived high risk significant historical or political links. Countries that are widely This is usually a colonial vestige. perceived to be actually or potentially Examples are the use of the CFA franc, unreliable often choose to reduce the whose value is guaranteed by the economic effects of this by adopting a French government, in most of France’s fixed exchange rate. The causes of the former territories (and two additional damaging perceptions may be political countries) in Africa, Liberia’s fixed or economic or both. Recent examples exchange rate (until 1997) with the are Hong Kong (in anticipation of, and United States dollar, and the rigid link since, its constitutional change in 1997) with the British pound of the currencies and international pariahs such as Iraq of Falkland Islands, of Gibraltar, of and Libya. Guernsey, of Isle of Man, of Jersey, and (vii) Acute crisis of St Helena (which is the remnant of In an attempt to reduce economic the Sterling Area). (and therefore also political) instability, (iii) Significant integration with, but fixed exchange rates are often not domination by, a larger introduced by countries experiencing neighbor severe economic and political Examples are the fixed exchange upheavals. Recent examples are rate, until 1979, between the Irish Argentina and Poland. Republic pound and the British pound, (viii) Recent independence the fixed exchange rate between the A fixed exchange rate is often Brunei-Darussalam dollar and the expedient for newly independent Singapore dollar, and the monetary countries (such as parts of the former union, until 1999 (when it became part Union of Soviet Socialist Republics and of the euro zone), of Belgium and of the former Yugoslavia) because it Luxembourg.

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