The mountain of bad debt still on the books of the United States banking system and now emerging in the European banking system, as well as the furious monetization of dubious assets undertaken by the Federal Reserve and European Central Banks, is coming back to haunt us.
The Greek crisis is a direct result of an insane policy of artificially low interest rates which allowed the reckless fiscal extravagance of an entire nation to continue unchecked. Such profligacy left Greece’s terms of trade stagnating since the advent of the euro and perpetuated tax evasion — estimated at more than 30 percent of tax revenues — taking gross government debt to 115 percent of the country’s $352 billion economy.
Exacerbating this were debatable accounting practices and Goldman Sachs-engineered financial tricks that led the credit default swaps (CDS) spreads to 450 basis points.
To mitigate the impact of the Greek crisis on other European nations, the European Monetary Union (EMU) took the seemingly paradoxical step of issuing a gigantic package of almost 1 trillion euro in further debt. This being debt, rather than the bank equity offered in the United States’ TARP program, it does not provide the benefit of the money multiplier, due to the fractional banking system. This has had the net effect of weakening the euro and spreading the contagion throughout Europe, thanks to the immediate widening of CDS spreads for some “Club Med” countries, which then extended outright to France and Germany.
As the Greek fiasco spreads, we should not forget the Gulf Cooperation Council nations, which have in recent years entered serious talks on establishing a single currency. This new currency, with its proposed US dollar peg, will now be subject to a thorough, critical revision.
Through the introduction of a single currency the GCC would provide a broader platform for economic integration and promote the non-oil sector, which could supply a more balanced mix of revenues and more distributed job opportunities to grow the region’s economy. Also, a single currency would decrease the transactional cost involved in bilateral exchange between the region’s countries. As the degree of economic integration increased, the non-oil sector would help offset foreign exchange costs, reduce accounting expenditure and other costs firms incur when operating in more than one GCC country.
However, the first lesson we can draw from the euro crisis is that a monetary union without fiscal and inevitably political unification may fail under the stress of crisis. A common currency fosters an artificial convergence of interest rates to the lowest denominator, and allows countries to defer addressing productivity disparities and fiscal imbalances, until a crisis forces a painful realignment of the fiscally weaker. A common currency imposes currency rigidity that precludes the possibility of engineering fast International Monetary Fund-type interventions, such as a dramatic devaluation to jump start growth.
So how would a single GCC currency impact the region should a crisis threaten macroeconomic stability?
Most GCC countries currently maintain considerable surpluses — collectively 26 percent of GDP in 2008 — and therefore need not issue debt. Until oil revenues constitute less than 50 percent of GDP, however, the proposed new currency will inevitably be linked to oil prices. After 2008, which saw oil peak at above $100 a barrel then plunge briefly to $30, possible volatility could be uncomfortable to say the least.
As an April 2010 Jadwa Investment report rightly noted, Greece’s high budget deficit had been largely based on its ability to draw on Eurozone membership to borrow cheaply abroad. However, the bank said a comparable scenario was unlikely in the GCC due to the similarity of the Gulf nations’ oil-based economies, meaning imbalances between nations were less likely.
As we can see from the ongoing euro crisis, a regional common currency can be a double-edged sword. As such, the architects of a GCC monetary union will have to evaluate and incorporate lessons from the euro’s woes, and carefully consider if the next logical step — a fiscal and political union — is a wise choice for the future.