Asia Central Bankers Say It with Gold

By David Roman
The Wall Street Journal
Monday, December 28, 2009

http://online.wsj.com/article/SB20001424052748704718204574616280863871104.html

Strong dollar equals falling gold price, right?

Except, perhaps, when Asia's central bankers are involved.

Three-quarters of the region's $5 trillion in foreign-exchange holdings are parked in U.S. dollars. A desire to diversify away from the greenback, though, has become evident. The dollar's share in reserve accumulation dropped to less than 30% in the third quarter, Barclays Capital estimates.

Admittedly, knowing exactly what is in central bank reserves takes guesswork, but analysts think most diversification in 2009 favored the euro.

Recently gold has turned up as a second alternative. The Reserve Bank of India stirred markets when it revealed it purchased 200 tons of gold from the International Monetary Fund in October, increasing gold's share of central bank reserves to 6.4% from 3.6%.

Even if other central banks don't start making large purchases like India's, they will likely remain a substantial buyer as reserves continue to pile up. In the 12 months through November, the banks added around $800 billion to their foreign-exchange holdings, a side effect of their efforts to slow the appreciation of local currencies.

China, which has seen its reserves rise by more than 50% in the past two years to about $2.3 trillion, has bought 450 tons of gold during the period, Merrill Lynch estimates. That is a substantial chunk in a market where annual turnover is about 3,800 metric tons. Accumulation of reserves by Asia's central banks will likely continue as long as strong regional growth and high interest rates continue to attract foreign investors.

A shift in portfolios, like India's, would only add to this, and there is scope for this to happen. Gold accounts for around 2% of reserves in emerging markets, Merrill Lynch calculates. That compares with a 10% average globally, and more than half of all holdings in the case of the U.S. Federal Reserve, and France's and Germany's central banks.

Asia's central bankers will move slowly, particularly with gold prices still above $1,000 an ounce. But a shift toward the global average would mean more buying -- regardless of what the dollar does.

Do We Need a New Reserve Currency?

By Emirates Business, Dubai
Sunday, December 27, 2009

http://www.business24-7.ae/Articles/2009/12/Pages/26122009/12272009_b60d075ae8834ca981282abc0ee85802.aspx

A new global currency should replace the US dollar as the international reserve currency, as the long-term deterioration of America's economy and the greenback is fuelling a "currency-regime crisis," says Martin Wolf, associate editor and chief economics commentator of the Financial Times.

Wolf, who has honorary doctorates from three universities, bases his argument in part on the Triffin dilemma, an economic paradox named after economist Robert Triffin. The paradox shows that the US dollar's role as a global reserve currency leads to a conflict between US national monetary policy and global monetary policy. It also points to fundamental imbalances in the balance of payments, particularly in the US current account.

Speaking at an event organised by the Singapore Institute of International Affairs, Wolf said Triffin believed that the host nation of a global reserve currency will inevitably run up a huge current account deficit that would consequently undermine the credibility of its currency and adversely impact the global economy. "You can't have an open globalised economy that relies for its ultimate liquidity on the currency of one country. That was his [Triffin's] argument. And, therefore, he said the Bretton Woods system would break, which it did. And exactly the same thing happened with Bretton Woods II, which is the system of pegging.

"So I agree with this. And I'm absolutely convinced now, in a way that I was not three or four years ago, that we cannot continue with a genuinely global economy which relies on national money, and that's not sold by just adding another couple (of currencies). It actually means having a global money."

Indeed, Wolf said he's in complete agreement with China Central Bank Governor Zhou Xiaochuan, who has argued for a new global currency "most credibly and convincingly."

"On the dollar, there is nothing to support this currency except the Chinese government and a few other governments that are prepared to buy it," said Wolf. "Anybody can look at the arithmetic of the fiscal deficit, the monetary policy, the external balance, which has improved but largely because of the recession -- the dollar is not adequately supported."

The US currently has a national debt in excess of $12 trillion or almost $40,000 per citizen, with a debt to GDP ratio of more than 85 per cent. In the July-September quarter, the US current account deficit rose sharply by 10.3 per cent from the previous quarter to $108 billion. In the past year, the US dollar index, which measures the performance of the greenback against a basket of currencies, has also fallen significantly.

Apart from the economic risks posed by the decline of the US dollar, China's devaluation of its currency is causing "a real problem" for Europe. The "very perverse currency adjustment" is highly destabilising for the euro zone economy and could create a crisis, said Wolf.

"There is nothing to prevent this, unless the Europeans decide they are going to intervene in the foreign currency market to buy dollars, and that would be over (European Central Bank president) Jean-Claude Trichet's dead body."

As there is "no chance" of European governments intervening in the foreign exchange markets to improve the competitiveness of the euro, it will result in major currencies such as the euro and Japan's yen becoming "very vulnerable."

"This is simply the American way of shifting the recession from them to their trading partners," said Wolf.

"What we need are global currency adjustments and it has to include the renminbi and global macro adjustments in those countries which make this less painful."

"In terms of the impact of this on the role of the US dollar as the currency of denomination for international transactions, basically I think it's become very unreasonable."

"Because the dollar, to my mind, given its underlying conditions, is no longer a credible long-term store of value," said Wolf. The decline of the US dollar underscores a phase of global power transition, with the balance of power moving from the US to Europe, China, and India, Wolf argues, adding that the greenback's loss of credibility as the dominant global reserve currency is part of this messy transition.

"The Americans no longer have the means to save themselves, this is what I think people don't understand. There is no credible American policy," said Wolf.

"We need to discuss this globally in a harmonious way. It's not happening, so at the moment the euro zone is a prime victim and it will continue to be, and that will create very big problems for European-based manufacturers, and quite particularly those that are relatively vulnerable to global price effects.

"And it's a tremendous mess, a horrifying mess, and that's where we are. I'm sorry. And we've got to get through this transition as quickly as possible to a more stable global monetary system with a lesser reliance on the dollar. We're going to get there over the next 10 years; I'm sure of it. We're going to get there. The only question we have to decide is how we're going to get there."

Meanwhile, a trade skirmish between the US and China could ensue, if Beijing continues to devalue its currency to bolster export-driven economic growth at the expense of economic recovery in the US, said Wolf.

He says China is working hard to defend the artificially low value of the renminbi in the hope that exports will pick up when external demand recovers. According to China's customs authorities, exports from January to November plunged by 18.8 per cent to $1.07 trillion from a year ago. However, according to the Royal Bank of Canada, export growth should pick up in the coming months and reach double-digits in early 2010.

China's efforts, Wolf said, will spark a "very vigorous, even vicious" reaction from the US as it's destabilising US efforts to engender an economic recovery.

Central Problem: The Central Bank

By Robert Klein and George Reisman
Barron's
Saturday, December 26, 2009

http://online.barrons.com/article_email/SB126167814839704681-lMyQjAxMDI5NjIxNjYyNzY4Wj.html

The Federal Reserve's easy-money madness must end.

President Barack Obama heads the list of Americans who believe that the continuing financial crisis should be blamed on excessive risk-taking by bankers who had an unbridled desire to make money in mortgages. These would-be reformers want stronger government regulation of the bankers to make sure that nothing like this ever happens again.

In a recent 60 Minutes interview, Obama blamed "fat cat bankers" for causing the crisis, putting America through its "worst economic year...in decades." He went on to chide Wall Street banks for "fighting tooth and nail" the new regulations he believes would be vital in preventing future crises.

A deeper examination, however, reveals that this is neither a housing crisis nor a Wall Street banking crisis. This is a monetary crisis, rooted in the lending of money created out of thin air. This is what leads to economic booms and busts.

The current crisis goes back to the Asian Contagion of 1997 and the meltdown of the Long Term Capital Management hedge fund in 1998. In response to each of these situations, the Federal Reserve cut interest rates and rapidly expanded the money supply. This excess liquidity helped push stocks, especially tech issues, to unsustainably high levels. The excess money created by the Fed and the banking system spilled into the rest of the economy, pushing up consumer prices.

To combat the rise in prices that it had caused, the Fed tightened monetary policy, which precipitated a massive plunge in stocks. Then, to bail out investors and stimulate the slowing economy once again, the central bank expanded the money supply rapidly to force rates lower. It ultimately jammed down the overnight fed-funds rate to 1%.

Unhappy with the correspondingly low returns on money-market funds, recently burned by the stock market, and spurred on by Washington policies intended to encourage homeownership, investors turned to real estate, largely housing, seeking higher returns. In time, in the hands of frenzied investors, the new money created by the Fed and banking system boosted home prices sharply.

In our present crisis, excess money created by the Fed also pushed up consumer prices. Once again, concerned about this, the Fed raised interest rates, thus raising mortgage rates. Subprime borrowers were the first casualties of these higher rates. Unable to afford their interest payments, they kept refinancing their loans by taking out new ones. When the easy money and credit stopped flowing, the loans became harder to refinance, and these borrowers began to default; the higher interest rates and reduced availability of easy mortgage credit also hurt more highly rated borrowers looking for homes. And, of course, the speculators, or flippers, who had feasted on the easy-money loans, saw their schemes disintegrate without easy credit flowing from Washington.

When the Fed tries to induce business activity in this manner, it never lasts. This is because the central bank always has to cut off the flow of easy money, in fear of causing further damage in the form of rising consumer prices. When the Fed removes this artificial stimulus, business activity dependent on it grinds to a halt, asset prices plunge, and recession sets in. In some ways, the process is analogous to a doctor administering adrenalin to a patient. Remove the stimulus and the patient collapses.

Healthy economic growth is supported by savings, rather than newly created money. People and businesses save and invest the money they don't need to consume right away. They make loans and investments that create computer equipment, copper mines, retail stores, and new homes. These loans and investments need not be cut off suddenly by a Fed worried about rising prices, as is the case when the Fed induces business activity by simply creating money.

In the most recent boom, total debt rose to a record 375% of gross domestic product. (By comparison, debt was 150% of total GDP in the inflationary boom of the 1970s.) Thus, the Fed has had to resort to desperate measures to bail out the economy. Along with its gargantuan loan programs, it has injected over $1.2 trillion in new bank reserves into the system -- building upon a base of about $800 billion -- in an effort to hold overnight interest rates near zero. This has propelled stock and commodity prices upward, while credit spreads have tightened. In time, borrowing and lending should accelerate, and economic activity should increase. This should continue until the inflationary consequences of the easy-money policy become evident. Consumer prices should rise, as should long-term interest rates. Then, confronted with the inflationary effects, the Fed once again will have to reverse its easy-money scheme and raise short-term interest rates, or allow the inflationary effects to accelerate.

How many more crises must we endure until we realize the common denominator is the creation of money and credit by the Fed? Wall Street bankers and speculators, who try to game the system and make profits during each boom, are mere bit players in these crises. By fostering the booms and triggering the busts, the real villain is the institution of central banking itself. Thus, instead of providing stability to the economy, central banking has created great instability. Until this is understood, we will make little progress in preventing future crises or easing the current one.

Lurching from crisis to crisis in boom-bust fashion is unacceptable and unnecessary. The Federal Reserve must stop juicing the economy with massive amounts of newly created money and move to a monetary system free of government-caused booms and busts. The only effective way to do this would be to remove control of our money supply from politicians and their appointees. We need to move to a money that is 100% backed by a commodity, such as gold. Only then can we rid the economy of the devastating effects of the creation of money and credit out of thin air.

Robert Klein is a financial advisor in Newport Beach, California and George Reisman is author of "Capitalism: A Treatise on Economics".

For further reading:
"America's Forgotten War Against the Central Banks", Mike Hewitt, October 19, 2007

Can China Beat US in Gold Reserves in 10 Years?

By David Lew
Commodity Online
Wednesday, December 23, 2009

http://www.commodityonline.com/news/Can-China-beat-US-in-gold-reserves-in-10-years-24146-2-1.html

China has set the most ambitious task on gold reserves and gold mining: take the country’s gold holdings from the current 1054 tonnes to a massive 10,000 tonnes in the next 10 years.

Is this grand task a realistic plan or a golden dream? Chinese officials say the dragon country wants to overtake the United States in gold reserves. America is the world leader in gold reserves. America owns 8133 tonnes of gold reserves that accounts for 76.5% of its foreign exchange reserves. Naturally, the Chinese plan is to ensure that bulk of its foreign exchange reserves--currently held in the forms of US dollar and bonds--is turned into gold reserves.

Unlike the United States, China has been acting slow all these years in building up its gold reserves. In 1981, China had 395 tonnes of gold holdings; it increased to 500.8 tonnes in 2001, and 600 tonnes in 2002. In April 2009, China officially announced that it has increased its gold holdings to 1054 tonnes. Since then, Chinese officials and People’s Bank of China have been meticulously chalking out plans to build up gold reserves in the next one decade.

China’s move to step up gold reserves got a moral boost when last month India—a large consumer of gold in the world—bought 200 tonnes of gold from the International Monetary Fund (IMF) for a big amount that Chinese would have never thought of purchasing. According to Zhang of the China Gold Association (CGA), India’s decision to buy IMF gold has been the real boost for China’s recent spirited moves to step up gold reserves.

“In view of the declining US dollar value, it is paramount that China steps up gold reserves. How to do this is the only question that China is debating these days. The possible steps include opening up new gold mines, aggressively going for gold mining, buying gold from the open market etc. All said and done, it is imperative that China needs to buy more gold,” Zhang points out.

China has emerged as the largest consumer and producer of gold in the world. It is, thus, natural that the Chinese mop up gold reserves to keep up its status as the No 1 gold consuming and producing nation in the globe, bullion analysts argue. In 2007, China overtook South Africa to become the world’s largest producer. The World Gold Council and global consultancy GFMS have already predicted that China will overtake India as the world's largest consumer as well.

China raised its national gold holdings in April by buying domestically mined gold. Bullion commentators like Mark Robinson are surprised as to why China has not yet shown any interest in buying gold from international markets. As a result of this, shares of Chinese gold mining companies have been rocketing all these months in the last one year. Shanghai and Hong Kong-listed shares of companies like Zijin, Shandong Gold and others are up 3x-4x this year alone. But the main factor at play is fear of a U.S. dollar devaluation.

Erik Bethel of seekingalpha.com points out the following major thrusts to explain how the Chinese appetite for gold reserves is simply rising and rising:

People in China are seriously starting to take notice of the fragility of the U.S. dollar and are loading up on commodities.

Chinese retail investors are also starting to take notice. As an example, there are "gold retail stores" popping up throughout major cities where individuals can buy mini gold bullion. There's even a China Gold Store located in Beijing Airport's new Terminal 3.

Another example is that while it was illegal to buy gold two years ago, Chinese citizens can now go to the bank and purchase "paper gold" certificates. Paper gold is basically the Chinese equivalent of an ETF and is supposedly backed by bullion held at the banks.

Chinese gold mining stocks are red hot and up 2-4x since last year.

China has US$2 trillion and is going to start deploying it in overseas mining assets.Following are also some of the major points you wish to read on China’s gold mining spree:

China’s domestic gold production has risen by 15% annually compared to the 3% decline in global production in 2006. This tremendous increase has been due to rapid capital expansion and low costs of labor. Chinese gold producers have gained enormously from the record high gold prices as investors worldwide are seeking stability due to the decline in the value of the dollar.

Domestic producers still suffer from a lack of scale. In 2000, there were about 2,000 gold producers - most of them relatively small and unsophisticated by international standards. Few are able to operate on a global platform, though the number of producers had shrunk to about 800 in 2007 after mergers and acquisitions and restructuring and consolidation. Most of these firms' technological standards and management are weak and inefficient.

China’s oldest and largest gold producer is the China National Gold Group Corporation (CNGGC), which accounts for 20% of total gold production in China and controls more than 30% of domestic reserves. CNGGC also controls Zhongji Gold, the first publicly listed gold mining company in China.

China's gold reserves are relatively small (about 7% of the world total). Production has usually been concentrated in the eastern provinces of Shandong, Henan, Fujian and Liaoning. Recently, western provinces such as Guizhou and Yunnan have seen a sharp increase, but from a relatively small base.

Zhaoyuan, a Shandong provincial city of a population of 580,000, has more than 60 gold mines operating in the hills around the city. They annuall produce about 15% of China's total gold - the most in the country.

In the last five years (2002-2007), China's Geological Survey Bureau found that five new gold deposits with reserves of 600 tons were found.

Top foreign investment has come from Canada and Australia. Though foreign investment still constitutes a very important part gold mining expansion, since 1995 it has no longer been actively encouraged by the Chinese government.

Vancouver-based Jinshan Gold Mines Inc. started production in July at its Chang Shan Hao gold mine in China's northern province of Inner Mongolia, reaching 19,000 ounces of gold by December 18. The mine is designed to produce about 120,000 ounces of gold per year, making it one of the country's largest producers.

Gold Fields and Australia's Sino Gold Mining Ltd., have set up a joint venture focused on discovering large gold deposits in China with the potential to produce about 500,000 ounces a year. Sino Gold has been buying stakes in Chinese gold deposits and explorers. In May it started production at its Jinfeng mine in southern China, with planned gold production of 180,000 ounces per year.

For further reading:
"China Set To Drive Up Global Demand For Gold", Adrian Ash, December 18, 2009

Social Media Websites Move Toward Virtual Currency Standardization

By Max Burns
Pixels and Policy
Monday, December 21, 2009

http://www.pixelsandpolicy.com/pixels_and_policy/2009/12/social-currency-standards.html

While the big graphical virtual worlds developers grapple with each other about standardizing the virtual experience for consumers, several big social media websites are steaming towards currency standardization with surprising cooperation.

Pixels and Policy reports on how several social media sites are preparing for the launch of a currency exchange in early 2010. It's going to change the way social media does business.

Creating a Foreign Exchange for Zynga Dollars

A recent article in CNET details how social media websites IMVU and MyYearbook are well into the process of constructing a virtual currency market to better facilitate transactions between websites. The joint project - currently titled "Currency Connect" - aims to foster a big change in the way social games bring in money:

Currency Connect is billed as a "cross property virtual currency exchange" system similar to how you would change U.S. dollars into euros if you were traveling in Europe.

Users simply swap their currencies depending on what site they are on. Overall this is not a bad idea as I still find it surprising that users pony up real money for virtual money that can never be taken out of a specific site.

Currency Connect may seem overambitious, but if it succeeds, the project could serve as a much-needed catalyst for encouraging the easy swapping of currency across virtually every social media game. Think of the project as a Lindex that includes other virtual worlds in addition to Second Life - a truly global virtual currency exchange.

Low on FarmVille Dollars? Why not convert some of your Mafia Wars currency at a predetermined exchange rate? Since earning Mafia Wars currency is much simpler than amassing the slowly-accumulating FarmVille dollars, you'd best be prepared to fork over a pretty penny for the higher-valued Farmville bucks.

As the article points out, a successful launch could spur PayPal - the biggest name in purchasing goods online - into providing a universal virtual currency. PayPal would certainly be the heavy hitter in any future currency exchange, perhaps even powering the mechanics behind the trades, and the weight of PayPal would surely bring in names like Facebook, MySpace, and pay-for-perks worlds like Runescape and Evony.

A Virtual Market Economy

These browser-friendly social worlds are blossoming into revenue-generating monsters, and a true virtual currency exchange would further remove constraints that limit the market potential of games like Evony and FarmVille.

What constraints, you might ask? Simple: Gamers invest a great deal of time in their Mafia Wars or FarmVille rank, and aren't keen on starting over from scratch at another time-consuming online game.

By opening up the virtual currency markets to easy trading, gamers can now use their progress in a game like Mafia Wars to purchase a helping hand in Evony, and vice versa. In effect, creating a virtual currency exchange like IMVU and MyYearbook have planned would mean your wealth and success in one virtual world would become transportable to other participating worlds.

What about speculation? Could players invest real money into virtual currency in the hopes that their holdings will appreciate compared to another game? Does the virtual currency exchange mean that virtual currencies can also be cashed out into real-world money at a market-driven exchange rate? If so, wouldn't virtual currencies also qualify as investments in the same way foreign exchange trading does?

Developing a virtual currency trading mechanism opens up a lot of questions about the platform of social media gaming. Will consumers jump at the chance to move their virtual coins around with the same eye to profit that they focus on a child's college fund or their own sagging stocks? Most of all, will competing in a world where long-time gamers can throw their wealth around be as fun as the current environment?

For further reading:
"Virtual currency exchange to launch in 2010", CNET News, December 15, 2009
"IMVU and myYearbook set up virtual currency exchange", Dean Takahashi, DigitalBeat, December 15, 2009

Do We Really Need a Central Bank?

On December 2, 2009, Professor Steven Horwitz gave the following speech at The Future of Freedom Foundation’s “Economic Liberty Lecture Series.” The speech "Do We Really Need a Central Bank?" can viewed above in its entirety. It was part of a student lecture series sponsored by the GMU Economics Society, the Future Freedom Foundation, and the Atlas Sound Money Project.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University in Canton, NY. He is the author of two books, Microfoundations and Macroeconomics: An Austrian Perspective (Routledge, 2000) and Monetary Evolution, Free Banking, and Economic Order (Westview, 1992), and he has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and the economics and social theory of gender and the family. His work has been published in professional journals such as History of Political Economy, Southern Economic Journal, and The Cambridge Journal of Economics . He has also done public policy research for the Mercatus Center, Heartland Institute, Citizens for a Sound Economy, and the Cato Institute. His current project is a book tentatively titled Classical Liberalism and the Evolution of the Modern Family. Horwitz currently serves as the book review editor of The Review of Austrian Economics and as an academic advisor for the Heartland Institute and a contributing editor to Critical Review and Journal des Economistes et des Etudes Humaines. A member of the Mont Pelerin Society, he completed his MA and PhD in economics at George Mason University and received his A.B. in economics and philosophy from The University of Michigan.

From the Atlas Sound Money Project:

"Professor Horwitz joked that the question he set out to answer over the course of the lecture could simply be answered, “No.” But, for the sake of doubters, and to advance the cause of free-banking, Horwitz went on to explain the history of the central bank, the role it has played in our financial history, and the reasons why there are viable alternatives to the Federal Reserve system as we know it. Contrary to claims of the critics of free-banking, the United States has never really given the free-market a chance when it comes to banking. Since the earliest years, banks in the United States have been subject to regulation, first from the states, and later from the national government. The history of these regulations, and the evolution from primarily state-charted banks to the system we know today, is a gold mine for political economists. The centralization of banking in the United States is highly correlated with war, as politicians inevitably discover that the most politically expedient method of funding their budget is to print currency for themselves. A monopoly on money guarantees that in the short term, Congress can run whatever budget it desires without worrying unduly about costs. And so the Federal Reserve system came into existence as politicians required easy money during the Civil War, World War I, and the Great Depression. It is an unsavory history, tied to the centralization of power rather than the good of the financial system. Still, it is only in recent years that criticism of central banking has become mainstream, and its supporters still seem to outnumber its detractors."

"And yet, Horwitz argued, the Fed is unable to do just the things its supports claim it can do. Those who argue for the necessity of the central bank say that banking would be far too chaotic without a governing body, some government agency to watch the financial system and provide counter-cyclical force to erratic economy. However, throughout its history, the efforts of the Federal Reserve have been detrimental to the economy. Because of knowledge problems, time lags, and issues of incentives, the central bank is often unable to act, or worse, act in ways that increase the bubbles and worsen the recessions. And out of these crises, the Fed seems always to come out the other end with more power over the financial system. We have seen even in this latest crises unprecedented powers granted to, or taken by, the Fed. By singling out specific corporations to receive credit and aid, the Fed has taken on the role of caretaker for those institutions who they believe pose systematic risk to the industry at large. The criteria for deciding which institutions are ‘too big to fail’ is vague and arbitrary, and as a result the central bank has never had more political and financial clout."

"But despite the obvious failings of the central bank in the past, and the clear dangers it poses to the free market in the future, the current system still finds support in the media and the government. The current administration continues to call for more regulations of the financial industry and more powers granted to the central bank. Professor Horwitz explained to his audience that it will be no easy task to change the way banking works here in the United States. Not only is the free-banking movement still considered by many to be a fringe movement more suitable for “nutjobs” than informed citizens, but the interests and incentives of those most involved still point toward more centralization than less. The only way to get our arguments out to the general public is to continue to provide reasonable and factual arguments for why the Fed has been a force for ill rather than good in the past and, most importantly, to define and defend workable alternatives. The free-banking movement, Horwitz argued, is not really all that radical. The advent of paperless money and the extensive use of financial instruments like debit cards approximates how the system would operate with free-banking. Allowing individual banks to issue commodity backed currency would allow the market to dictate money supply, and would strictly limit the power of the federal government. The knowledge problems and perverse incentives of the central bank would be almost entirely eliminated in a free-banking system and would in turn provide greater, not less, stability. With this alternative, and all of the objections to the system as we find it today, Horwitz concluded, no, we do not really need a central bank."

Gulf Petro-powers to Launch Currency in Latest Threat to Dollar Hegemony

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, December 15, 2009

http://www.telegraph.co.uk/finance/economics/6819136/Gulf-petro-powers-to-launch-currency-in-latest-threat-to-dollar-hegemony.html

The Arab states of the Gulf region have agreed to launch a single currency modelled on the euro, hoping to blaze a trail towards a pan-Arab monetary union swelling to the ancient borders of the Ummayad Caliphate.

“The Gulf monetary union pact has come into effect,” said Kuwait’s finance minister, Mustafa al-Shamali, speaking at a Gulf Co-operation Council (GCC) summit in Kuwait.

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.

Europe took 40 years to reach the point where it felt ready to launch a currency. It began with the creation of the Iron & Steel Community in the 1950s, moving by steps towards a single market enforced by powerful Commission and European Court. The EMU timetable was fixed at the Masstricht in 1991 but it took another 11 for euro notes and coins to reach the streets.

Khalid Bin Ahmad Al Kalifa, Bahrain’s foreign minister, told the FIKR Arab Thought summit in Kuwait that the project would not work unless the Gulf countries first break down basic barriers to trade and capital flows.

At the moment, trucks sit paralysed at border posts for days awaiting entry clearance. Labour mobility between states is almost zero.

“The single currency should come last. We need to coordinate our economic policies and build up common infrastructure as a first step,” he said.

Mohammed El-Enein, chair of the energy and industry committee in Egypt’s parliament, said Europe’s example could help the Arab world achieve its half-century dream of a unified currency, but the task requires discipline. “We need exactly the same institutions as the EU has created. We need a commission, a court, and a bank,” he said.

The last currency to trade in souks from Marakesh, to Baghdad and Mecca, was the Ottomon Piaster, known as the “kurush”. It suffered chronic inflation as the silver coinage was debased.

There is a logic to an Arab currency. The region speaks one language, has the unifying creed of “Umma Wahida” or One Nation from the Koran, and has not torn itself apart in savage wars – ever – in quite the way that Europe has in living memory.

Yet hurdles are formidable even for the tight-knit group of Gulf states. While the eurozone is a club of rough equals – with Germany, France, Italy, and Spain each holding two votes on the ECB council – the Gulf currency will be dominated by Saudi Arabia. The risk is that other countries will feel like satellites. Monetary policy will inevitably be set for Riyadh’s needs.

Hans Redeker, currency chief at BNP Paraibas, said the Gulf states may have romanticised Europe’s achievement and need to move with great care to avoid making the same errors.

“The Greek crisis has exposed the weak foundations on which the euro is built. The gap in competitiveness between core Europe and the periphery has grown wider and wider. The obvious mistake was to launch EMU without a central fiscal authority and political union, as the Bundesbank warned in the 1990s,” he said.

“The euro was created for political reasons after the fall of the Berlin Wall to lock Germany irrevocably into Europe. It was not done for economic reasons,” he said.

Ben Simpfendorfer, Asia economist for RBS and an expert on the Middle East, told the FIKR conference that the rise of China had paradoxically disrupted the case for pan-Arab economic integration.

There was a natural fit ten years ago between rich oil state and low-wage manufacturers in Egypt and Syria, but cheap exports from China have forced poorer Arab states to retreat behind barriers to shelter their industries. “The rationale for a single currency has become weaker,” he said.

The GCC also agreed to create a joint military strike force – akin to the EU’s rapid reaction force – to tackle threats such as the incursion of Yemeni Shiite rebels into Saudi territory earlier this year.

This is a major breakthrough after years of deadlock on defence cooperation.

The Sunni Gulf states are deeply concerned about the great power ambitions of Shiite Iran and its quest for nuclear weapons, to the point where the theme of a possible war between Iran and a Saudi-led constellation of states has crept into the media debate.

They nevertheless repeated on Tuesday that “any military action against Iran” by Western powers would be unacceptable

For further reading:
"Gulf Arab states move closer to single currency", Associated Press, December 15, 2009
"Gulf Monetary Council to Tackle Single Currency Peg, Launch", The Wall Street Journal, December 15, 2009
"Gulf nations sign monetary pact", Al Jazeera, December 15, 2009
"fairCASH – A Digital Cash Candidate for the proposed GCC Gulf Dinar", Heinz Kreft and Wael Adi, IEEE, 2006