The Death of Money (21 page)

The Shanghai Cooperation Organization was formed in June 2001 as the continuation
of a predecessor organization, the Shanghai Five. The SCO members are the original
Shanghai Five members—Russia, China, Kazakhstan, Kyrgyzstan, and Tajikistan—plus new
member Uzbekistan. However, the SCO includes India, Iran, and Pakistan among its observer
states and regularly invites the former Soviet republics and members of the Association
of South-East Asian Nations (ASEAN) to their meetings.

The SCO had its origins in security issues indigenous to its member states, including
suppression of secessionist tendencies in the Caucasus, Tibet, and Taiwan. The members
also had a shared interest in defeating Al Qaeda and other terrorist groups in Chechnya
and western China. But the SCO quickly evolved into an Asian counterweight to NATO.
Russia gained China’s support in its confrontation with NATO in eastern Europe, and
China gained the support of the Russians in its confrontation with the United States
in East Asia. In this context,
the SCO’s rejection of a U.S. application for observer status in 2005 was unsurprising.

In addition to conducting joint military exercises and cooperating in dozens of large-scale
infrastructure projects related to energy, telecommunications, and water, the SCO
has also launched initiatives in banking and multilateral finance, which are pertinent
to the international monetary system’s future.
The Prime Ministers Council of the SCO signed an agreement at its Moscow summit on
October 26, 2005, creating the SCO Interbank Consortium, designed to facilitate economic
cooperation among its central banks, joint infrastructure financing, and formation
of specialized development lenders to its members.

At the SCO Prime Ministers Summit in Astana, Kazakhstan, in October, 2008, Chinese
premier Wen Jiabao and Russian prime minister Vladimir Putin endorsed Iran’s application
to become a full member of the SCO. At that summit, Iranian vice president Parviz
Davoudi remarked that “
the Shanghai Cooperation Organisation is a good venue for designing a new banking
system which is independent from international banking systems.” The SCO summit in
June 2009 was conducted side by side with the BRICS summit in Yekaterinburg, Russia.
Chinese president Hu
Jintao and Russian president Dmitry Medvedev used the occasion of the SCO and BRICS
summits to sign
a joint Sino-Russian declaration calling for reform of the global financial system
and international financial institutions and greater developing economy representation
in the IMF.

Newly elected Iranian president Hassan Rouhani had a kind of international coming-out
party at the SCO summit in Kyrgyzstan’s capital, Bishkek, on September 13, 2013. At
the summit, Iran received strong support from Russia, China, and the rest of the SCO
for noninterference in Iran’s uranium-enrichment efforts.

As geopolitics are increasingly played out in the realm of international economics
rather than purely military-diplomatic spheres, the SCO’s evolution from a security
alliance to a potential monetary zone should be expected. This has already happened
covertly through Russian and Chinese banks’ role in facilitating Iranian hard-currency
transactions, despite sanctions on Iranian money transfers imposed by the United States
and the EU.

The convergence of the BRICS’ and SCO’s agendas on international monetary matters
should be most worrying for traditional Western elites. The drivers are Russia and
China, the two most powerful members of both organizations. The BRICS and the SCO
may have separate agendas in military and strategic affairs, but they are like-minded
on the subjects of IMF voting rights, and they share an emerging antipathy to the
dollar’s dominant role.

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The Gulf

Another strategic and geographically contiguous alliance, the Gulf Cooperation Council
(GCC), genuinely has the potential to form a single-currency area that would diminish
the U.S. dollar’s role.

The GCC was founded on May 25, 1981, when Bahrain, Kuwait, Oman, Qatar, Saudi Arabia,
and the United Arab Emirates signed a pact in Riyadh, Saudi Arabia. There have been
no additions to this original group, although Morocco and Jordan are currently under
consideration for membership.

The GCC does not have links to Iraq or Iran, despite the fact that both of those nations
border the Persian Gulf along with all the GCC members. The reasons are obvious. Iraq
ruined its GCC relations with the invasion of member Kuwait in 1990. Iran is not a
candidate for membership because it is ethnically and religiously distinct from the
Arab states with which it shares the Persian Gulf and because it is Saudi Arabia’s
bitter enemy. But the possible additions of Jordan and Morocco make sense. The existing
GCC members are all Arab monarchies. Jordan is an Arab monarchy, and Morocco is an
Arabic-speaking monarchy and Arab League member. While the GCC pursues relatively
liberal economic and trade policies, it is still a de facto club for the remaining
kings of Arabia.

The GCC has pursued a path not unlike the EU in that it successfully launched a common
market in 2008 and is now moving toward a single currency. The GCC’s significance
for the international monetary system lies more in its single-currency initiative
than in other facets of strategic and economic cooperation, which are of mostly regional
rather than international importance. As was the case with the euro, implementation
of a single currency in the GCC will take a decade or more to complete. Key issues
that need to be resolved include convergence criteria for members’ fiscal and monetary
policies and the powers of the new central bank. Most vexing in the short run are
the inevitable politics that swirl around issues such as the physical location of
the central bank’s headquarters and the membership and governance of its board.

The GCC members are already in a quasi-currency union because their individual currencies
are pegged to the U.S. dollar and therefore to one another using fixed exchange rates.
However, each GCC member retains an independent central bank. This arrangement resembles
the European Rate Mechanism (ERM), which lasted from 1979 to 1999 and was a predecessor
to the euro, although the GCC has had more success than the ERM, which witnessed numerous
breaks with designated exchange-rate parities by its members.

The conversion from the current GCC arrangement to a single currency would appear
to be a straightforward process. But recent stresses in the Eurozone have given pause
to the GCC members and impeded the monetary integration process. The most prominent
impediment is running a single monetary policy with divergent fiscal policies. This
problem
was one of the principal contributors to the European sovereign debt crisis. Countries
such as Greece and Spain engaged in nonsustainable fiscal policies financed with debt
issued in a strong currency, the euro, to investors who inferred incorrectly that
Euro-denominated sovereign debt had the implicit support of all the Eurozone members.
The core problem for any proposed currency union (such as the GCC) is how to enforce
fiscal discipline among members when there is a single central bank and a single monetary
policy. The need is to prevent a recurrence of Greek-style free-riding on the stronger
members’ fiscal discipline.

The GCC has already witnessed this free-riding problem in the 2009 Dubai World collapse.
Dubai is part of the United Arab Emirates along with six other principalities, most
prominently Abu Dhabi. The emirates share a single currency, the dirham, issued by
a central bank located in Abu Dhabi.

Dubai World, an investment holding company, was created in 2006 by Dubai’s ruler,
Sheikh Mohammed bin Rashid Al Maktoum. Although Dubai World insisted its debts were
not government guaranteed, its debt appeared to investors as tantamount to a UAE member’s
sovereign debt. Between 2006 and 2009, Dubai World borrowed approximately $60 billion
to finance infrastructure projects, including office buildings, apartments, and transportation
systems, many of which remain empty or underused to this day.

On November 27, 2009, Dubai World unexpectedly announced it was requesting a “standstill”
among creditors and called for debt-maturity extensions across the board. This default,
rather than any specific event in Europe, was the catalyst for the sovereign debt
crisis that quickly engulfed Europe and lasted from 2010 to 2012. Eventually Abu Dhabi
and the UAE central bank intervened to bail out Dubai World in much the same manner
as the EU and the European Central Bank intervened to bail out Greece, Portugal, Ireland,
and Spain. These lessons from the UAE and Europe are not lost on Saudi Arabia, Qatar,
and the other wealthy GCC members. An enforceable GCC fiscal pact with limits on deficit
spending is likely to be required before the single-currency project moves forward.

The other major issue looming over the GCC single currency is the question of an initial
par value relative to the U.S. dollar. Too low a value
would be inflationary, while too high a value would prove deflationary. This is the
same dilemma that confronted the U.K. when it returned to the gold standard in 1925
after suspending it in 1914 to fight the First World War. The U.K. blundered then
by setting sterling’s value against gold too high, which caused extreme deflation
and contributed to the Great Depression.

When a country or group of countries peg to the U.S. dollar, those countries effectively
outsource their monetary policy to the Federal Reserve. If the Fed is engaged in monetary
ease and the pegging country is running a trade surplus or experiencing capital inflows,
the pegging country has to print its own money to purchase the incoming dollars in
order to maintain the peg. In effect, the Fed’s easy-money policy is exported through
the exchange-rate mechanism, which forces the pegging country to engage in its own
easy-money policy. If the pegging country economy is stronger than the U.S. economy,
this easy-money policy will produce inflation, as has occurred in China and the GCC
since 2008. The simplest solution is to abandon the peg and allow the local currency
to appreciate against the dollar. Such reductions in the dollar’s value are the Fed’s
goal under its cheap-dollar policy.

An alternative solution is to maintain a single currency with a value fixed to a currency
other
than the dollar. Monetary experts have suggested
several candidates for an alternative peg. One obvious candidate is the IMF’s special
drawing right, the SDR. The SDR itself is valued relative to a currency basket that
includes the dollar but with significant weight given to the euro, sterling, and the
yen. Importantly, the IMF retains the ability to change the SDR basket composition
periodically, adding new currencies to better reflect trade patterns, changes in comparative
advantage, and the relative economic performance of the countries whose currencies
are included in the basket. An SDR peg would align the future GCC currency more closely
with the economies of its trading partners and decrease the Fed’s impact on GCC monetary
policy.

GCC member economies are highly dependent on oil exports for revenue and growth. Volatility
in the dollar price of oil translates into volatility in economic performance when
the GCC currency is pegged to the dollar.
A logical extension, then, of the SDR basket approach would be to include the dollar
price of oil in the basket. By doing so, the exchange
value of the GCC currency would move in tandem with the dollar price of oil. If the
Fed pursued a cheap-dollar policy and the dollar price of oil increased due to the
resulting inflation, the GCC currency would appreciate automatically, mitigating inflation
in the GCC. This way the GCC currency can be both pegged and free of the Fed’s cheap-dollar
policy.

A more intriguing solution to the peg issue—and one with large implications for the
future of the international monetary system—is more radical:
to price oil and natural gas exports in the GCC currency itself
, thereby allowing the GCC currency to float relative to other currencies. This could
truly mark the beginning of the dollar’s demise as the benchmark currency for oil
prices, and it would create immediate global demand for the GCC currency.

This trend toward the abandonment of the dollar as the benchmark for pricing oil was
dramatically accelerated in late 2013 as a result of White House efforts to legitimize
Iran as the regional hegemon of the Middle East. Implicitly since 1945 and explicitly
since 1974, the United States has guaranteed Saudi Arabia’s security in exchange for
Saudi support for the dollar as the sole medium of exchange for energy exports and
for Saudi promises to purchase weapons and infrastructure from the United States.
This nearly seventy-year-long relationship was thrown into grave doubt in late 2013
by President Obama’s modus vivendi with Iran and implicit tolerance of Iranian nuclear
ambitions.

The U.S.-Iranian rapprochement occurred after Saudi-U.S. relations had already been
badly strained by President Obama’s abandonment of Saudi ally Hosni Mubarak in Egypt
in 2011 during the Arab Spring uprisings, and by the president’s failure to support
Saudi rebel allies in the Syrian Civil War. The Saudis then spent billions of dollars
to help restore military rule in Egypt and to crush the Egyptian Muslim Brotherhood
favored by President Obama. More recently the Saudis publicly displayed their displeasure
with the United States and moved decisively to secure weapons from Russia, nuclear
technology from Pakistan, and security assistance from Israel. The resulting Saudi-Russian-Egyptian
alliance removes another prop from under the dollar and creates a community of interest
between Saudi Arabia and Russia, which had already announced its preference for an
international monetary system free from dollar hegemony.

For a GCC currency to become a true global reserve currency as opposed to a trade
currency, further deepening of GCC financial markets and infrastructure would be needed.
However, Saudi Arabia’s reevaluation of its security relations with the United States
combined with the euro’s expansion and the efforts of the BRICS and the SCO to acquire
gold and escape dollar dominance could presage a quite rapid diminution in the dollar’s
international reserve-currency role.