Does Putin's Proposed Eurasian Currency Area Make Sense?

At a meeting in Kazakhstan last week,  Russian  President Vladimir Putin proposed a currency union for the members of the Eurasian Economic Union (EAEU).  Russia, Kazakhstan, Belarus, and Armenia are the current members, and Kyrgyzstan is scheduled to join later this spring. Does a common currency for the EAEU make sense? Not in economic terms, but perhaps there is a political subtext that makes the proposal more understandable.

Some currency union basics

A currency union is simply a group of countries that share a common currency. The Eurozone (EZ) is the best-known example. The much smaller Common Monetary Area, based on the South African Rand, is another. The 50 states of the United States are sometimes viewed as a currency union for economic purposes, even though the members are not sovereign countries.

Currency unions have both advantages and drawbacks. On the plus side, currency unions facilitate trade and integration. They reduce the costs of currency exchange for travel and trade. They remove the risk that a change in exchange rates will render import-export deals or foreign investment projects unprofitable before they are completed. They eliminate costs of hedging against currency risks. The major disadvantage is that a currency union takes away exchange rate changes as an instrument for adjusting to external economic shocks, such as changes in the relative prices of a country’s imports and exports, or sudden surges in capital inflows or outflows.

There is a well-developed theory of optimum currency areas, growing out of a seminal 1961 article by Robert Mundell,  that explores the conditions under which the advantages of a union outweigh the disadvantages. Three of the most important conditions are structural similarities, flexible markets, and fiscal centralization. >>>Read more

Follow this link to view or download a related slideshow, "The Breakup of the Ruble Area."