On March 25, 1999 the Senate Committee on Banking Trade and
Commerce invited five economist to give their views on the prospects for a
Common Currency in North America. At the time Herb Grubel was a former
Member of Parliament and a professor in the Department of Economics at Simon
Fraser University. Thomas Courchene was a professor in the
Department of Economics, Queen’s University. John W. Crow was an Economic
Consultant and the Former Governor of the Bank of Canada. Jack Carr was a professor in the Department of Economics,
University of Toronto. Bernard Wolf was a professor of economics in the
Schulich School of Business at York University. The following extracts are
based on their testimony to the Committee.
Herb Grubel: Let us suppose that on January 1, 2000,
all Canadian, U.S. and Mexican prices, wages, assets and liabilities are
converted into a new currency, which might be called the "Amero".
With the U.S. dollar set equal to one amero, the Canadian conversion might be
.5 amero for every Canadian dollar. The precise conversion rate would be chosen
so that Canada's international competitiveness remains unchanged.
At the end of such a conversion,
Canadian living standards and wealth would be totally unchanged. Your income,
instead of being $100,000 a year, will be 50,000 ameros. However, the car that
you buy, which used to be a very nice BMW at $100,000, will now be costing you
only 50,000 ameros. Therefore, you will find that your real living standard has
not changed. However, there would be a number of economic benefits sure to
accrue in the longer run.
First, there would be reduced
costs of foreign exchange dealings. It has been estimated by the Delors
Commission that this might be as much in some European countries as .5 per cent
of national income, all of which would accrue in perpetuity. It has been
estimated that about 85 per cent of the foreign exchange business of banks in
Europe will disappear.
Second, interest rates in Canada
would fall by perhaps as much as 1 percentage point as the currency risk for
investors is eliminated. These lower interest rates would reduce debt service
costs for all governments and private borrowers. The federal government savings
alone would be about $6 billion annually at the current level of the debt.
Third, elimination of the
exchange risk is equivalent to the lowering of the cost of international trade
and capital flow. It is like the elimination of a tariff. This effect has been
estimated, in the case of the free trade agreement, to come to several
percentage points of national income in the longer run. Hence, we could expect
a similar, but smaller effect resulting from the elimination of the currency
Fourth, labour market discipline
would be increased as union leaders and managers face the fact that currency
devaluation can no longer be counted on to maintain the competitiveness of
firms which have allowed real labour costs to increase. Labour unions in
countries like Italy during the postwar years used to demand higher wages even
when there were no corresponding increases in productivity. Managers used to
give in to these pressures even though higher wages caused their business to
become uncompetitive and threatened to cause recessions. They did so in the
knowledge that the central bank of Italy would bail them out by letting the
exchange rate depreciate. I believe that a similar process was at work in
Canada until at least the early 1990s.
The fifth benefit would be that
economic adjustment to the secular decline in world commodity prices would take
place at a more appropriate pace, as the depreciation of the exchange rate no
longer protects domestic producers from the reality of falling world prices.
The present system is like having protection appear every time that there is a
fall in world prices. Like all protection, it prevents or at least slows the
adjustment is needed in these industries.
Sixth, price stability around
any existing inflationary trend would be greater, since in the larger currency
area positive and negative price shocks are more likely to be offsetting than
they are in Canada alone. When we have a bad wheat harvest, there might be a
good harvest of oranges, and vice versa. As a result of this, when prices are
down in Florida and they are up in Canadian regions that grow wheat, we will
find that the two price changes are offsetting each other, and the overall
level of prices measured in the Consumer Price Index would be more stable. The
more stable prices are, the greater is economic efficiency.
The seventh advantage is that
monetary policy adventures driven by ideology or politicians would no longer be
possible in Canada. The 1970s were characterized by excessive monetary
expansion in all of the industrial and developing countries because, finally
freed from the restraint of fixed exchange rates, politicians and policy makers
said, "Now we can print as much money as we want to in order to get lower
unemployment, even if it results in a higher rate of inflation." When that
happened, reserves of natural resources, which historically have always been
adequate to cover demand for the next 15 years, became adequate for shorter and
shorter periods in the future.
These developments, together
with high rates of global inflation, induced the tightening of monetary policy in
many countries including Canada. Many still remember interest rates around 20
percent and the havoc they played with their lives and those of their friends
and neighbours. After the inflation ended economic conditions returned to
normal, but the entire cycle of inflation and deflation brought huge economic
and social costs. These costs could have been avoided if fixed exchange rates
had been maintained and prevented the monetary adventure. The proposed monetary
union will assure that such adventures cannot take place in the future.
The eighth advantage is that
Canada would gain more influence on monetary policy in "Ameroland".
We would have representatives on the monetary policy-making committee of the
North American Central Bank. While we would have only a few votes on that
committee, there would be opportunities to vote strategically with US
representatives from regions that have economic characteristics like Canada.
Ninth, the profits from the
printing of notes and minting of coins, called seigniorage, would remain in
Canada as we would produce in our own existing facilities the currency used
here. The loss of seigniorage, which in Canada in 1997 was $2 billion, is one
of the disadvantages of the system used in Panama, which has no currency of its
own but simply employs US dollar notes and coins.
The tenth and final advantage is
that the creation of the amero system is likely to require that governments
limit their deficits, much as happened in the European Monetary Union. This
requirement would benefit the Canadian economy and future generations.
The costs at which these
benefits are acquired are as follows: First, economic sovereignty would be
reduced because of the inability to adopt monetary, fiscal and exchange rate
policy to the specific needs of Canada. I do not wish to belittle those who
consider this cost to be high. The issues are complex. However, let me
summarize my view briefly as follows: Concern over economic sovereignty grew
out of Keynesian economic theory. It led to the adoption of the flexible
exchange rate system of the 1970s. The economic sovereignty attained did not
lead to lower unemployment rates and higher growth as had been expected. To the
contrary, it worsened these indicators of economic performance in Canada and
elsewhere. Keynesian theory, in this respect, is in disrepute. Economic fine
tuning is out. For these reasons, European governments agreed to form their
The loss of national economic sovereignty should not so much
be bemoaned, but should be welcomed.
The second disadvantage is the
loss of cultural and political sovereignty. Again, I do not wish to belittle
those who hold such concerns. However, the fact is that Canada's sovereignty in
these areas would remain unchanged, just like it has in the wake of all of the
numerous free trade agreements signed since the end of the Second World War.
Let me conclude my brief remarks
with some musings about the political feasibility of a North American monetary
union. There are mixed signals, at least in Canada and Mexico. I have found a
surprisingly large proportion of Canadians in favour of such a union. I have
heard of growing support for the concept in Mexico. Americans have not paid
much attention to the issue, though they followed with great interest the
development of the euro. However, I expect political acceptance of monetary
union to increase if we succeed in having a widespread public discussion of the
proposal and its merits.
Thomas J. Courchene : The advent of the euro in January 1999
represents a watershed in the annals of economic and monetary history. At
one level, the euro signals the de-nationalization of national monetary
regimes. At another and related level, the euro is also signalling that
in a progressively integrated global economy, currency arrangements are
emerging as one of those supra-national or international public goods, an
international public good that will be fully consistent with the 21st century
notion of what national sovereignty will be all about.
Understandably, this is not the
view of Canada’s macro officials. In recent weeks, the Governor of the
Bank of Canada, Gordon Thiessen, noted:
The euro is not a blueprint for
North America. The political objectives that motivated monetary union in
Europe do not have a parallel in North America.
I grant that NAFTA is largely a
trade and economic blueprint, and European integration in addition incorporates
some confederal and, in some areas, some federal overarching infrastructure.
However, to link the euro solely to political evolution in Europe is to
ignore the compelling economic rationales for a supra-national currency.
It is highly unlikely that the British will ever buy into the political
projects in Europe. It is highly likely, however, they will buy into the euro,
and that will be driven by trade and economic grounds. Indeed, even
Switzerland, not a member of the EU, is going to have a tough problem; and
right now, it is undergoing what one might call “market Euroization” as it has
been from policy Euroization. Policy Euroization would mean the Swiss
would adopt the euro. Their institutions are going to do it. Their
private sector institutions are en route to doing it.
The floating exchange rate is
not serving us well. There are persuasive arguments for greater exchange
rate fixity. The long-term objective of exchange rate fixity should be
what I call the North American Monetary Union. While a “NAMU” is not on
the immediate horizon — it may well take a decade to get this; it
took the Europeans that long — there is an urgency, nonetheless, in
terms of focusing on this, and that is because policy development elsewhere in
America appear to be moving in the direction of dollarization. I will
talk about that a little bit later. Dollarization is simply using the
U.S. dollar; it is very, very different from common currency or North American
Monetary Union. In the latter, we would maintain all our institutions.
We would actually maintain our ability to have some Canadian symbolism on
our bills. The problem is that if dollarization proceeds, and we discover
five years from now that we want to have a North American Monetary Union, it is
too late. That option will be cut off. That is why I think it is
incredibly important to be looking at this today.
In 1974 the Canadian dollar was
worth 104 U.S. cents. Now it is worth roughly 66 cents. It was as
low as 63.5 cents last summer. This represents an enormous fall in our
living standards vis-a-vis the Americans. It not only puts Canadian prices
at bargain basement levels, as with the Canadarm last week. What is it
going to be this week? It provides an enormous incentive for young
skilled Canadians to ply their trades south of the border, as they are doing in
Why did we do this to ourselves?
One always hears that a floating rate enhances our economic sovereignty,
but the implications of a dollar less than two-thirds of what it was 25 years
ago represents a dramatic counter to the sovereignty argument.
The greater the degree of
integration between two economies, the greater will the benefits be of a common
currency or a permanently fixed exchange rate. We have not yet in Canada
realized just how dramatic our north/south integration is. In 1996, all
but two of the provinces exported more to the rest of the world than they did
to the rest of the country. Probably by now all of them probably do that.
For each dollar exported in 1996, international exports were running at
$1.83. More recent data put international exports twice as high as international
exports. Since over 80 per cent of Canada’s international exports go to
the United States, it is clearly the case that our exports to the U.S. now
substantially dominate our exports to other provinces.
Ontario is a particularly
interesting case. In 1980 in Ontario, international exports were $40
billion, and exports to the rest of the provinces were $40 billion. In
1996, exports to the rest of the provinces were something like $50 billion.
International exports are $150 billion, nearly three times as much.
Ontario has dramatically become north/south. Other parts of Canada
are doing this as well. If you look at the European example, we are more
integrated to the United States than the average euro country is to the rest of
the European union. On economic integration grounds alone, the case for
exchange rate fixity in Canada is at least as strong as the case for the euro
in Europe. On economic grounds, not on political grounds.
Dollarization is the ultimate
fix. We simply abandon the Canadian dollar. No more central bank.
Probably no more financial deregulation in Canada; we eventually adopt
the American stuff. It might be useful to distinguish between market
dollarization, where you and I try to do it, and policy dollarization, where the
Prime Minister officially says we should do it. Market dollarization is
alive and well, and we have to be careful, because I do not think market
dollarization is the way to go. I would much prefer a North American
Monetary Union, which is far more sovereignty preserving. A willy-nilly
drift into dollarization triggered by an unstable exchange rate would be
enormously costly to the country.
I want to turn now to the North
American Monetary Union and why I think it is a good idea. It would be
equivalent to the euro. There would be an overarching supra-national
federal bank, probably called the Federal Reserve Bank of North America, with a
board of directors selected in part from the still-existing banks. Our
Bank of Canada would still be around, just like the Bank of France is still
around under the euro. The Bank of Canada would have to decide on its
share of the voting rights; they would have to be agreed upon. However,
since the dollar is already the world’s foremost reserve currency, there is no point
in destroying it. The dollar would still be the American currency.
We have flexibility here. Our side, we would have a currency that
says this is equivalent to one North American Monetary Unit, or one U.S. dollar
on one side. On the other side, on the $5 one, we would put on the
prairies; the $10, the Rockies, or whatever we want. The Europeans call
that the landscape side of their currency. At the eleventh hour, they
decided not to do this. They are going to have a single landscape side
with all the emblems rather than 13 separate currencies. Their coins are
going to be different. The German coin is going to have an eagle on it.
This gives us some ability to preserve the symbolism that I think
Canadians think is important. We have to revalue our prices in
order that we can be one-to-one with this new currency. Every single
European currency is doing that right now. There is a mark price, and
there is a euro price. We will have to watch that process, because that
is what we would do.
Whether the Americans would be
on side or not, I do not know. I am trying to make sure the Canadians are
I want to conclude with some
geo-politics here. Argentina’s president, confirmed recently proposed
that his country move away from its currency board towards full dollarization.
More importantly, in January of 1999, the head of the Mexican
Bankers Association called for some version of a common currency. When I
was in Mexico, the equivalent of Canada’s BCNI called for full dollarization.
Intriguingly, U.S. economist Robert confirmed Barro, who is one of
the leading American economists, writing in The Wall Street Journal,
said, “These are good ideas; we Americans have got to figure out some way to
support this.” Hence, what he said was Argentina needs about $16 billion
of U.S. currency to run dollarization. Give it to them. It doesn’t
cost us anything. Just print it; you have the cost of the paper and ink.
We will take papers in return. We will get all the seigniorage as
those dollars start rising over time. Then he said, “There is another
problem with dollarization; there is no lender of last resort.” America
can be the lender of last resort to anybody who joins the dollar area. He
even suggested that the U.S. should take the lead in promoting this monetary
integration. Since President Clinton is looking again for some legacy,
this could be it. Robert Barro was not the U.S. government, but it is
significant that this issue is now raised in the financial papers of The
Wall Street Journal. My concern is that all this emphasis is on
dollarization, not on a monetary union. If we want to keep the NAMU
option alive, we must become party to these negotiations and these
deliberations elsewhere in America. The ‘we’ I refer to is not only academics,
but presumably our peak business associations and, at the political level,
perhaps the senate could play an important role here.
It would be most unfortunate if, when Canadians
finally realize that they really want a common currency of the North American
Monetary Union type, we cannot get it because the dollarization process that we
were watching has taken over the Americas, and the common currency option is no
John W. Crow: I am very skeptical of this whole
initiative, the common currency for Canada. What I think is constructive
in the debate is we have shifted off the so-called pegged or fixed but
adjustable exchange rates to something which is more unconditional. In
the Americas, Argentina took the lead, in this direction, with a currency
board. Now Argentina has been, in response to the troubles in Brazil,
talking about going to official dollarization. Why did Argentina go to currency
board in the first place? Because Argentines were basically using the U.S.
dollar as their currency. If Argentina wanted to preserve the peso in any
form, it had to reform its financial arrangements, and that is why it
essentially went to a currency board a number of years ago. Whether this
is a common currency, however, is yet another question. It would
certainly depend upon what the U.S. wanted to do in this regard to make it
common. Euroland does have a common currency; it has a central bank in
common where every national central bank is represented. No central bank,
in Europe, is any more important than any other central bank, at least among
the five who are members of the executive board as well as the governing
council. There are five members: Germany, France, Spain, Italy and
Why would Canada want to change
its system? Falling living standards is what we hear. I would
question that very seriously. Whether our living standard has fallen or
not is a very important question. Whether it has much to do with the
exchange rate is a very relevant question for this committee. I am rather
skeptical about the productivity arguments. As anybody who reads the
newspapers knows, StatsCan put out some different numbers recently. What
I would suggest is the productivity question is basically off the table now,
given the new numbers. In any case, I would argue that from a conceptual
or theoretical point of view, the argument would go from relatively poor
productivity to the exchange rate, rather than from the exchange rate to a relatively
poor productivity. I think there is more theory and more justification,
let us say, for that kind of view of the world than there is for the rather
more exotic one that it is the exchange rate that causes less-than-ideal
productivity in Canada.
I will note, however, that the
so-called “lazy manufacturer” argument for having a common currency, which I
think is a very thin thread to hold this whole thing together by, has resonated
in one place. That is with the Government of Quebec. Anybody who saw
the reports on the Davos meeting will remember that the Deputy Prime Minister
made a lot of this. I guess the interesting question there is once the
productivity argument is demolished, whether the Government of Quebec would
favour officially a common currency. That is what they based their
argument on, at least in Davos. I suspect that they will not change their
argument, for reasons fairly obvious to a politician.
How has Canada done with
flexible exchange rates? I would say we have done pretty well. It
would have been, inappropriate to push up interest rates to hold the dollar at
72 cents in 1998, for very good reasons given what happened to Canada’s terms
of trade, which deteriorated substantially in that year on the basis of
declined economy prices and in fact shaved about a half a per cent off our GDP
in that period. It was a perfectly sensible response for our exchange
rate to adjust and to shift resources within the Canadian economy. I
would say that the Canadian flexible exchange rates experience has essentially
been positive. In this more recent period, we can go back over less
positive experiences, perhaps, but in the recent period everything has worked
out the way you would expect. The currency has depreciated; that is for sure.
Interest rates have stayed down. There has been no inflationary
effect particularly, and the Canadian economy has continued to perform pretty
decently. There are other factors in how the Canadian economy performed
besides this, but I do not think one can lay too much blame at the door of the
I also refer to Professor
Barro’s piece, “Let the Dollar Reign from Seattle to Santiago”. He did
not say, for example, let it reign from Vancouver to Valparaiso or from Toronto
to Tierra del Fuego. Why did he not say that? His argument about
what should happen vis-à-vis the countries south of his border was that they
had basically screwed up on financial policy, and therefore they would be much
better off using the U.S. dollar. An impolitic corollary of what I have
just said about this, if Canada screws up on financial policy, maybe it would
be better off using the U.S. dollar as well. Whether we are going to screw up
is another question, which we will have to see.
In my view there are virtually no lessons from Euroland as
regards the North American arrangement.
We can debate back and
forth to what extent European union is political versus economic.
Clearly, both factors are there. The central bank is very much a
pooling setup. One bank, one vote. No one is seriously suggesting
that for North America. One of the interesting questions to explore is
why Germany would be interested in Euroland, and what are the issues there.
They are as much political, as economic. Why the U.S. would be
interested in a U.S. dollar area that would in any sense constrain U.S.
behaviour is difficult for me to fathom, but that is a question for the
Americans, not for us. We tend to assume that they would be interested.
One can ask, I guess, the same question: Why would the U.S. be
interested in having a free trade agreement with Canada in the first place?
We certainly put much more effort into that exercise than the U.S. did.
One could argue, that it emanated from geo-political considerations in
the United States.
In terms of Euroland, one
important question, and I am harking back to theory here is that one of the
principles of something that makes a common currency or a fixed exchange rate
work is that there is mobility of factors across borders, that people can move
backwards and forwards in response to economic advantages. Europe does
have mobility in principle. Whether people use it as much as they could
or should is another question, but you can move anywhere in Europe in response
to shifting economic circumstances. Labour flexibility is definitely not
on the table in North America. In fact the North American Free Trade
Agreement, from the U.S. point of view was to basically stop Mexican labour
coming across the border. Quite the reverse of what one would argue in
the case of a common currency. That is just to illustrate some of the
kind of undercurrents of this issue.
Jack Carr: In the question of a common currency
between Canada and the United States, there are only two real possibilities.
Either Canada and the U.S., and perhaps Mexico, form some sort of North
American currency union, or Canada adopts the U.S. dollar. My own
feeling, as a monetary economist, is the second option would be the only real
possibility open for Canada. People underestimate how expensive it was
for the euro to be adopted. The U.S. dollar now is a reserved currency
used all over the world. It has taken the U.S. government a lot of time
and money to establish the position of the U.S. dollar as an international
currency. The U.S. government is not going to get rid of the U.S. dollar
for some new type of North American arrangement, a North American currency.
They have that brand name. The U.S. dollar is staying. We can
say all we want, but I do not think there is a real possibility that there will
be some type of North American currency. Because of that, I think the
only real possibility, if we are going to have a common currency, is for Canada
and perhaps Mexico to adopt the U.S. dollar. Dollarization is the proposal
I am going to talk about, because I think it is the only one that has even a
chance of being adopted.
Monetary unions are more a
political than an economic statement. Many of the supporters of the euro
believe that monetary union is the necessary first step for political union,
and I think that is why some supported it who otherwise would find it difficult
to support a common currency. In Canada, there does not appear to be any
sentiment for closer political union in the North American environment. Hence,
this argument falls by the wayside. The only real political impetus that
I see for a common North American currency really comes from the government of
Quebec. Bernard Landry, Quebec’s Finance Minister, has stated that this
option of using the U.S. dollar should be given serious consideration.
They have used a number of rationales, and if those rationales fall by
the wayside, I am certain they will find other rationales. If we adopt the U.S.
dollar, there will be substantial adjustment costs. I think the Quebec
separatist government would like that adjustment cost to be borne by the
Canadian union as a whole, so that if Quebec does leave the union, there will
not be any further adjustment costs imposed on Quebec, and Quebec can tell its
citizens that life after separation is going to be very much like life before.
We are going to still be using the U.S. dollar. You could say: “Why
do they not simply say to the Quebec people that even the status quo is okay?
After separation you will still be using the Canadian dollar.” I
think this is a very difficult statement for separatists to make, because it
means if they use the Canadian dollar that they will have no independent
monetary policy, and they will be subject to the dictates of the Bank of Canada
in which they will have no influence. What is the purpose of separation
if you cannot have autonomy in both the fiscal and monetary areas? Having
a lack of autonomy with regard to a broader North American union is not as bad
as having to rely on Canada.
Let me look at the economic
considerations. In the economic literature, there are primarily two
strands of argument concerning currency union. One of these strands is
made by monetary economists; the other by trade theorists. I am primarily
a monetary economist, and I will concentrate on that but I will mention some of
the trade theorists’ arguments. The adoption of the of U.S. dollar
essentially means that we replace the monetary policies of the Bank of Canada
by the monetary policies of the federal reserve system. Of late, the
federal reserve has followed a sensible monetary policy, and the U.S. economy
is one of the strongest economies going. If you look at a broad picture
of U.S. monetary policy, they have had periods of time when, in the 1970s,
things were fairly uncertain with U.S. federal reserve policy. They had
high and volatile monetary growth rates. We would have had those same
high and volatile monetary growth rates. In fact the price level in
Canada from 1910 to the present is very similar. We have had really very
similar monetary policy to the Americans. If we look at the 1970s and
1980s, we have had a slightly higher inflation rate. We have had 6.7 per
cent average inflation; they have had 5.8 well within the error of measurement
in the Consumer Price Index.
For countries such as Panama,
which has a very unstable government, it makes a lot of sense for them to say,
“We cannot let this government have control of the printing presses” or “We are
simply going to not have printing presses; we are going to simply use the U.S.
dollar.” For them it makes sense. For Liberia it makes sense.
Maybe even for Argentina now it makes sense. For Canada, it does
not make sense. We have had a fairly sensible monetary policy. We
have had periods where things have not been so good, but so have the Americans.
In fact when John Crow was in office, that was one of the times we had
almost the most sensible of monetary policies.
We have a lot of trade that
takes place within corporations. General Motors imports engines from the
United States. They do not pay their U.S. parents in U.S. dollars; they
re-export finished cars. It is really mostly bookkeeping transactions
that take place. There is not a lot of exchange cost that takes place
The other thing about our
current system is that in some sense it is optimal. High tech companies
are listing on the NASDAQ, and if you want to buy their stock, you have to pay
in U.S. dollars. Why are they doing that? They are not doing it
because of the nature of the exchange regime. They are doing that to access
huge U.S. capital markets. The Toronto Blue Jays pay their players in
U.S. dollars. They are not doing it because the exchange rate is floating
and there is risk; they are doing it because the players are American, and the
players want U.S. dollars. There are areas in the Canadian economy where
it is optimal to use U.S. dollars. In our current system where it is most
optimal to use U.S. dollars, we do. For most transactions people, do not
want to use U.S. dollars.
Both from a political and economic point of view, I do not
see any argument in favour of adopting a common North American currency.
Let me look at the optimum
currency area arguments. This is an argument which was first made in 1961
by a noted Canadian economist, Bob Mundell. Professor Mundell said, “Canada is
not an optimum currency area; the U.S. is not an optimum currency area.”
He said, “Canada plus the U.S. are not-optimum currency areas; optimal
currency areas are areas in which the economies are similar like regional
economies, and most of the external shocks are similar.” That is not the
case for Canada/U.S. If you look at the correlation between shocks
hitting the Canadian and U.S. economies, they happen to be negatively
correlated. So, this idea that Canada plus the U.S. would be an optimum
currency area is not the case, and people who have looked at that data know
that there have been real forces that have buffeted the Canadian economy.
Of course it has hurt our living standards. It has not been because
the exchange rate is floating. It is because of these real shocks that have hit
the Canadian economy. There is nothing we can do, no matter what exchange
rate we are on. If the price of the things we sell go down relative to
the price of the things we buy, if oil prices fall, if gold prices fall, if
lumber prices fall, it is going to hurt Canadian living standards whether we
use the U.S. dollar, whether we have a floating exchange rate, whether we have
a fixed exchange rate
There is another problem with
the optimum currency area. What is an optimum currency area in 1960 may
be different in 1970 or 1980 or 1990. California was part of the western
region with a resource-based economy in 1960. It is certainly not a
resource-based economy in 1990. Optimum currency areas change over time.
Given the huge cost of adopting some type of monetary unit, you cannot
keep exchanging that unit as optimum currency areas change.
Bernard Wolf: The desirability of pursuing a
common currency between Canada and the U.S. is clearly something that should
not be taken lightly. The effects are far reaching and affect every
Canadian. Thus, it is very important to look at this thing with a very
clear perspective, and also to look at the theory and to look at the history,
because I think they both tell us quite a bit. Sometimes the ideology
gets in the way.
I would concede given the way
the global economy is going, you might have a common currency for the whole
world. I am never going to see it in my lifetime; I am not sure that my
children will; but it is certainly conceivable, and there are some very strong
arguments. However, for Canada today, I would submit that the costs
associated with monetary union dwarf the benefits, and that the time for this
fundamental change is certainly not here.
The costs of monetary unions are
sizeable, and they exist in the Canadian context. Probably the most
significant of these costs is that with respect to the loss of monetary policy,
loss of an independent monetary policy. Despite the strides taken in
recent years, Canada’s economy remains significantly more exposed to the
resource sectors than does the U.S. economy. Forty per cent of our
exports are still resource oriented. The sharp decline in the Canadian
dollar related to falling global commodity prices over the past 18 months is
testimony to this kind of exposure and provides the obvious example of the
benefit of flexible exchange rates. I do not decry the fact that the
Canadian dollar has gone down. The fact is commodity prices have gone down, and
that has got to be reflected. It happens to have been reflected in a lower
dollar. In the absence of such downward flexibility in wages and prices
in our economy, we could not absorb the shock that way. The currency decline
provided the necessary offset and support to the domestic economy which allowed
exports to be fostered, and encouraged import-competing production which
stimulated investment. If we did not have the flexible exchange rate, we
would have had to have had a very different monetary policy, and that monetary
policy that we would have had to have would have been extremely detrimental to
this economy. It would have had to have been really kind of Draconian.
It is clear that there is no arrangement that is possible if
you were to consider it now, other than adopting the U.S. dollar. There
is no way that the U.S. dollar is not going to be the currency of the United
We should also take into account
the history here. In the past the effect has worked the other way too.
If we go back to 1950 or 1970, the generalized rise in commodity prices,
which also led to a significant capital inflow into this country, put upward
pressure on the currency, making the maintenance of the existing fixed exchange
rate and those either impossible, or at least very, very difficult.
Again, if we had not stuck to a floating rate, there would have been
problems. Commodity exposure is the best example of the risk of asymmetric
shock, a risk that obviously has been realized historically and is still with
us. The currency cushion has no obvious substitute at the moment, and its
elimination would be extremely risky.
Currently, the factors which would
tend to offset the asymmetric shock effect are not significantly in evidence in
North America. First, labour mobility between Canada and the United
States is not high. Except for Quebec, there is the common language, to
some extent a much more common culture than exists in Europe. But the
reality is that current immigration policy on both sides of the border does not
allow that kind of mobility. It is even hard enough to get people across
the border for temporary positions. On either side of the border there
are real problems. Labour mobility really does not exist at the moment.
Second, fiscal policy maybe
could substitute for monetary policy. If you do not have the monetary
policy lever, maybe fiscal policy could work. Unfortunately, given that
Canada’s public debt is relatively high, somewhere around 90 per cent of GDP,
we are not going to be able to use that lever for expansionary fiscal policty.
Third, the other thing that
would help in terms of adjustment would be transfer payments between the areas.
Within Canada we have these transfer payments, but you are not likely to
see them going across a Canada/U.S. border. In the future some of these
things may change, and common currency might make some sense.
The Canadian economy has
seen structural change in the 1990s: freer trade, exposure of Canadian industry
to more competition, the quashing of inflation, and the end to fiscal
profligacy. All of these changes, while intensely positive for the
fundamental health of Canada’s economy, have been painful for Canadians.
I would submit that the process of adjustment has not yet ended; it is
not yet complete. Significant work remains to be done on various fronts,
particularly on the issues of taxation and productivity. Yes, the numbers
indicate that we have not done as badly as we thought we had, but productivity
in Canada is still considerably below that in the United States, and that needs
to be addressed. In fact the historic lows on the Canadian dollar must at
least in part be recognition that the Canadian economy has not fully worked
through these changes and remains vulnerable on a fundamental level. It
is also worth noting here that the Canadian dollar’s historically low valuation
itself represents a significant barrier to monetary union, in that a large
appreciation of the currency would be needed to reach a suitable level at which
to enter into a union, posing yet another burden to the Canadian economy.
Surely the US would object to a pegging of the Canadian dollar at a level below
70 cents US. At the moment Great Britain has the opposite problem. One reason
it hesitates to adopt the Euro is the overvaluation of Sterling. Joining the
Euro with too high a valuation of the Pound would enviably lead to
I worry also about what might
happen in terms of transparency. Usually, I prefer transparency, but in this
case, the ability of a Canadian worker to compare, without exchange conversion,
his wage with that of comparable workers across the border, could give him
impetus to close the gap. I think the resulting possible inflation-push should
not be underestimated.
We can look at another case
where in fact we have gone to a common currency, that is the case of Germany
with reunification. The conversion of the East German mark into the
D-mark provides an illustration of the lasting costs of adopting an
inappropriate rate. We still have a situation in East Germany where the
unemployment rate is roughly double that of the rest of Germany, something like
18 per cent.
It is always possible to argue
that the environment for just about anything may be better down the road. The
European Monetary Union (EMU) provides a contemporary case of a common currency
where the "one size fits all" monetary policy is creating economic
difficulties. For example, the great disparity between strong growth in some of
the peripheral countries such as Portugal and Ireland, compared to relative
weakness in some of the core countries, particularly Germany, is a serious
concern. I would suggest that the recent decline of the euro is partly a
reflection of the incompatibility of the business cycles. I would go further by
suggesting that the economic problems associated with the adoption of the Euro
were well understood by policy makers who were interested in the creation of
the European Monetary Union not for the questionable net economic benefits but
for political reasons.
As has been indicated before for
Canada, the political imperative works against currency union with the United
States. Certainly Canada has no need at present to find a mechanism to
provide peace and political stability with its neighbour. Additionally,
the loss of sovereignty involved in a currency union is a more pressing issue
for Canada than for the individual European countries.
Finally, another benefit to the
currency union among some countries in Europe, and that again is absent in the
case of Canada, is the reduction of risk premiums on medium- and long-term
interest rates. That is largely absent. If you look three years ago
at Italian ten-year bonds, they yielded 5 percentage points over their German
counterparts. The participation of Italy in the monetary union and the
corresponding drop in the risk premium assigned to Italian assets has narrowed
that spread by a factor of 20 to roughly a quarter of a percentage point, which
is really very small. Conversely, the yield on Canadian ten-year bonds is
already very close to that of U.S. 10-year bonds. Thus, the scope for an
additional fall in the risk premium would be very limited. In contrast,
Argentina is seriously considering this adoption of the U.S. dollar as its
currency. With major creditability problems, Argentina would have quite a bit
to gain in terms of a reduction in the risk premium and consequently, a
reduction in the interest rate burden.