Konrad Yakabuski, The Globe and Mail
October 24, 2009
The arguments in favour of a separate Canadian currency have been refuted by experience. The time has come for North American monetary union. It is essential for Canadian prosperity.
Every institution has its orthodoxies. These are the mostly unwritten rules that no one from within challenges without risking marginalization or outright ostracism. To be a member of the club is to acquiesce.
At the Bank of Canada, arguably the most important player in the Canadian economy, there is only one orthodoxy more inviolate than inflation targeting – though this has been the central bank’s only official objective since 1991. No, besides keeping the annual inflation rate between 1 per cent and 3 per cent, those who toil in the glass house that is the bank’s Ottawa headquarters accept as holy creed the existence of a separate Canadian currency.
This goes far beyond any desire among bank staff to preserve their own jobs. It is partly the result of a cultural bias, since Canada was the first major country to adopt a floating exchange rate in 1950 and, except for eight years after 1962 when the loonie was pegged to the U.S. dollar, our currency has navigated countless peaks and valleys, to the delight and horror of cross-border shoppers, snowbirds, manufacturers and speculators. Managing monetary policy in a floating-rate regime is what the Bank of Canada knows best.
The Floating Habit
It is also what the bank’s well-regarded research staff believes to be in the best interest of the Canadian economy. By letting its dollar float, the bank reasons, Canada can adjust more quickly and effectively to domestic and global economic shocks than it could if we implemented a fixed exchange rate, embraced a common North American currency or simply adopted the U.S. dollar as this country’s legal tender.
The central bank believes that the Canadian and U.S. economies are just too different to warrant a single currency and monetary policy. We’re net exporters of natural resources; they’re net importers of the Earth’s God-given abundances. Hence, when commodity prices crater – as they did during the 1997-1998 Asian financial crisis or at the outset of the most recent recession – so does the Canadian dollar.
The loonie’s collapse a decade ago was hailed by then Bank of Canada governor Gordon Thiessen as proof of the benefits of a floating rate. The decline buffered the blow delivered to the economy by low resource prices by helping “Canadian manufacturing and other non-commodity sectors to increase their exports to the United States,” he said in a 2000 speech. “In this way, the impact of falling employment and incomes in our primary sector because of lower commodity prices was largely offset by greater expansion in other sectors.”
Mr. Thiessen’s speech did not come out of the blue. At the time, economists here were embroiled in a heated debate about the pros and cons of North American monetary union. NAMU, as it was dubbed, was seen as the next logical step in the continuing integration of the Canadian, U.S. and Mexican economies, after the 1994 ratification of the North American free-trade agreement. Talk of a currency union on this continent was also spurred by its realization in Europe in 1999. If countries as disparate as France, Finland, Italy and Ireland could do it, why couldn’t two countries as economically and culturally integrated as Canada and the U.S?
It soon became clear, however, that NAMU was a political no-no. Canadian economic nationalists equated common currency with a loss of sovereignty, just as they had fought the Canada-U.S. free-trade agreement, saying it would mark the end of public health care here. Besides, it suited the Chrétien government to have a low loonie, to take the edge off its tight fiscal policy and create manufacturing jobs. Hence, as the Canadian dollar dug a historic trough, hitting 61.75 cents (U.S.) in 2002, Ontario was on its way to surpassing Michigan in auto production.
If the past decade has taught us anything, though, it is that Canada enjoys all the inconveniences of a floating exchange rate and independent monetary policy, with precious few of the benefits. The protracted low-dollar period wrought an unprecedented widening of the gap between Canadian and U.S. productivity levels, and has left our economy (outside the resource sector) painfully uncompetitive as our currency nears parity with the U.S. dollar.
Tempted to be Lazy
A decade ago, Mr. Thiessen dismissed the idea that a low loonie would encourage Canadian businesses to get lazy. “If the argument here is that a low exchange rate gives exporting firms easier profits and blunts their motivation to innovate and become more efficient and competitive, I am inclined to say that this suggests a rather serious problem of corporate governance,” he countered. But blaming Canadian businesses for responding to the incentives created by a low dollar is like expecting an apple picker paid by the bushel to ignore the low hanging fruit for the McIntoshes on top. First things first, after all.
When the dollar hovered around 60 cents, then 70 and later 80, everyone agreed that it was undervalued. Now as it approaches parity with the U.S. dollar and threatens to surpass it, as it did in 2007 and 2008 when the price of oil peaked near $150, almost everyone – including the Bank of Canada – insists it’s overvalued.
But though the loonie has been extremely volatile in recent years, big and unjustified currency swings are nothing new. When they argued for Canada-U.S. monetary union in a 1999 C.D. Howe Institute paper, policy experts Thomas Courchene and Richard Harris noted that our floating dollar has been prone to “major and prolonged misalignments.” This leaves the Bank of Canada constantly, and usually unconvincingly, trying to influence our supposedly free-floating exchange rate. This week, Mark Carney, the current Bank of Canada Governor, channelled Pierre Trudeau and dared speculators to question his resolve. “Markets should take seriously our determination to set policy to achieve the inflation target. Markets sometimes lose their focus. We don’t lose our focus.” Such uncharacteristically blunt language from a central banker is a sign of panic. A soaring Canadian dollar can create deflation, depressing the prices of imports and creating a Japan-like spiral into perennial recession.
Instead of easing economic shocks, then, leaving our chronically overshooting loonie to float ends up making adjustments more brutal and counterproductive than they need to be. What’s more, the Bank of Canada’s apparent indifference to where the country’s economic growth comes from – whether from resources or value-added manufacturing and knowledge industries – ignores the fact that not all industries produce the same set of public goods. Some encourage a more innovative and educated work force than others. Some position us more for the future than others.
So, just why do we keep our loonie anyway? Is it to protect the illusion that Canada has a monetary policy truly independent from that of the U.S. Federal Reserve Board? Martin Coiteux, an economist and professor of international business at HEC Montreal, tracked monetary policy in both countries for a prolonged period up to 2004. He found that, though the Fed has a much broader mandate than the Bank of Canada, it had a better record of keeping inflation within the 1 per cent to 3 per cent band than our central bank. The Fed leads, the Bank of Canada follows. “Even if [the bank] says we have a made-in-Canada monetary policy, it mostly tracks that of the Fed,” he says.
Nothing proves his point more than the present. One of the reasons markets had, until this week, been expecting the Bank of Canada to follow Australia’s recent lead and start raising interest rates soon is that the Canadian housing market is looking dangerously bubbly. House prices have risen 14 per cent in the past year. But the bank is standing pat, Mr. Coiteux reckons, because any increase in the spread between Canadian and U.S. interest rates would send the loonie even farther into the stratosphere.
The past 10 years have reinforced Mr. Courchene’s belief that some kind of currency union is essential to this country’s long-term prosperity. If the U.S. dollar is now in secular decline against other global currencies, as many argue, then Canada needs to get with it and start negotiating with Washington. “It’s in decline that we’re really going to get clobbered,” Mr. Courchene warns. “Suppose the U.S. dollar goes so far down that the Canadian dollar goes to $1.30 instead of 95 cents. Is that what we want?” Canada could just adopt the U.S. dollar and be done with it. But we would be better off with a formal currency union that allowed for some Canadian representation, and influence, in the Federal Reserve System.
Naysayers have always said the Americans would never go for it. Mr. Courchene thinks Canada, with the world’s second-largest oil reserves, has a strong argument going for it. “The Americans would like the idea [of Canadian representation] more than they did a decade ago because the entire Canadian commodity world would come entirely within their currency area, so they wouldn’t get anywhere near the oil shocks they’re getting now.”
China may have just overtaken Canada as the biggest exporter to the United States. But the title is possibly temporary and any suggestion that this country would do better by reducing its reliance on the U.S. market is based on wishful thinking. No other major country faces better long-term economic or demographic prospects than the U.S. By 2050, the U.S. work force will have grown by 30 per cent; China’s will have contracted by 3 per cent. The median age in China will be 44, up from 33 now. The U.S. will age only marginally. Its median age will rise to 39 from 36. China, the saying goes, will get old before it gets rich.
Canada needs to take heed. Clinging to the loonie’s woeful song is no way to keep our economy humming. Those paper George Washingtons may be an anachronism in our coin-loving culture, but the U.S. dollar is not destined to become one any time soon.