Transcript Tom Courchene`s Power Point Slides

A COMMON CURRENCY FOR
NORTH AMERICA
by
Thomas J. Courchene
Jarislowsky-Deutsch Professor
School of Policy Studies, Queen’s
and
Senior Scholar
Institute for Research on Public Policy
Montreal
Common Currency: Introduction (1)
Significance of the Euro
•
Former Governor Gordon G. Thiessen:
The introduction of the Euro ushers in an exciting new
era for the Europeans, and we should all wish them well.
But the Euro is not a blueprint for a North American
monetary union. The political objectives that motivated
monetary union in Europe do not have a parallel in North
America.
•
This is true. However, once the Euro is launched, the
focus is no longer on its origins, but on what it signals:
• Common currency is a supra-national public good
• Signals denationalization of independent national
monetary regimes
• Dramatic shift toward currency integration and
consolidation
Common Currency: Introduction (2)
Re: Currency Consolidation:
When tomorrow’s historians look back at the recent financial crises
and subsequent efforts to reform global finance, they will reach two
conclusions. First, the grand rhetoric of creating a new global
architecture yielded few results. Second, we failed to foresee the
most profound consequence of the turmoil: regional currency
unions. By 2030 the world will have two major currency zones – one
European and the other American. The Euro will be used from Brest
to Bucharest, and the dollar from Alaska to Argentina – perhaps
even in Asia. These currencies will form the bedrock of next
century’s financial stability.
(Zanny Minton Beddoes, “From EMU to AMU: The Case for
Regional Currencies”, Foreign Affairs (July/August, 1999).
Common Currency: Introduction (3)
Outline of Presentation
•Problems with Canada’s floating exchange rate;
•Arguments for greater exchange rate fixity;
•Alternative approaches to fixed rates (currency
boards, dollarization, NAMU);
•Nationalism, identity, sovereignty;
•Why might the US agree to a common currency or
NAMU?
•Where to from here?
The Failings of Canada’s Float (1)
First, the Case for a Floating Rate

Need a floating rate if want to have independent monetary policy
(i.e. if want to set an inflation rate different from that in the US).
But: will show that it is too costly to do this.

The Bank of Canada is viewed as an excellent central bank – has
earned a good deal of “credibility” in banking circles.
But: issue is not the Bank, per se, but its policy.

Case for a common currency in Canada is not related to
achieving a stable internal monetary environment, since Bank of
Canada has achieved an inflation rate lower than that in US.
Hence, reason for Canada to have a N.A. common currency is not
the same reason for Mexico to prefer it.
The Failings of Canada’s Float (3)
Falling Living Standards

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In mid-1975, C$ was worth about 105 US cents;
In 1991, worth 89 US cents;
In 2001, worth just over 62 US cents.
Because:



Our nominal inflation is less than in US;
Our productivity is lower than in US;
Much of our 40% export share is priced in US dollars.
This has led to a dramatic fall in Canadian living standards relative
to those in the US.
The Americans now spend more public money on health care than
we do [evaluated at PPP at 78 cents].
The Failings of Canada’s Float (4)
Volatility or Misalignment

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C$ has departed both upward and downward from underlying
fundamentals for long periods of time.
This volatility is typically referred to as the “misalignment
problem”.
When way overvalued (89-91), leads to downsizing, offshoring
and exit.
When way undervalued, exports and profits do increase. But
quality labour begins to move in response to high wages
elsewhere (brain drain).
Result: bouts of misalignment lead to shifting our comparative
advantage toward resource-based activities with an employment
base that is less diversified and less human-capital intensive
than if exchange rates were stable.
Failings of Canada’s Float (5)
Buffering and Productivity (A)

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Probably the strongest argument for a floating rate is that it can act
as a buffer against asymmetric shocks.
Bank argues that by allowing the exchange rate to fall as
commodity prices fall, this shores up output and employment in
commodity sectors.
But – result could well be a decline in productivity – the “lazy
dollar” hypothesis. Producers take advantage of low dollar to
increase exports but fall behind competitors in implementing
productivity-enhancing equipment and technology.
John McCallum notes that at first blush it appears that a 10 percent
reduction in the C$ is associated, two years later, with a 7%
reduction in the ratio of Canadian to US productivity in
manufacturing.
Failings of Canada’s Float (6)
Buffering and Productivity: A Theoretical Model

Two “shocks” are occurring
a
fall in commodity prices (i.e. a negative shock to the “old
economy”)


emergence of a generous purpose technology (GPT) priced in
US$ (a positive shock to the new economy).
Assume that the GPT increases productivity
Failings of Canada’s Float (6) Cont’d

If we buffer (depreciate C$ as commodity prices fall)
entice capital and labour to stay in old economy
 increase C$ price of GPT and, therefore, underinvest in new economy
 hence, new economy is smaller and less capitalized and our
productivity falls relative to the US


If we have common currrency
commodity price fall leads to a transfer of labour and capital out of
old economy
 provides incentive to invest in GPT
 hence Canada adjusts to the shock in the same way as California
adjusts. This will close the income gap.

Failings of Canada’s Float (7)
Fire-Sale Assets

At the 62 US cents per C$, Canada’s assets are at fire-sale prices.

On the resource side, if US buys the Canadian companies, the
mining/forestry/oil activity still must take place in Canada.

Not so for manufacturing. The purchase of innovative high-tech
firms typically means the transfer of the firm, jobs and people to the
US.

Result: increase our reliance on resource-based production in a
progressively human-capital era.

Major counter to those who argue that a common currency erodes
sovereignty.
The Case for Exchange Rate Fixity (1)
North-South Integration:

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Ontario’s trade has dramatically shifted north-south (see
charts).
True for all provinces except NS and PEI.
Thus, Canada is less and less a single east-west
economy and more and more a series of north-south,
cross-border economies.
Enhances case for common currency.
The Case for Exchange Rate Fixity: (2a)
The Case
Case for
for Exchange
Exchange Rate
Rate Fixity:
Fixity: (2b)
(2b)
The
The Case for the Exchange Rate Fixity (3)
Adjustment under Fixed Rates
 Major case for flexible rates is that exchange rate is a buffer
against foreign shocks. But fixed rates can handle shocks too.
 Regional adjustment
 Assume that Ontario is in equilibrium with US Great Lakes states,
Alberta is cost competitive with the Texas Gulf, BC is on-side with
the Pacific Northwest, etc.
 Now comes a price shock, say an increase in raw material prices.
Initially, this affects both sides of the cross-border regions
similarly, i.e. Ontario is affected the same way as Michigan.
But if we allow the exchange rate to appreciate, then all Canadian
regions become vis-à-vis their US counterparts. Highly
questionable policy – better to have fixed exchange rate.
Real asymmetry is between Alberta and Ontario or Texas and
Michigan --(not north-south).
The Case for Exchange Rate Fixity (4)
National Adjustment
There is still a national problem because resources are a
larger part of Canadian GNP than US GNP and there is also a
Canadian interregional problem.
But we have policies to handle this
•
For the former, there is fiscal policy.
•
For the latter, there is income taxation, equalization, EI and
labour mobility.
Therefore, not true that we lack effective adjustment under
fixed rates. Ontario would adjust more or less in the same way
as Michigan.
The Case for Exchange Rate Fixity (5)
Fixed Rates as a Consumer Buffer

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Previous adjustment focused on producers. What
about consumers? Here, fixed rates have an
advantage.
Again, assume a price shock (fall in commodity
prices) which affects Canada more than the US. If the
C$ falls in response, consumers assets denominated
in C$ fall relative to US assets. This serves to focus
the impact of the price fall within Canada.
Under common currency, we would hold assets in
same currency as Americans. Fall in resource prices
would not affect our generalized asset values vis-à-vis
Americans.
This is an offset to the fall in price.
The Case for Exchange Rate Fixity (6)
Other factors

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Remove exchange rate volatility.
Cost certainty is increasingly important as we shift
from a resource base to a human capital base.
Reduction in transaction costs (including costs for
hedging against currency shifts).
Capital markets would be deeper and interest rate
spreads narrower, thereby increasing the efficiency of
financial markets.
Evidence suggests that trade will increase
dramatically
Alternative Approaches to Fixity (1)

Bank of Canada and many mainstream analysts assert:
Fixed exchange rates are unsustainable, and a common currency is
unattainable, therefore the real choice is between flexible rates and
dollarization. Since dollarization is unacceptable, flexible rates rule!


This will not wash. Fixed rates can work – look at the Austrians
and the Dutch. They held their fix to the D-Mark even through
German unification. And Canada is as integrated to the US as
they are to Germany.
We would have to make the fixed exchange rate the keystone of
our national economic policy within NAFTA geo-economic space.
Alternative Approaches to Fixity (2)
Currency Boards (CB)

Under a CB, the conversion rate is fixed precisely and
the CB stands ready to buy and sell at this dedicated
rate. There is no scope for domestic monetary policy
because there is no central bank, as such.

Two lesson from Argentina’s experience:
1.
2.
Currency boards hold incredibly well.
Make sure that you anchor your currency to the currency of
your major trading partner.
North American Monetary Union (1)
Nature of NAMU

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Modelled along Euro lines.
Supra-National central bank – Federal Reserve Bank of North
America (FRBNA).
Bank of Canada would still exist, as does Bank of France under
the Euro.
B of C would have a seat on the board of the FRBNA (but US
would maintain control – has 12 Federal Reserve Banks).
US dollar would continue to be US currency. Why destroy
world’s foremost currency?
We would issue a new Canadian currency, that would exchange
one-for-one with the US dollar. (Suppose that the conversion rate
was 150 Canadian cents for each US dollar. Then 100 new
Canadian dollars would exchange for 150 old Canadian dollars
and items that formerly cost $150 dollars would now cost $100 of
the new currency. Thus, we maintain existing price differences,
i.e, no real change in real prices. This is the identical process
that all Euro countries are going through.
North American Monetary Union (2)

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One side of the new currency, (say the $5 bill) would say that this
is a North American $5 bill, identical to 5 US dollars. The other
side could have a picture of the rockies, for example. Hence,
Canadian symbolism could remain.
The B of C would issue the new currency, in the same way that
the 12 US Federal Reserve Banks issue the currency in their own
regions. Thus, we would keep the seigniorage.
We would enter into some version of the European EMS in order
to move toward an appropriate currency conversion rate. This
took nearly a decade in Europe.
We would maintain control over financial regulations.
As an important aside, during this conversion process, we
should work down our debt/GDP ratio to the US level, to ensure
that we have similar fiscal flexibility under NAMU, I.e. a variant of
the Maastricht Guidelines under the Euro.
There would no longer be an exchange rate.
NAMU vs Dollarization
Why Not Simply Use US dollars?
•
•
Could do this unilaterally, whereas NAMU requires US
cooperation.
We eliminate the exchange rate and generate much of the
benefits noted earlier.
However:
•
•
•
•
We would lose seigniorage and lose currency symbolism.
The clearings system would likely become north-south by region,
rather than a national clearings system which is then reconciled
internationally;
Our financial institution regulation would begin to fall into the US
orbit and ambit;
There would be no rationale for maintaining the Bank of Canada
(I.e. there is no fall-back position).
The USA and NAMU (1)
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Will the US ever agree to a NAMU? Perhaps not.
But consider this. When the Euro coins and notes
arrive in 2002, they will be legal tender in the 12 Euro
nations. They will presumably be an anchor currency
(for fixed rates or CBs) or be a circulating currency for
all of those countries soon to enter the EU and Euro.
As important, the Euro will begin to circulate in
Russia, former Soviet countries, and perhaps as far
away as South Africa and Brazil.
And the Euro area has a large current account surplus
while the US has a large current account deficit. Over
the longer term, therefore, the odds are for a
substantial appreciation of the Euro relative to the US
dollar.
The US and NAMU (2)

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Hence, the US may have a problem, because the Euro
will compete with the dollar in major portfolios. At the
very least it will lose significant seigniorage.
At some point, therefore, the Americans will
presumably be interested in expanding the formal
dollar area.
Initially, this will likely take the form of encouraging
countries to dollarize – to declare the US$ legal tender.
The US may even agree to share the resulting
seigniorage with these countries, as Senator Connie
Mack’s Bill proposes to do.
The US and NAMU (3)


But once countries dollarize, they will then want some
influence over monetary policy. And as more
countries dollarize, some power begins to shift to
these countries.
Initially, the Federal Reserve will want to monitor and
ameliorate any problems associated with spreading
dollarization in the Americas. This can be addressed
via informal meetings. These will then begin to evolve
toward more formal contacts and this could trigger the
beginnings of what could eventually become the
Federal Reserve Bank of the Americas.
[This is one way of conceiving how we might replicate the Euro
in the Western Hemisphere].
Sovereignty and a Common Currency (1)

Naturally, a common currency means that we buy into
US monetary policy.

Not obvious that we have much independence now:
 Low
dollar is resulting in an asset “fire-sale”, as noted earlier;
 We tend to follow the US monetary policy (interest rates)
anyway;
 Question: If we had fixed the dollar at 80 US cents at the time
of the FTA, would we now have a softwood lumber problem?
That is, is the US going to stand by in a recession knowing that
the C$ depreciated from 89 cents to the low 60-cent range over
the past decade?
Sovereignty and a Common Currency (2)

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We Canadians are proud to have created a special
place and space in the upper half of North America.
The Pearson years were initially important in creating
a social vision that differed from that in the US – the
CPP/QPP, the final version of Medicare, the Canada
Assistance Plan, making the Equalization program
comprehensive, and DREE, among others.
But the Pearson years represented the only post-war
period where Canada was using US monetary policy –
our exchange rate was fixed at 92.5 cents.
Thus, there is no evidence that a common currency
would limit our ability to legislation in our own
likeness and image across a broad range of policy
areas. Quite the opposite!
Where to From Here? (1)
Britain vs Canada

The Brits have, in some respects, a similar choice to
make.
 They
do not want political union with Europe.
 Their choices: keep the floating pound; fix the pound to the
Euro; allow Euroization; or embrace the Euro and the ECB.
 The British will have one vote of 13 on the Board of the ECB,
and a lesser role as more countries join.

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Yet, my guess is that the British will join the Euro.
This will probably have an influence on Canadians.
Where to From Here? (2)
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NAMU, if possible at all, is still probably a decade
away;
If Mexico dollarizes, this might tend to force some
choices on Canada.
Happily, in the polls, Canadians now prefer a common
currency to dollarization.
My guess is that any further push needs to come from
the business sector.
Meantime, it is important that we engage in the
necessary research so that we can make the
appropriate choice when the time comes.
References
Thomas J. Courchene and Richard G. Harris (1999) From
Fixing To Monetary Union: Options for North
American Currency Integration, Commentary 127
(Toronto: C.D. Howe Institute).
Available at:
http://qsilver.queensu.ca/~courchen/papers.html