Imagine that on January 1, 2000 Canada, the United States and Mexico adopt a common currency, the North American dollar, NA$ for short. On that day banks in all three countries would start to exchange existing national bills and coins for those with the new denomination. Americans would receive one NA$ for every US$. Canadians and Mexicans would have their currencies exchanged at the current exchange rate.
At the same time in Canada and Mexico all existing prices, wages, credit and debit balances would be converted at the existing exchange rate with the US dollar. Consider that the rate of exchange was 66 cents Canadian for one dollar US. What would it mean to the standard of living of Canadians?
The standard of living would be unchanged because the nominal NA dollar level of incomes, assets, liabilities and the prices of all purchases would fall by the same percent. An income of $100,000 Canadian would be $ 66,000 NA, but the price of groceries, housing, clothing and everything else people buy in Canada would fall by the same one third. The value of investments, pensions and debts relative to income would also be unchanged. So would be tax payments. So what would be the advantages of introducing such a NA dollar?
The fall in the value of the Canadian dollar against the US dollar, which has seen the Canadian dollar drop by one third since the 1970s, would cease for ever. There would be no more cost and inconvenience of currency conversion for tourists and business. The exchange risk premium on Canadian dollar bonds issued by private firms and governments would disappear and therefore Canadian mortgage rates and other costs of borrowing would be lower.
International trade and capital flows between Canada, the US and Mexico would increase as businesses could expand without uncertainties about the domestic currency value of imports and exports in the future. The value of the NA dollar against other currencies of the world would be more stable through time because within the larger a currency area is the more stable is its economy. The effects of natural and cyclical influences on trade in some region are more likely to be offset by balancing effects in other regions. The lower interest rates and increased trade would result in more investment and higher economic growth per capita.
So what are the costs of having a NA currency? Many people are concerned about the loss of national sovereignty. It is true that the national symbol of a unique Canadian dollar with its imprint of the Queen and different colours would disappear. But none of the truly important dimensions of national sovereignty would suffer. The national border with its control over the flow of goods, services and people would remain. There would be no change in the legislation which provides Canadians with the health care, welfare, unemployment and pensions benefits considered by many to be so superior to those in the US. There would be no additional obstacles to the continuation of dairy supply management, the auto pact, regional and industrial subsidies or any other government programs managing the economy.
The governments of Canada could continue to spend and tax at much higher rates than the US. Canadian troops would keep their uniforms, insignia, weapons and special dedication to peace-keeping. Canadian and US foreign policies could continue to clash over the treatment of Cuba and the banning of land mines. Subsidies to Canadian culture would be protected as much as they were under NAFTA. Canadian and US environmental and safety standards would continue to be different.
Would Canada lose on the printing of money? Under the present system, the Canadian mint has very large profits because the cost of printing bank notes is very low relative to their value. These profits are known as seigniorage and enter the general revenue fund of the federal government. They can be used as if they were tax revenue. Under the proposed new system the Canadian mint would continue to operate and make profits for the government of Canada. The only differences are that it would produce the NA currency and the output has to be equal to the amount of additional currency demanded by Canadians.
But what about the ability of the Canadian government to make monetary and exchange rate policy to deal optimally with disturbances to the economy from domestic developments like natural calamities, inflation and unemployment and external influences like global changes in the demand for exports and imports, especially natural resources? Traditional economic theory emphasizes the benefits which national monetary and exchange rate sovereignty bestows on Canada for dealing with these problems. If the world price of lumber falls because of a recession in Japan, Canada lets its exchange rate depreciate. As a result, the yen price of lumber in Japan is lowered. Canadian exporters can sell more and retain market share. Workers and firms in the lumber industry suffer less.
The merit of these arguments in favour of an independent, floating dollar is highly questionable. Interest rates in Canada have followed those in the US very closely throughout the postwar years. The record shows that in spite of the exercise of national monetary sovereignty since the introduction of floating rates in 1969 Canada’s unemployment rate has steadily risen. The exchange rate has fallen by more than one third. It could be argued that without national monetary sovereignty, Canada’s record of unemployment would have been even worse. I disagree. Under a NA currency area arrangement Canada would have representatives on the NA central bank which determines interest rates. Most important, the new currency arrangement would bring a number of benefits.
In my view, much of Canada’s economic malaise since the 1970s, high unemployment, currency depreciation and slow growth in labour productivity (the ultimate determinant of living standards) were caused by the floating exchange rate system. The main reason is that floating exchange rates reduce discipline in the labour markets and permit governments to engage in politically profitable but economically damaging policies.
Take the current slump in the world prices of natural resources and the exchange rate depreciation accompanying it. The low dollar raises the demand for Canadian automobiles and generates good profits for the industry. Automobile workers insist that the profits be shared the workers through higher wages. Workers in the natural resource industries take small or no cuts in pay. This is all great for the workers in these industries. Employers don’t mind paying the higher wages. Profits are just fine and they don’t mind escaping the need to rationalize their own operations and to invest more.
Exchange rate depreciation also represents a subsidy to regions and other industries that export or compete with imports. The lower dollar reduces the need for industries in the Atlantic provinces to adjust to their loss of competitiveness due to changes in technology, world demand and declining natural resource supplies. It reduces the amount of money the BC government has to pay to bail out bankrupt pulp mills, bailouts which might not have taken place if the bill had been higher. It retards the downsizing many industries have to make eventually in response to global changes.
What happens when the world prices of natural resources rise again? The exchange rate should appreciate. But the workers and employers in these industries will lobby the government not to let this happen. It would result in high unemployment and bankruptcies in the automobile industries. The natural resource industries would lose market share. Pulp mills will go bankrupt. The government gives in to these demands. The exchange rate may rise a little but inevitably it will stay at a lower level than existed before the latest fall. For these reasons the dollar has been on such a steady downward slide through the postwar years.
The preceding description is supported by empirical evidence. During 1990-95, when the exchange rate fell nearly 10 cents, the average income of Canadians fell 5 percent in real terms and before taxes. Only in two places in Canada did incomes rise during this period. In Southwestern Ontario, the bastion of auto-unions and Victoria, BC, where the NDP government of Glen Clark had increased the pay of one of his main constituencies, unionized civil service workers.
My analysis explains the postwar trend of the falling Canadian dollar. It also has important implications for the well-being of all Canadians. Automobile workers and others in similarly situated industries gain wage increases, but the remaining labour force suffers declines in their living standards as the prices of exportable and import competing goods are pushed up by the fall in the dollar. The prices of oil and lumber are set in US dollars in world commodity exchanges. The fall of the Canadian dollar does not affect these world prices of goods but increases them in Canada. The effects of a lower dollar on living standards is readily apparent to all those who travel abroad for holidays and work. In effect, the floating exchange rate system allows well organized groups of workers to raise their incomes at the expense of the rest of Canadians.
The reduced incentives to adjust to changes in technology, aided and abetted by explicit regional and industrial subsidies and the effects of steady transfers through the unemployment insurance system, have had a very damaging effect on productivity and unit labour costs. When workers through exchange rate and other subsidies are encouraged to remain in industries like fishing and other natural resources, average productivity in the country is lowered. The workers and capital in these industries do not move to new and growing industries. Recently, there have been labour shortages in Alberta’s energy sector and the high tech industries all over Canada while subsidies, unemployment insurance transfers and wasteful retraining programs keep them in depressed areas.
A depreciating currency also influences the expectations of investors. Consider a Canadian or US owner of funds seeking an investment. Since 1976 and 1998 the exchange rate has fallen from 1.02 to 65, for a loss of 37 points, equal to 36 percent or more than 1.5 percent annually on average. Such investors are likely to assume that the causes of this downward trend will continue to lower the dollar further in the future. They therefore will insist on getting a premium of 1.5 percentage points on returns from investment in Canada over that in the United States. Under these conditions industry in Canada faces higher capital costs, undertakes less investment and labour productivity in Canada lags behind that in the US. All Canadians suffer.
A common currency for North America would put an end to this ability of some strong unionized workers to gain at the expense of others. It would force governments to face the full cost of subsidizing workers and industries which should shrink or relocate. It would lower the cost of investment and induce higher economic growth. These benefits outweigh by far the loss of national monetary sovereignty which during the postwar years has failed to deliver on its promise for lower unemployment. The loss of the Canadian dollar would not affect Canada’s sovereignty to make foreign and social policies different from those in the United States.
Would the Americans agree to create a NA currency area to include Canada and possibly even Mexico? They may well be once the European Currency Union is in place, works successfully and threatens the dominance of the US dollar. At any rate, we will never know unless we bring up the subject and, once we have agreed that it is in Canada’s interest, ask them.