Part two of David Bond's article.
<snip>
Is the Loonie a dead duck? Part II
Written by David E. Bond, Senior Consulting Economist to HSBC Bank
Canada, the Economic Bulletin is a weekly commentary on current
economic issues.
EB #99-032
Is the Loonie a dead duck? Part II
Last week I laid out the argument developed by two economists, Tom
Courchene of Queens and Richard Harris of Simon Fraser, against our
current regime of a flexible exchange rate. They advocate fixing a
rate and doing so within a Monetary Union using a new currency unit
with US. This week, the question is how to get to a monetary union.
The two economists are worried about the increasing use of the US
dollar as a means of pricing Canadian products and consequently
maintaining corporate books in that currency. They believe the
practice has a strong chance of becoming so wide spread that
eventually the Canadian government will have no choice but to adopt it
as the Canadian currency unit.
Were this to happen, while the existing institutional framework would
be intact, Canadian monetary policy would have a sharply lessened
ability to impact upon the Canadian economy -- unless interest and
exchange rate changes were substantially larger. That very volatility
would, however, further accelerate dollarization, putting Canadian
monetary authorities in an increasingly defensive position. Harris
and Courchene believe this could eventually lead to official
government acceptance of the US dollar as the Canadian monetary unit.
Harris and Courchene believe that "dollarization" pricing of products
and keeping company books denominated in the US dollar would make the
Bank of Canada redundant, and the financial and regulatory regime
would be drawn inexorably under the US influence. All in all,
dollarization would solve the exchange rate problem but potentially
obliterate our de facto sovereign independence. The authors term this
a "non starter" but they do not assign it a zero probability.
Thus the concept of a monetary union is preferable because, using the
new Euro currency and central bank as a model, a monetary union would
give us some say in the formulation of monetary policy and allow us to
maintain our own financial institution regulatory regime, clearing
system, deposit insurance scheme, etc.
But it takes two to tango and what's in it for the US that would make
them willing to even consider such a move? It would give them a
chance to extend the reach of the dollar area and such a union could
be extended southward to Latin America, ending what appears to be the
endless currency instability and subsequent US bailouts of the region.
Two questions remain: How and when?
Courchene and Harris believe we cannot go immediately from flexible to
fixed rates. That would, in their opinion, make achievement of a fixed
rate virtually impossible since it would immediately set off
speculation about the willingness and ability of the Canadian
government to stay the course. Therefore they see first the
announcement of some sort of exchange rate target and then a gradual
tightening of the range of exchange rate movements. As the authorities
become more accustomed to acting in a fashion appropriate to maintain
the exchange rate, the market will become more acclimatized to the
reality of a fixed rate. In the meantime, negotiations would be
ongoing respecting the possible monetary union.
The question of when, is more problematic. Courchene and Harris say
the sooner we start negotiating the better, but looking at Europe as a
model, they believe it will likely take the better part of a decade
before the final union is in place
A monetary union would end sovereignty in Canadian monetary policy.
But will it stop there? The authors admit they don't know, but cite a
number of facts including that the implementation of much of our
social support system took place during a period of fixed exchange
rates. Now that our government's fiscal position is restored to
surpluses they see no reason why the previous cuts to the social
support system cannot be restored. They also note that with the advent
of the Euro each individual nation is still able to express its unique
opinion when it wishes.
But the bottom line, according to Courchene and Harris, is either we
drift into a fixed rate because of accelerating dollarization or we
negotiate something better. While it may engender hostility on the
part of some Canadians, it would be prudent for Canada to begin
exploring the issue with the US lest we want to drift unwittingly into
a second best solution.
Bumbling through on this issue is just not wise policy.
~
Economic Bulletin conomique, prepared by David E. Bond, Senior
Consulting Economist, HSBC Bank Canada, reflects his personal
observations and does not necessarily reflect the position of HSBC
Bank Canada or its board of directors. The Economic Bulletin
conomique is not intended to be a comprehensive review of all
developments nor is it intended to provide financial advice. Readers
should not act on information in Economic Bulletin conomique without
seeking specific advice from qualified advisors on particular matters
which are of concern to them.
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