And so it continues. I noted on Wednesday that the Globe and Mail's lead editorial on exchange rate policy demonstrated a singular lack of understanding of the economics of exchange rate policy. A particularly astute commenter noted that it was only a question of time before the zombie notion of monetary union started lumbering across the political landscape in search of brains, and it would appear that the Globe's Konrad Yakabuski has succumbed, in the form of a long essay in the Saturday edition.
I don't have a shotgun, so I'll just fisk it:
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.
Oh, please. These two paragraphs are self-serving boilerplate: "How brave I am to challenge orthodoxy!"
This goes far beyond any desire among bank staff to preserve their own jobs.
You stay classy, Konrad! Attributing base motives to those who argue against your position is the path to hackdom. But as it happens, Bank staff have nothing to worry about. The people who should be worried are Bay Street economists and Globe and Mail editorial writers; their jobs might be taken by people who know what they're talking about.
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.
Mr Yakabuski would do well to read this or this for the background behind the Bank's decision to float the CAD. The Bank of Canada knows how to conduct a fixed exchange rate regime - it's not a particularly demanding task. It chooses not to.
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.
Hey! It's not a holy creed after all! It's the conclusion of the work of generations of talented researchers! Maybe you should rewrite those first two paragraphs!
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.”
And this was a bad thing because ... why, exactly?
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.
Excellent use of the passive voice. Who thought this, and why?
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?
You already answered that when you talked about natural resource prices, remember?
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.
And this was a bad thing because ... why, exactly?
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.
It has taught us nothing of the sort. Over the past business cycle, the appreciation of the CAD has allowed us to have consistently lower interest rates. And the increase in commodity prices has been a significant contributor to Canadians' purchasing power. Why on earth should the source of these benefits be put in parentheses and forgotten?
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.
This is exactly backwards. The dollar was low because Canadian productivity was so abysmal.
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.
Has there ever been a country whose exchange rate - whether it be fixed or floating - has always been correctly valued? Is today's Spain-Germany exchange rate correct?
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. a monetary union in 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.
Um, no. It's a sign that interest rates are at the zero lower bound. When we weren't at the lower bound, the Bank's response to such a situation was to cut interest rates. Was that a sign of panic as well?
A soaring Canadian dollar can create deflation, depressing the prices of imports and creating a Japan-like spiral into perennial recession.
Hence the need to cut interest rates. Or for quantitative easing, if that's not possible. Nothing we can't deal with.
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.
An absolute train wreck of a paragraph. How is an exchange rate regime going to favour one exporting sector over another? A lower CAD benefits resource exporters just as much as it does manufacturing exporters. And why should we care where the growth comes from? Is someone giving out points for style? How do you know that the real source of innovation won't be from the resources sector?
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.
I'm going to guess that this is the study in question. I'm afraid I'm not convinced. From the Coiteux article:
the Canadian terms of trade, relative to the US terms of trade, have shown no declining trend over the last twenty years... How could the price of commodities argument explain the downward trend in the value of the Canadian dollar?
Here is a graph of our terms of trade and the Bank's broad commodity price index (this monthly series converted to quarterly averages):
One reason why commodities didn't play a significant role in Coiteux' sample is that they didn't move very much. And it may be true that when commodity prices are stable, there are no particular gains from having an independent monetary policy. But when commodity prices do move - whether it's in the late 1940's or the late 2000's - the advantages of having a floating exchange rate are significant. Think of it this way: lifeboats are a waste of space and weight in good weather, but they're handy to have around when a storm swamps your ship.
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.
I thought the problem was that the Bank was 'panicking' by considering quantitative easing to bring down the exchange rate. But here we find that the problem is that the Bank should be tightening policy, increasing interest rates and increasing the exchange rate! And it can't! Or can it? It's all so confusing! Is there no end to the havoc that an independent monetary policy can wreak? Won't Mr Bernanke remove the burden of this choice from us?
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?”
Maybe it is. Why not? If one CAD were worth 1 trillion USD, I could buy the entire US economy with the loose change in my car. Would that be so a bad situation to find ourselves?
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.”
I don't see how a monetary union with Canada would mean cheap oil for the US. And if it does, why is that a good deal for Canada?
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 w's ill 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.
Why is this at all relevant to a discussion of a Canada-US monetary union?
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.
And so we end with a non sequitur. The US dollar isn't going to disappear, so the Canadian dollar must! Neither can live while the other survives!
Here's a question that Mr Yakabuski didn't discuss: Would we have been better off in the last recession if a monetary union had already been in place? Consider what monetary independence gave us over the past 12 months:
- A 25-30% depreciation to cushion the blow of the recession
- A central bank that didn't have to participate in the bailout of US banks
I'd be very interested in a counterfactual explaining how the recession would have been less painful if Canada and the US had shared the same currency. If none is forthcoming, then I'm going to somewhat less kind the next time someone floats the idea of monetary union.