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On number 1 I agree the Eurozone crisis makes talk about the "Amero" seem silly. However, I would note that at least in principle some Canadian provinces could join a currency union with the United States even in the absence of a centralized fiscal authority if and only if (1) they shared similar business cycles and (2) had other shock absorbers in places. The way I see it fiscal transfers (that come from having a centralized fiscal authority) is just one of several shock absorbers. A member in a currency union could have other shock absorbers (labor mobility, flexible prices, diversified economy,etc.) in lieu of fiscal transfers. With that said, in practice I don't think it would work.

On another note I see an important development in the $1 trillion rescue package for the Eurozone. Among other things it lays the foundation for the a meaningful Eurozone Treasury, as noted here.

David: I liked your recent posts on this, by the way.

I think the traditional optimal currency area considerations are fine in normal times, when central banks are doing normal monetary policy. But that a whole lot of additional considerations come into play when central banks are called in as lenders of last resort.

Yep, when I wrote my point 8 I had in mind the sort of stuff that you and Ambrose Evans-Pritchard were writing about. A couple of weeks ago, at a Carleton seminar, I put forward the following totally paranoid conspiracy theory: in a bunker somewhere, deep in the heart of Euroland, a group of Eurocrats is breaking out the champagne. "Finally, the crisis we always wanted and predicted when we set up the Euro has happened. Now they will have to create a United States of Europe!"

Mr Bean (Rowan Atkinson) has a brother, Rodney. http://en.wikipedia.org/wiki/Rodney_Atkinson . He sees the EU as an attempt to create what Hitler tried and failed to create: a united Europe run by Germany. He's looking just a little bit less crazy today.

Just to add to my first point above: there's already a lot of arguing in the US over whether US taxpayers should have to be on the hook for bailouts. Imagine if Canadian taxpayers were on the hook too. It would make the Tea Party look like...ummmm,...a tea party.

Reminds me of an episode of Yes, Minister:

Jim Hacker: "Europe is a community of nations, dedicated towards one goal."

Sir Humphrey: "Oh, ha ha ha."

Jim Hacker: "May we share the joke, Humphrey?"

Sir Humphrey: "Oh Minister, let's look at this objectively. It's a game played for national interests, it always was. Why do you suppose we went into it?"

Jim Hacker: "To strengthen the brotherhood of Free Western nations."

Sir Humphrey: "Oh really. We went in to screw the French by splitting them off from the Germans."

Jim Hacker: "So why did the French go into it then?"

Sir Humphrey: "Well, to protect their inefficient farmers from commercial competition."

Jim Hacker: "That certainly doesn't apply to the Germans."

Sir Humphrey: "No no, they went in to cleanse themselves of genocide and apply for readmission to the human race."

Jim Hacker: "I never heard such appalling cynicism. At least the small nations didn't go into it for selfish reasons."

Sir Humphrey: "Oh really? Luxembourg is in it for the perks; the capital of the EEC, all that foreign money pouring in."

Jim Hacker: "Very sensible central location."

Sir Humphrey: "With the administration in Brussels and the Parliament in Strasbourg? Minister, it's like having the House of Commons in Swindon and the Civil Service in Kettering."

2. If Quebec separates, should it keep using the Canadian dollar? Forget it.

O.k., I can understand your arguments about why the Eurozone is bad. But is it worse than the alternatives? If Quebec doesn't have credibility to defends its own currency, what does it do? Dollarization etc.

Is that elephant joke original? I like it!


On the Tea Party I wonder how unified its members would be if it were pointed out that some states are paying out more in federal taxes than they get in federal benefits. Might some Tea Party members quietly walk away when they realize their state is a net beneficiary? Other Tea Party members would just get more incensed when they learn for every $1 in federal taxes they get less than a dollar in federal benefits. We might start having regional, competing Tea Party movements!

Patrick: "Yes, Minister" always revealed the reality!

Frances: The elephant joke isn't original. I must have heard it 30 years ago. In the version I remember, the French student wrote about "The love life of the elephant", and the German student wrote a 12 volume thesis on something like "Towards a metaphysics of elephants". But I just Googled it, and found:
"You have perhaps heard the story of the four students - British, French, American, Canadian - who were asked to write an essay on elephants. The British student entitled his essay "Elephants and the Empire." The French student called his "Love and the Elephant." The title of the American student's essay was "Bigger and Better Elephants," and the Canadian student called his "Elephants: A Federal or Provincial Responsibility?"
- Robert H. Winters"
Found it here: http://homepage.eircom.net/%257Eodyssey/Quotes/Modern_World/Racist_Humour.html

I hadn't heard of Robert Winters. Must be this man: http://en.wikipedia.org/wiki/Robert_Winters

But then he assumes that some of his audience had already heard the joke. Since he died in 1969, it must be a very old joke.

Frances: If Quebec separates, dollarisation would be as bad as keeping the Loonie. All the costs, plus the transition costs. They would have to create their own currency from scratch.

"The Eurozone is what Canada would be if we abolished the Federal government, leaving only the Bank of Canada. The 16 Eurozone countries are the 10 Canadian provinces... What are the lessons for Canada from the Eurozone crisis?"

I don't think the Eurozone crisis precludes a scenario with 10 provinces, no Federal government, and a central bank.

The lesson to be learned is that given that sort of Eurozone structure, better monitoring of slacker governments and their sufficient punishment is necessary. So if the Ontario government's debt metrics exceed those of the other provinces, its debt must be penalized with a larger haircut at the central bank. The ECB treated Greek and German debt homogeneously, in reality the latter was decent while the former stunk.

You'd also need predetermined rules on how a province could leave the system, and how other provinces could kick it out.

David: Maybe. But my sense is that people living in (say) Nebraska think of themselves as American before they think of themselves as Nebraskan. People living in Greece of Germany do not think of themselves as Europeans before they think of themselves as Greeks or Germans. The very fact that nobody in the Tea Party (to my knowledge) has bothered calculating the statistics on a state-by-state basis suggests that nobody is interested in thinking of it that way.

That's what I meant by my:
"9. Real institutions have to reflect, or evolve out of, real facts on the ground. They cannot be imposed from above by poncy elites. Otherwise, when the cliches hit the whatever, their rules will be worthless."

The USA is a real fact on the ground.

David: The Tea Party is fairly strong in states that are net beneficiaries, such as the sparcely populated agricultural states. The states that pay more in taxes than they get back, such as the North East and California tend to be less fiscally continent. It's an interesting hypothesis, but I don't think it is supported.


I think the central point of the argument is that in times of crisis central banks stop being purely monetary actors and become fiscal actors. Qualitative and quantitative easing policies are essentially fiscal actions and could even turn bad, which would result in taxpayers footing the bill.

And I agree that Quebec would need to create its own currency (la piastre?) if it were to secede from Canada. I always found it puzzling that Parizeau apparently never thought it would be necessary. http://en.wikipedia.org/wiki/Piastre

I wonder if you know of any literature on the creation of new currencies. This could be pretty useful in the brave new world we live in. The Patacon is an interesting predecessor to the Californian IOUs http://en.wikipedia.org/wiki/Patac%C3%B3n_(bond)

"10. Something will always go wrong. A good system will be plastic enough and robust enough to deform rather than break when things do go wrong."

Try getting rid of all the currency denominated debt and there will be fewer (probably a lot fewer) problems.

"1. A currency union with the US and Mexico? Forget it."

What about one amero currency to settle balance of payments and local currencies for the lower and middle class that constantly devalue?

"4. Provinces should keep the debts and deficits low."

Provinces and the federal gov't should have zero currency denominated debt. Any deficits should be currency funded.

Nick, I tend to think that elites in both English and French Canada would want Quebec to stay very much part of the Canadian monetary union. A separate currency for Quebec might make sense if one is focused on the short-term production and outcomes. Others may be more focused on building and maintaining wealth which is to a large extent dependent on the cost of borrowing for capital investment. The reputation capital of the Canadian monetary system is sunk.

I see some advantages to an Amero currency for NAFTA. Gone would be the commodity price and investment-driven surges in the Canadian dollar that punish exporters of manufactured goods and services in Eastern Canada.

Overall I like the list of virtuous economic policies. Mind you, many would apply to most jurisdictions regardless of the degree of de-centralization. Perhaps some provinces should think about creating sovereign wealth funds with the mandate to invest only outside the province. Naturally, this fiscally conservative idea comes with risks.

Regarding point 7: During the Depression, the Federal government let Alberta default, but then stepped in to bail out Saskatchewan and Manitoba with loans.

The issue is that #8 undermines #3,4,5 and #6.

A common problem with wish-lists, which is why engineers tell product managers "it can be done quickly, cheaply, and well. Pick two."

Local governments have different optimal tax/service trade-offs. Some areas want a lot of services with high levels of government spending while others want fewer services with less spending. This forces each area to have its budget making ability and revenue generating ability. As soon as that happens, you need each area to have its own borrowing ability -- do you want to save for 30 years to pay for that metro extension up front?

And these large, multi-generational fixed costs -- sewers need to replaced every 100 years, pension obligations for workers long since retired -- are such that labor and capital mobility actually hurts the position of depressed areas. It's not like the workers can take the bits of sewer and transit investments with them when they migrate to the booming area, but they do take the tax revenue and spending power with them when they migrate. The migration of capital and labor is pro-cyclical, while the financial position of the area experiencing flight deteriorates even further.

So I repeat, you can have regional differences in fixed investment expenditures, labor and capital mobility, and stable regional budgets. Pick two.

Nick Rowe,

You are right about the issue of cohesion. It is important if you realize that Canada is a community while Europe is not, as it is only a market. A community is operated by solidarity and guided by duty. A market is operated by competition and guided by interest. In a proper community there is no discussion of crime and punishment of provinces/states but need and assistance. Fiscal transfers in a community based system is not a bail out but a federal duty towards citizens that share common attributes and rights.In a community there is no moralizing against provinces/states with debt problems but deserved support.

Panayotis: there is some moralizing in Canada, with some parts of the country (the payees of region equalization) scolding the recipients of equalization for over-generous social programs.

Nick Rowe:

Supposedly (heard this among the grapewines) that Parizean is a post-keynesian that perfectly understood how modern fiscal and monetary operations work and that, consequently, had no intention whatsoever to hang too long to the Canadian dollar. He said publicly that Quebec would keep the Canadian dollars in case of separation, but that was just political posturing.


Nick, I wonder if you would comment on another extreme option: suppose Canada decentralized its currency into multiple regional currencies. The Ontario and Alberta economies are very different and yet each province has few tools to work with when being dragged down by the other. If Quebec could get its own currency, what about the rest of us chickens? Now that I think about it, Toronto would probably be most enthusiastic about having its own currency!

Of course, the best part is coming up with names for these new currencies.

The Maritimes and Newfoundland (especially Newfoundland) would be the ones who would really cheer for separate currencies (possibly only after the fact). No more having to bribe Michellin with anti labour laws and money. Just devalue, and watch enterprises set up shop. No more Goin' Down the Road.

Alberta would have real labour supply problems. No more Calgary Roughnecks from Frobisher Bay.

Angelo: I hadn't known that about Alberta, Saskatchewan and Manitoba in the 1930's. I wonder if the Feds imposed conditions on Saskatchewan and Manitoba?

RSJ: Interesting point. If there is greater capital and labour mobility, a province in recession gets spared the unemployment, but suffers a drop in provincial GDP as its resources leave, and this may worsen its ability to pay its debt. The only cure I can think of is to levy taxes on fixed factors, i.e. land.

But if provinces go into deficit to pay for long-term investment, that's OK, as long as they finance it with *long term* debt. The danger is short term debt, which needs to be rolled over, and so creates the danger of a liquidity crisis. If a long term investment creates the long term revenue to pay the long term debt, there's no problem with debt-finance.

Guillame: I don't know of any literature on the introduction of new currencies. It mostly happens after war, I think. (I'm not counting currency reforms, where 100 old Francs are swapped for 1 New Franc). The hardest problem is finding a focal point for the value of the new currency. When Cambodia introduced a new currency ex nihilo, post Pol Pot, they made it initially convertible into rice, I think.

Panayotis: I'm not comfortable, as an economist, talking about cohesion, which seems to be much more a political question. But yes, it seems to be important. The older, conservative, conception of a nation, seems to be what matters here. Cohesion is never 100% of course, but I think Canada has more of it (whatever it is) than the Eurozone.

Gregory: the standard Optimal Currency Area analysis says that there is a trade-off between increased transactions costs if you have too may monies, vs. the "one size fits all" problem if you have too few monies. But the Eurozone crisis has taught me that the standard Optimal currency area analysis isn't what's most important. It ignores the role of the central bank in a liquidity/solvency crisis.

Hmm, this short term vs. long term distinction seems to come up a lot, and I just don't see it. Perhaps you are referring to maturity transformation as practiced in the financial sector? There, it's a not a choice, but a business model.

But outside the financial sector, you don't see businesses or governments funding long term projects with short term debt. Macy's does not sell commercial paper to finance opening a new store, they sell bonds for that, and they sell commercial paper to finance the purchase of inventories. They fund long term projects with long term debt and short term projects with short term debt.

But in all cases, there is always an on-going (and typically increasing) flow of long and short term projects that give rise to an on-going and increasing level of long term debt, but hopefully not an increasing level of debt to revenue.

I'm not aware of a city or business saying "OK, we are done. No more capital investments need to be made from here on out -- our long term debt is "repaid" ".

Moreover, long term debt must always be serviced. And a drop in revenue may jeopardize a city's or businesses ability to make those debt payments.

But the unemployment issue is an interesting one. In the U.S. states must still pay unemployment when residents leave, and the same goes for disability insurance. I think the cut-off is 1 year for unemployment, and I'm not sure if there is a cut-off for disability. I had a relative leave California when she lost her job and still received unemployment from them for a year -- her new state was not going to pay it until she got a job in that new state, and started paying into that state's fund.

In the same way, when you retire, you can move to a different (cheaper) state, but still get the pension payments from the state you were working for. Perhaps, in Canada it's different?

RSJ: I think it matters in that businesses (and presumably gov't too) need short term debt to smooth out cash flows, and thus keep operating. If I can't get money to meet payroll and pay my suppliers, or roll over the portion from last week that I can't pay this week because we don't get paid on that big order we just shipped until next quarter (for example), what does it matter that the bonds I issued to build my factory don't come due for another 25 years? I'm Friday afternoon I'm out of business. The same probably applies to gov't. The timing of incoming tax revenues doesn't perfectly match the timing of required outlays. Even in a situation where a gov't runs a surplus, there will be times when they need short term debt to continue operating, and if they can't get it, then it all grinds to a halt.

I hear you Patrick, and I believe you and Nick have the following mental model:

* There is "short term" debt, which is used to cover a (perpetual, irresponsible) operating deficit. If short term funding dries up, then so do operations, hence "Danger Will Robinson!"

* There is "long term" debt, which is like a 30 year zero coupon bond that is "paid back" -- i.e. the government (or business) is patiently stockpiling financial surpluses -- perhaps there is a warehouse somewhere holding all these assets -- which are then handed over to the bondholder with Great Ceremony on year 30. Because it is long term and zero coupon, the ebbs and flows of revenue wash out and do not affect the ability to repay.

But business and government are not like households. It is impossible, or rare, for a business to stockpile financial assets. Shareholders typically don't allow this. The job of households is to stockpile claims on businesses, and the job of businesses is to incur claims and service them with operating profits. A business does not have a goal of having no liabilities, but has a goal of having the greatest operating profits per share -- e.g. the highest possible average return on capital. The business *wants* more liabilities, assuming it can meet them. As a result, the business maintains a steady or growing flow of interest payments as much as possible -- the model should be of amortizing debt or of a growing set of consol obligations rather than a long term zero coupon bond that is "paid back".

In the same way, it is politically impossible, or rather, rare, for a government to tax its citizens by a greater amount than the services it provides, and so it is difficult for a government to stockpile claims on its citizens.

Voters typically don't allow this -- tax-payers will not suffer a large increase in taxes to fund a project that is in use for 30 years. The pain should be smoothed out with relatively constant annual payments over the life of the project. Here, too, the model should be of amortizing debt payments, or of a consol.

What is more likely to happen, is a system in which large capital projects are funded over a time period approximately corresponding to the useful life of the project, and growing level of debt is maintained as new projects are started and existing projects are upgraded.

And in that case, whenever revenue dips or borrowing costs rise, there is pain from both short and long term debt. The local government can no more default on its long term obligations than it can suspend short term operations. In both cases, it *must* borrow at the prevailing rates to make up the shortfall, increase taxes (during the recession), or default.

Nope. I'm talking about something much simpler.

Businesses, like individuals, don't always get paid before they need to or want to incur expenses. Businesses need cash to operate. Without short term credit to smooth cash flows the business can find itself in a position of being technically solvent but with no cash to pay for daily operations. It won't be able to pay suppliers, or meet payroll. If this happens, the business is done regardless of it's balance sheet solvency; last one turn out the lights.

I assume gov't is similar in some respects.

Andrew F,

I use polar cases to sharpen the differences in the paradigms of private/market process and the public/community process developed in my framework of analysis. In reality there are no polar cases but a factor of degree.

Nick Rowe,

The point I am trying to make is that the traditional/mainstream view of economists to analyze using the private/market paradigm does not allow us to see that there is an alternative dynamic behavior based on the public/community paradigm which in my work I try to incorporate. This is in the tradition of Political Economy rather than Economics!

The story of the Alberta default (and the subsequent support for Saskatchewan and Manitoba) is described in "Maturing in Hard Times" by Robert Broughton Bryce (see p 188 and forward). It's available online for free via Google Books (just use Google to find it). After a few initial loans, the federal government tried to impose some restrictions including a "loan council" on Alberta in exchange for further loans, but the recently elected SoCred government refused, so King and his cabinet allowed it to fail on April 1 1936. Saskatchewan seemed willing to go along with the idea of a loan council, but the change of heart (letting Alberta fail but supporting Saskatchewan) seemed to have more to do with the efforts of John Towers, the first governor of the Bank of Canada. King and his cabinet thought that financial markets would reward them (i.e. buy the federal government's bonds) if they were seen to be strict with Saskatchewan as well as Manitoba. Towers convinced the government that a second default within a month would impair the federal governments ability to borrow abroad, so a first rescue package was put together. Then many more....

Getting back to the original question: what are the lessons for Canada from the Eurozone crisis?

This paper: http://www.centreforum.org/assets/pubs/more-than-we-bargained-for.pdf argues that collective bargaining in the UK causes economic damage by preventing regions from realizing their competitive advantage in wages. Another way of putting this is that the collectively bargained sector in the UK is not operating in an optimal currency area; it is like Greece & Germany writ small.

Canada's unionization rate is as high as the UK's; does it have a similar problem?

Yes, Patrick, I agree. Some businesses need to borrow short term. Everyone needs to borrow long term. In both cases, there are monthly payments to be made and falling revenues or rising funding costs can cause a lot of pain. I was just pointing out that the funding crisis seen by local governments (e.g. California) is not the result of these states taking on a lot of short term debt, and at the time, the long term debt they took on was viewed as reasonable given their expectations of revenue growth.

The latter turned out to be false, of course. I don't think there is any way around this for governments. A business can decide to maintain a coverage ratio of N:1, but a local government cannot, because it borrows to invest in the capital goods that the voters want. I think letting them default may be the best option, because at least in that case, they will experience rising funding costs as they approach the danger-zone, whereas if they are viewed as having an artificially low default risk, then it will be easier for them to borrow excessively. It's tough to say what the best option is.

Alberta went bankrupt 3 times. The feds bailed them out the first two times.

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