Introduction
In recent months,
there has been much discussion about the possibility of a monetary
union between Canada and the United States. Various scenarios have
been put forward for implementing such a change. The public, however,
is often confused because experts switch between different concepts
of "monetary union."
A monetary union with
the United States would strictly involve creation of a new currency,
such as the "amero" proposed by Professor Herbert Grubel,
to replace the present American and Canadian dollars. This option
is generally considered unrealistic, given the strong attachment
of Americans to their own dollar. The two countries could, however,
find another way of using the same currency, through "dollarisation."
In brief, under dollarisation Canada would adopt the American dollar,
as some countries have already done (Panama and Liberia), or are
considering (Argentina). Dollarisation would involve the most loss
of sovereignty over Canadian monetary policy.
Money performs three
functions: it is a unit of account, a means of transaction and a
store of value. Different monetary regimes will have different effects
on these functions.
Arguments
in Favour of a Monetary Union between Canada and the United States
Canada and the United
States have already established an agreement on trade called the
Free Trade Agreement (FTA) that now includes Mexico (NAFTA). This
agreement, together with the development of vastly enhanced economic
integration between the two countries, has considerably increased
the volume of trade over the past decade. A common currency would
eliminate many irritants and uncertainties with respect to the floating
exchange rate and would consequently reduce the costs associated
with these uncertainties. In fact, many argue that a common currency
would be a good complement to the NAFTA and would enhance the benefits
of this Agreement.
Canadian industries that
trade with their American counterparts must, in addition to bearing
the costs related to uncertainty, bear foreign exchange transaction
costs. John Murray, the Chief of the International Department at
the Bank of Canada, has estimated these costs to be nearly $3 billion
per year. Thus, using the same currency as the United States would
save these industries a significant amount of money.
Removing the risk associated
with the exchange rate would also help to lower interest rates on
debt, especially long-term bonds, mostly because of the reduction
in the risk premium. Canadian interest rates are now lower than
their American counterparts, owing mainly to our lower inflation
rate, but our real interest rates still tend to be higher. A common
currency would lower real rates that would encourage more investment,
benefiting the economy through higher productivity.
Under a common currency,
prices in Canada and the U.S. would be easier to compare. Such ease
of comparison would facilitate the application of antidumping laws
and reduce tension between the two countries. Moreover, it would
help to enhance competition and efficiency. The message from many
companies is that, as they already have to quote their merchandise
and services in U.S. dollars, it would be logical to dollarise the
economy as soon as possible.
Entering a monetary union
with the U.S. would stop Canada from using currency devaluation,
a tool it has employed in the past. Many argue that a weaker dollar
conceals lower productivity. Industries do not feel the need to
make substantial structural changes to adapt to changes in the market,
and the result in the medium and long term is a lack of competitiveness.
Using the U.S. dollar would prevent such an occurrence.
Another argument in favour
of a monetary union with the United States is the need for a defence
against the euro; adopting the American dollar would perhaps offset
the effect of the eurozone on the Canadian economy. This policy
response would avoid the marginalisation of the Canadian dollar
in a world where three major currency zones could appear: the euro
in Europe, the yen in Asia, and the dollar in the Western Hemisphere.
Indeed, proponents of a common currency see it as inevitable and
believe that Canada should enter into negotiations quickly, while
we still have some bargaining room.
Economists also observed
that, during last year’s crisis in Asia, short-term capital
flowed in great quantities to investments denominated in U.S. dollars.
Nobody was surprised by that situation since the U.S. dollar is
a well-known refuge for investors. Thus, adopting the American currency
would shield against speculative attacks during high-turmoil periods.
Finally, American monetary
policies have historically been better at controlling inflation
than Canadian policies, although this is not true today.
Arguments
against a Monetary Union between Canada and the United States
For a currency union
to work, theory suggests that countries need to be in an "optimum
currency area." Participating countries need to have similar
economic structures as well as full mobility of the factors of production
(capital and labour). Many argue that this is not the case for Canada
and the U.S. Canada’s economy is still strongly commodity-based
and thus is quite different from that of its neighbour. Since Canada
and the United States do not represent an optimum currency area,
a monetary union between them would not be optimal, especially for
Canada.
Responses to external
shocks — which at present are made through movements in the
Canadian exchange rate — would have to be made through fiscal
policy, movements of capital and labour, and changes in factor prices.
Given factor price rigidity in this country, this would lead to
lower output and lower employment. The "shock-absorbing"
capability of the present flexible currency would be completely
lost. Gordon Thiessen, the Governor of the Bank of Canada, has argued
that without a flexible exchange rate system, we would possibly
have experienced a deep recession over the last year.
Another important argument
is that under a common currency regime Canada would be overwhelmingly
dominated by the United States. Inevitably, Canada would lose a
substantial degree of control over its monetary policy. Canada could
not aspire to be more than just a thirteenth district of the Federal
Reserve — and this is a best case scenario. Americans would
look after their own interests, notwithstanding the presence of
Canada. Moreover, since there are many structural differences between
the two economies, American decisions could affect the Canadian
economy adversely. We already see something similar; many people
argue that the Bank of Canada conducts its monetary policy to satisfy
Ontario’s needs while British Columbia, for example, would
benefit from a more expansionary monetary policy. Under a common
currency agreement with the U.S., the situation could become even
worse for small, resource-based provincial economies such as those
of New Brunswick, Nova Scotia and Newfoundland.
Finally, such an agreement
between the two countries would imply a $1.4-billion reduction per
year in Canadian government revenues now obtained from domestic
seignorage (right to print money).
Conclusion
There are as many arguments
for as against a monetary union between Canada and the United States.
Which arguments are better is hard to say. What is at present only
a debate of ideas may soon become one that is political and financial
in nature. The debate is active and is now being put before Canadians
through newspapers and the politicians and analysts who are in favour
of it. In view of its nationalist aspects and its implications for
Canadians’ everyday life, the debate promises to be even more
important and controversial than that which occurred on the FTA.