Shared+money

cite an internet source Note that MLA style calls for both the date of publication (or its latest update) and the date on which the information was retrieved. According to the most recent edition of the //MLA Handbook//, there is now information required about any foundation involved. Also note that many schools/institutions slightly change the syntax. Another example:
 * "Plagiarism." __Wikipedia, The Free Encyclopedia__. 22 July 2004, 10:55 UTC. Wikimedia Foundation, Inc. 10 Aug. 2004. .

Be sure to double check the exact syntax your institution requires. For citation of Wikipedia as a site, use:-
 * "Plagiarism." __Wikipedia: The Free Encyclopedia__. 22 July 2004 .

---paragraph one- The North American Currency Union got the idea to combine the current dollar of the three North America countries Canada, United States, and Mexico into a new dollar called the Amero. Jeffrey Frankel and Andrew Rose, international finance experts says “ditching the loonie could make Canada's economy could grow by as much as 37%.”1 Other experts say that combining the Canadian and American currencies would not help Canada at all and, in fact would be detrimental to Canada's sovreignity. --paragraph two- If Canada has a shared currency with the United States, “ One argument is that it would save up to $3 billion in currency transactions”3. Also by having one shared currency it will eliminate dynamic gains, exchange rates, and will “eliminate the currency risk premium on domestic debt instruments”4. The banks of the countries might join in a cooperative agreement to “pursue a common set of goals with respect to inflation and financial stability, consistent with a common currency zone.”5 but also it will "Eliminate the currency risk premium on domestic debt instruments"5 paragraph three--- We shouldn’t create the shared currency agreement because Canada would no longer have an independent monetary policy. If we have an single currency Canada will not have the shelter from any impacts on the U.S. market that a favourable exchange rate provides so anything bad that happens in the U.S. market will affect the Canadian market too. Also it can affect the Canadian government seignorage and the government will lose annually around $1.5 billion dollars and “The bank of Canada would lose its lender of last resort”5. -paragraph four--- A Canadian citizen might would feel like by getting rid of the Canadian loone we will be losing a piece of Canada itself, losing a piece of own culture, history, and a pieces of own selves as an Canadian citizen. If I was an member of the North American currency union I would feel this combination of currency is an good ideal there will be lots of befits even thought there might be some downfalls and might loss some money but overall the befits will be greater than the losses and relieve some stress of the exchange rates of the U.S. and Canadian dollars. -paragraph five-

-Bibliography--

**4**-  http://davidakin.blogware.com/blog/_archives/2006/11/21/2515713.html website accessed April 7, 2008 **5**- http://davidakin.blogware.com/blog/_archives/2006/11/21/2515713.html website accessed April 9,2008
 * 1**- http://www.unitednorthamerica.org/dollar.htm website Accessed April 2, 2008.
 * 2**- http://en.wikipedia.org/wiki/North_American_currency_union website Accessed April 5, 2008
 * 3**- http://en.wikipedia.org/wiki/Amero#Support website Accessed April 5, 2008

Research The University of Calfornia at Santa Barbara put forward that “ The United States dollar already acts as a global currency, meaning any transition to a 'new' currency would risk compromising this position and could cause a shift toward the euro or yen. The U.S. dollar is currently being used in over half of all the world's exports, double the total United States foreign trade. The adoption of the amero could threaten the seignorage that America currently gains from its American dollar.”2 Adopting the Amero can bring benefits and consequences towards the economy. http://www.cdhowe.org/pdf/harris.pdf Canadian conservative think tanl http://www.evtv1.com/player.aspx?itemnum=7956 http://davidakin.blogware.com/blog/_archives/2006/11/21/2515713.html Notes prepared for Minister of Finance Flahtery http://www.oldthinkernews.com/documents/the%20political%20economy%20of%20a%20single%20north%20american%20currency.pdf Lots to read but good pts to pick out 4.2 and 4.3 really good

Chapter 4: The Economics of a Single North American Currency

4.1. Introduction

In discussing the possibility of a single North American currency, a close examination of the economic issues is required. Setting aside the political aspects for the moment, how economically desirable is it for North America to use just one currency? If countries like Mexico and Canada are to consider abandoning their existing currencies, they will need good reasons for doing so. This chapter will discuss the potential benefits, and then the costs, of such an arrangement, in order to contribute to an emerging picture of NAFTA’s monetary options.

4.2. The Potential Economic Benefits of a Single North American Currency

The move to a single currency in North America has the potential to bring about certain economic benefits and efficiency gains in the three national economies. Herbert Grubel has usefully divided the range of potential benefits into static gains, which arise directly out of the elimination of exchange rates, and dynamic gains, which accompany the process. Finally, there are additional gains which require discussion.

4.2.1. Static Gains Interest Rates and Exchange Risk. A single currency in North America could have the effect of lowering interest rates, particularly for Mexico, and potentially for Canada. Interest rates on long-term government bonds often differ between countries as a result of factors such as currency risk, exchange rate fluctuation, risk of debt default, and bond liquidity. For example, investors have over several decades demanded an average 48 one percent premium above US interest rates to invest in Canadian dollar-denominated assets.105 Much more significant and costly has been Mexico’s interest premium, exceeding 10% as recently as 1999.106 By eliminating exchange risk, increasing stability, and reducing inflation differences between the three countries, a common North American currency could result in interest rate convergence. If interest rates fall in Canada,107 and particularly in Mexico, it could encourage business investment and longterm planning, increasing productivity (though reducing saving).108 Housing investments may also increase as the cost of borrowing is reduced. Over time, the cumulative effects of lower interest rates as a result of monetary integration could be of substantial benefit to Mexico.

Foreign Exchange Dealings. A single currency in North America would reduce the risk and volume of currency exchange, as well as trade in risk-reducing financial instruments. Currency dealings consume a certain amount of time and energy as well as capital and highly skilled labour. A single currency would mean that resources formerly devoted to North American currency exchange would be free to shift to the production of other goods and services in the economy.109 However, in an era of high technology where currency exchange is handled efficiency in a few financial centers, the real savings from a single currency must not be overstated. More significant is the cost of currency exchange charged to businesses and consumers by banks and other institutions. As

105 Grubel, 9-10. Kevin Clinton has attributed the bulk of this effect to the risk of Canadian currency depreciation. 17.

106 Chriszt, 33.

107 Laidler and Poschmann doubt that the benefits for Canada would be extensive. 8.

108 Chriszt, 33.

109 Grubel, 8. The European Commission’s 1990 Report on currency unification estimated (optimistically) foreign exchange savings of 0.3 to 0.4 percent of European income as a result of currency unification, though more currencies stood to be eliminated in Europe than in North America. A recent sensible estimate put the potential savings on $9.7 trillion (CAD) worth of US/Canadian dollar trading in 2001 at approximately $2.9 billion, or 0.26% of Canadian GDP. Robson and Laidler, 4.

49 pointed out by Paul De Grauwe, the cost of exchanging money is a deadweight loss and acts as a tax for which the consumer receives nothing.110 With a single currency, such charges would be eliminated in the NAFTA area.

Price Stability. Price stability includes not just low inflation, but also minimal fluctuations in the price level as a result of disturbances in trade and output. It is known that price stability encourages economic growth and efficiency because it increases the usefulness of money, and there is a theoretical argument that the larger a currency area is, the more stable is its price level.111 The reason is that a larger currency area includes more regions and allows for greater economic diversity, dampening the effect on the price level of a shock to one sector. If this effect is significant, Mexico and Canada could conceivably benefit from linking their currency to the much larger and more diverse US economy. There is little empirical evidence to support this notion, however, and it should be noted that price level fluctuations need to be significant in order to damage growth and efficiency to any great extent.112 In addition, the loss of a flexible exchange rate could actually result in //greater// movements in the domestic price level by removing an adjustment mechanism.

4.2.2. Dynamic Gains

Beyond the static gains that North America might realize through a single currency, there is also the potential for dynamic gains in efficiency, growth, and competitiveness following such a transition. However, estimates of their magnitude vary widely and economists often disagree on their significance. Several examples of potential dynamic gains are discussed below.

110 De Grauwe, 61.

111 Grubel, 10-11.

112 Forsyth, 15 May 2003.

50

Expansion of Trade//.// It is known that country borders affect trade flows. Even when international trade restrictions are minimal, regions of the same country tend to trade substantially more with each other than they do with a neighbouring country.113

While estimates vary, a recent study by Anderson and van Wincoop argued that international borders reduce trade among industrialized countries by 30%, and by 44% between Canada and the United States in particular.114 Among the costs associated with international borders is the existence of separate currencies, and many economists are curious about the potential for trade expansion as a result of currency unification. More than a dozen recent studies have attempted to estimate the trade effects of moving to a single currency. The results have been shockingly inconsistent. Depending on the methods and data used, estimates have ranged from negative trade growth to as much as 290% in a widely-cited (and criticized) study by Frankel and Rose.115 Those authors concluded that increased trade and the resulting increase in per capita income was the most compelling reason to pursue currency union. Early evidence from the Euro area is less dramatic, but also inconsistent. While Rose and van Wincoop found a 59% increase in intra-European trade since the advent of the Euro, de Souza found no such consistent trade effects yet occurring. Among the most recent research, the consensus appears to be that a significant positive trade effect from currency union is likely to exist, though exact figures are still difficult to come by. A June 2003 report released by the UK Treasury concluded that EMU has intensified trade within the Euro area, with an increase of between 3% and 25%

113 Alesina et al., 5.

114 Anderson and van Wincoop.

115 See Appendix Table 8 in Alesina et al. for a list of estimates from recent studies.

51 since 1999, depending on the specific study cited.116 The potential trade gain for the UK as a result of joining the EMU was estimated to be between 5% and 50%. These estimates remain rough, however, and the Euro area has the potential to shed more light on the question of trade gains as better data becomes available in the next few years. What //is// clear is that whatever the potential gains in trade may be, they will grow in accordance with the level of trade integration in a region. Given the massive volumes of trade conducted in the NAFTA area, the North American countries may stand to gain substantially from even a modest trade-enhancing effect of currency unification.117 It has been suggested that on the basis of existing trade patterns, NAFTA under one currency would be substantially more open than the Euro area.118

Structural Adjustment. Flexible exchange rates can also interfere with structural adjustment and productivity growth in an economy. For example, falling world commodity prices tend to lead to depreciation of the Canadian dollar. This effect protects commodity producers from having to respond with increased efficiency. In addition, mobile capital and speculation results in exchange rate fluctuation, confusing price signals and further delaying adjustment within industries.119 The result is that the economy fails to make optimal gains in productivity and fails to move resources away from commodity production and into growing and more profitable sectors such as high technology. There is also some evidence to suggest that slowdowns in manufacturing

116 HM Treasury, 3.

117 It should also be noted that if gains in trade do prove to be substantial following the implementation of a single currency, they may be a “one-off” effect, beginning to tail off after an initial period of adjustment, as was observed after the implementation of NAFTA. Forsyth, 15 May 2003.

118 Masson and Taylor, 13. Other authors, however, have pointed out that the existence of flexible and even volatile exchange rates in the 1990s did not prevent the explosion of North American trade in the wake of NAFTA. McCallum, 7.

119 Grubel, 14.

52 productivity growth are linked to periods of exchange rate depreciation.120 Further, it has been suggested that in the 1990s, Canada may have missed out on much of the high-tech productivity gains experienced in the US as a result of its undervalued dollar.121

Generally speaking, the elimination of North American exchange rates (like the elimination of trade barriers) has the potential to force greater competitiveness and productivity, resulting in higher living standards in the integrating economies.

Price Structure. A single currency could also potentially result in a more efficient price structure throughout North America.122 It is commonly known that the prices of identical products in two neighbouring countries can be significantly different, even on major products under minimal trade restrictions.123 While price discrepancies can have several causes, the greater question is why they continue to exist when distances and languages should not be a barrier to arbitrage by consumers. In theory, different currencies can complicate price comparison. By making prices transparent in addition to eliminating transaction costs, a single currency can not only increase trade but might also help to equalize the prices of consumer goods across an area, forcing inefficient retailers to either become more efficient or exit the market.124 There can also be an incentive for countries to end supply-management practices and to lower or harmonize taxation.125

120 The “lazy manufacturer hypothesis”. For counterarguments in the Canadian case, see McCallum, 7 and Murray, 19.

121 Courchene and Harris (1999), 9. Murray (20) has disputed the extent to which Canadian exchange rate trends have affected productivity, and the extent to which a common currency would help productivity. Also: Robson and Laidler, 10.

122 Hufbauer (2000) has argued that price divergence in North America is substantial, and if reduced as a result of integration, could be the source of significant gains in Mexico and Canada. 4.

123 Grubel, 11. De Grauwe, 63. The causes of such differences can be price discrimination, differences in taxation, the organization of markets, unionization, and efficiency in retailing.

124 HM Treasury, 1.

125 Grubel, 11-12. The lowering of taxes and the ending of supply-management practices are favourable from a classical economic standpoint, although the political left and those in favour of a redistributive model would perhaps be less enthusiastic.

53 North American consumers could gain from increased efficiency and lower prices, while the economies could gain generally from increased competitiveness and dynamism.126

Labour Market Discipline//.// A contentious idea is that a single currency may result in “increased labour market discipline”, as was optimistically suggested in 1990 by Europe’s Delors Commission. While this argument might apply more to Canada than to Mexico or the US, it has been suggested in the past that the effect of unions on wages and prices can be mitigated by currency union. In Canada, where unionization stands at around 35%, certain economists have argued that when currency depreciations have boosted export profits, unions have bid wages up, regardless of actual increases in productivity.127 In theory, a currency union might help to end this cycle by eliminating exchange rate protection of industries and forcing greater competitiveness. If this effect exists, however, it is likely to be limited, and there is not yet any convincing evidence to suggest that a common currency has increased labour market discipline in the Euro area.128

4.2.3. Other Gains Credibility and Stability in Monetary Policy. When several countries move onto a single currency, their inflation rates may begin to converge. For countries that have had difficulty in controlling inflation, monetary integration with a large, lowinflation economy can provide benefits in terms of microeconomic efficiency and overall stability.129 While Canada’s inflation record has been admirable over the past decade,

126 Kern. HM Treasury, 1. The jury is still out on Euro-induced price convergence in the Eurozone. Some observers have pointed out that internet marketing may also contribute to price convergence in coming years. Krugman and Obstfeld, 627.

127 Grubel, 13-14.

128 Forsyth, 15 May 2003.

129 Masson and Taylor, 5.

54 Mexico’s has only recently come under control. The move to a single currency would prevent future relapses and ensure credibility, assuming the central bank (either the US Fed in the case of dollarization or a supranational bank in the case of currency union) maintains a commitment to price stability. A related point is that in implementing just one monetary policy throughout the whole region, individual countries are unable to undertake politically-motivated adventures in monetary policy.130 In both Canada and the United States in the 1970s, and more recently in Mexico, inflationary monetary policies resulted in economic pain. The move to a single currency, particularly a currency union with a properly isolated central bank, would reduce the likelihood of such occurrences in the future.

Fiscal Responsibility//.// It has been argued in the past that a single currency could bring about more responsible fiscal policies in a region such as North America. The adoption of a single currency alone is unlikely to impart fiscal discipline,131 and may in fact cause the opposite. Discipline would thus have to arise through the implementation of rules regarding budget deficits and debt. This is the purpose of the EMU’s Stability and Growth Pact (SGP). If observed, such rules can provide discipline for governments that might otherwise be tempted to borrow excessively, as has been the case in Canada and Mexico’s past, and may now be the case in the United States. However, countries with different economic characteristics cannot necessarily accept both a common monetary policy and constrained fiscal policy at the same time. This arrangement is currently causing serious economic and political difficulties in the Euro area, where the president of the European Commission has gone so far as to call the SGP “stupid.” If the

130 Grubel, 14-15.

131 Crow, 31.

55 SGP continues to create headaches in Europe, a North American single currency area might be very unlikely to adopt such fiscal rules.

Confidence//.// Related to the above points about monetary and fiscal stability is the issue of investor confidence in a currency. When Mexico has run into severe difficulties with inflation and debt in the past, international confidence in the peso has disappeared, sending its value plummeting along with the international living standards of the Mexican people. A major incentive for Mexico to seek a single North American currency would be the confidence that it would command in comparison to the peso, resulting in a greater influx of capital and long-term investment. Canada might also receive modest gains in terms of confidence from a single currency, as the “second-tier” status of its dollar currently makes it more susceptible to speculation than the major world currencies.

4.3. The Potential Economic Costs of a Single North American Currency

While a single currency in North America could provide certain benefits, it could also impose serious costs on the economies of Canada, the United States, and Mexico. These potential costs will be discussed below.

4.3.1. Optimal Currency Area Criteria: Does One Size Fit All?

Major economic costs could arise in a North American single currency arrangement if it is simply not appropriate for one or more of the countries to share one currency and one monetary policy with the other countries; in other words, if “one size does not fit all.” This point relates to the theory of Optimal Currency Areas (OCAs), around which a substantial economic literature has built up since Robert Mundell first introduced the concept in 1961. At that time, Mundell asked what the appropriate 56 geographical domain for a single currency (or fixed exchange rates) might be, given that both the flexibility of exchange rates and independent monetary policy are no longer available to protect an area from asymmetric shocks, or economic shocks that affect it differently than its neighbours. Since Mundell’s original work, economists such as McKinnon and Kenen have helped to develop a set of criteria for determining whether several regions do in fact comprise an optimal currency area. These criteria can be divided firstly into those which affect the nature of shocks to a region, and secondly, those which affect how such shocks are absorbed. These criteria will be discussed below as a means of assessing the potential economic costs of a single currency in North America.

4.3.1.1. Shocks in North America Shock Asymmetry and Diversification. Assessments of shock asymmetry in North America, like the estimates of trade expansion as a result of currency union, have varied over time and depend on the methods used. In 1994, for example, Bayoumi and Eichengreen found major differences in supply shocks between the United States on one hand and Canada and Mexico on the other, concluding that the three countries “would have to undertake very major adjustments in policy and performance in laying the groundwork for monetary union.”132 Other studies have highlighted the value of flexible exchange rates for Canada and Mexico, given their large primary goods sectors relative to

132 Bayoumi and Eichengreen, 35. These authors took special care to use methods that did not conflate the effects of shocks and responses. Studies that look purely at output or other criteria do not necessarily avoid this complication.

57 the US, and low observed correlation between supply and demand shocks, business cycles, and terms of trade movements in the NAFTA area.133

Other studies of shock asymmetry have been somewhat more favourable to the idea of a single North American currency. Michelis’ methods found that Canada and the US likely comprise an OCA on the basis of shock similarity and business cycles, while Mexico has not yet converged sufficiently to make all of NAFTA an OCA.134 Chriszt agreed that both the US and Canada responded similarly to economic shocks (with a caveat about deep swings in global commodity prices) while Mexico responds differently, partly due to its oil exports and vulnerability to international interest rate movements.135

Past US-Canada correlation also exceeds that which is found in much of Europe.136 In addition, advocates of a common currency in North America argue that the increasing north-south organization of economies on the continent makes the east-west organization of exchange rate regimes less useful in dealing with shocks.137

While there is no firm consensus among economists on the issue, it seems that in terms of shock asymmetry, the NAFTA area does not form an obvious OCA at the present time. Although the economies are not totally dissimilar, the importance of primary goods in the economies of Mexico and Canada seem to continue to play a role in

133 White, 24. Lalonde and St-Amant. DeSerres and Lalonde. Murray, Schembri, and St-Amant, 1, 11. Murray, 9.

134 Michelis, 10-18. Among other things, Michelis found a correlation between Canadian and US GDP growth rates of 80.1%. The correlations for US-Mexico and Canada-Mexico were -6.6% and 15.7%. The fact that Canada-Mexico shows a higher correlation is likely due to the relatively larger primary goods sectors in those countries.

135 Chriszt, 30-31.

136 Beine and Coloumbe, 7. This should perhaps be qualified by the observation that North American business cycles have been somewhat divergent since the US downturn that began in 2000.

137 Courchene and Harris (1999), 12. Beine and Coloumbe point out that the heterogeneity of economic structure and business cycles across Canadian provinces means that some regions benefit more from a flexible exchange rate with the US than do others. They conclude that Ontario and Quebec could benefit from a fix with the US. 7. Murray, on the other hand, has pointed out that the response of national economies as a whole is what matters, given the existing national boundaries. 11-15.

58 distinguishing them from the United States. The fact that the NAFTA area experiences some shock asymmetry at the present time does not necessarily mean that it always will, however. Affecting how economies respond to shocks is their level of industrial diversification. The more diverse is a national economy, the less is the effect of a shock to a particular sector on the economy as a whole. Accordingly, the more diverse an economy is, the less is its need for exchange rate flexibility. It should be noted in the North American case that, firstly, the significance of the primary goods sector in Canada and Mexico is decreasing over time,138 and secondly, the increased trade and financial integration brought about by NAFTA may accelerate this process.139 Thus, in coming years, we might expect to see shock asymmetry decrease in North America. At the same time, however, it must be noted that increasing integration and the reduction of barriers to trade also results in specialization, which could lead to new shock asymmetries in North America.140

Openness and Regional Interdependence. Already discussed is the idea that more trade within a region may result in greater gains as a result of a single currency. McKinnon has also shown that flexible exchange rates are most useful to relatively closed economies in maintaining external balance and internal price stability. Very open economies, on the other hand (those with a large tradables sector), can make good candidates for fixed exchange rates, or currency union, with their major trading partners. While the Euro area is considered to be internally open, the NAFTA area is substantially

138 The contribution of services to Canada’s GDP rose from 56% in 1986 to 67% in 1996. Masson and Taylor, 15 and Buiter, 21. Buiter points out that Canada is “overwhelmingly” a service economy and is not particularly different from other industrial nations in terms of the significance of agriculture and other primary industries. 21.

139 Michelis, 18. Murray et al., 33.

140 Masson and Taylor, 16. If specialization occurs, its effect on the symmetry of shocks can depend on the extent to which increasing trade is intra-industry or inter-industry. Specialization through intra-industry trade can allow economies to remain diversified overall.

59 moreso. Recent data show openness and trade concentration within North America to be very high, having increased rapidly since NAFTA’s implementation.141 If openness and regional interdependence were the only criteria, Mexico and Canada could make good candidates for currency union with the US. Many other criteria must be taken into account, however.

4.3.1.2. Shock Absorption in North America

If a geographic area suffers from asymmetric shocks, as North America appears to, it is still possible for the area to use a single currency if certain mechanisms can absorb the effects of the shocks in the absence of flexible exchange rates. The potential for shock absorption in North America will be discussed below.

Capital Mobility. Capital, along with labour, is a factor of production that can move between regions to absorb asymmetric shocks when exchange rates are unable to, as would be the case under a single North American currency. In the NAFTA area, capital mobility is quite high and can assist in regional adjustment, though a distinction must be made between financial and physical capital. Financial capital in North American now flows easily to where it is needed on the continent (at least in times of stability), although smoothing through credit and capital markets is higher within the North American countries than between them.142 Physical capital, on the other hand, such as plant and equipment, moves a good deal slower than financial capital, and responds to differences in regulations, taxes, and culture, in addition to exchange rate risk.143 While NAFTA has eased the movement of physical capital in North America, it still cannot

141 Data from 1998 put total trade as a percentage of GDP at 67.1% and 63.7% for Canada and Mexico, respectively. Also in that year, 77.5% of Canada’s trade and 81.0% of Mexico’s trade was conducted with the US. Williamson, 5.

142 Antia, Djoudad, and St-Amant.

143 Masson and Taylor, 10.

60 respond quickly to shocks, and persistent regional disparities (even within countries) demonstrate that it is insufficient to eliminate significant differences in development. In general, however, North American capital mobility is high and might even be improved under a single currency, though additional mechanisms would be required to accommodate the loss of exchange rates.

Labour Mobility. Another important adjustment mechanism is labour mobility, or the ability and propensity of workers to relocate in response to shifts in demand and economic conditions. In North America, labour mobility within countries is considered to be significantly higher than within the Euro area,144 and mobility //between// the countries would also be very high were it not for the administrative barriers which exist. Few cultural barriers exist between Canada and the US,145 and a certain amount of labour mobility does take place between the two countries, particularly among the highly-skilled, whose movements were liberalized by NAFTA. Between Mexico and the US, the cultural differences which exist are more than overcome by the inequality between the two countries and the ease of assimilation into US Latino communities, which together produce a great deal of northward migration pressure. This issue is highly contentious in the US, which already treats North American migration asymmetrically: NAFTA imposes quotas on the movement of Mexican professionals into the US, but not on Canadians. It thus seems that the US will be slow to embrace open borders in the near future,146 a fact which is compounded by security concerns in the post-September 11

144 Blanchard and Katz. Lafrance and St-Amant, 12.

145 Only unilingual Quebecois would consider language to be barrier to Canada-US labour mobility. Differences in the provision of government services between the two countries may also have some effect.

146 Crow, 33.

61 environment.147 If borders are to be opened in North America, Mexico may not only have to experience substantial real convergence with its northern neighbours in order to reduce migration pressures, but may also be required to guarantee the security of its borders.148

Thus, any near-term currency union in North America might lack full labour mobility. Although such an arrangement might be sub-optimal, it may still be feasible,149

particularly if other mechanisms can help to accommodate the loss of exchange rates.

Wage/Price Flexibility. If exchange rate flexibility is lost, movements in North America’s wages and prices could also potentially act as an adjustment mechanism. However, different countries experience different levels of stickiness in their wage/price movements. All other things being equal, a country with greater nominal wage/price flexibility is a better candidate for exchange rate fixing with a neighbour. Although accurate data on wage/price rigidities in different countries is hard to come by, North America is generally considered to have greater flexibility than Europe,150 which suffers in particular from sclerotic labour markets. Wage/price rigidity in a country like Canada could pose an obstacle to currency union, although Canada (with its higher rates of unionization and lower rates of inflation) may well have the greatest rigidities of the three North American countries. Also unclear in the academic debate is the extent to which a single currency might result in greater wage/price flexibility.151 As discussed earlier, the hope for greater labour market discipline (and thus more wage/price flexibility) has yet to

147 Robson and Laidler, 25. De La O, 15. In June 2001, the US was showing some interest in harmonizing border controls and relaxing migration policies in North America. Following September 11, however, those ambitions were set aside for the time being.

148 De La O, 16.

149 Harris quoted in Dobson, 8. Harris points out that full labour mobility may not be essential, even in a North American common market, although more mobility would result in greater efficiency gains.

150 Ragan, 44.

151 Robert Mundell, among others, has argued that currency union might loosen prices and wages through deregulation, while Milton Friedman disagrees, suggesting that wage and price rigidity is a fundamental characteristic of economic behaviour. Ragan, 44.

62 be realized in the Euro area. To some extent, unions in Europe may even have become more militant in order to protect themselves following the Euro’s implementation.152

Fiscal Stabilization and Redistribution. Another mechanism through which asymmetric shocks and regional disparities can be smoothed is fiscal transfers. Within countries, automatic taxes and transfers shift funds between regions of high and low prosperity, while discretionary transfers can serve the same function. In the United States, fiscal transfers may cushion over one-third of the effect of regional shocks on income.153

Substantial stabilization effects exist in Canada as well, where a provincial equalization program also aims at long-term redistribution.154 In addition, regional governments can be vital to the adjustment process. In Canada, the substantial role of provincial governments and their ability to run deficits serves an important smoothing function.155

However, the success of a single North American currency could depend on the potential for fiscal smoothing //between// countries. At present, there is virtually no means for fiscal transfers across North American borders, and the portion of cross-country shocks that are unsmoothed by capital and credit markets could pose a substantial problem.156 Although some have argued that a supranational fiscal system may not be required in North America if national and regional fiscal authorities can carry out the necessary smoothing,157 it seems likely that some kind of supranational system would

152 Forsyth, 30 June 2003.

153 Masson and Taylor, 26.

154 Lafrance and St-Amant. Masson and Taylor, 27. Pastor has pointed out that Mexico’s fiscal arrangements are less effective than those of its northern neighbours. 38.

155 Masson and Taylor, 27. Beine and Coloumbe have also found that while the Canadian equalization system has contributed to the substantial reduction of disparities in Canada over the years, its effectiveness has been reduced, and it now may contribute to disparity by discouraging labour mobility.

156 Antia, Djoudad, and St-Amant, 18. At the same time, however, the researchers found greater consumption smoothing between Canada and the US through credit and capital markets than occurs across the OECD or Europe, according to results produced by Sorensen and Yosha.

157 Buiter, 27.

63 need to be established. The political obstacles to such an arrangement are daunting, given that even Europe has had great difficulty in agreeing on the transfer of funds between countries. Beyond the scope of cyclical smoothing is the longer-term issue of structural change and redistribution. The NAFTA area is marked by substantial disparities in wealth and development between the US and Canada on one hand, and Mexico on the other. Even if a North American currency union does not include supranational fiscal smoothing of shocks, it may be desirable to set up an arrangement that facilitates transfers to Mexico for the purposes of structural adjustment. As will be discussed below, the faster that Mexico can “catch up” with its Northern neighbours, the more efficient a single currency would be. To some extent, this is the idea behind the European Structural Funds which target regions in need of assistance.

4.3.2. Other Costs

While the North American countries could suffer serious costs if “one size does not fit all,” they could also incur other direct costs as a result of altering their monetary regimes.

Seigniorage. Seigniorage is the revenue that governments gain as a result of issuing currency. This includes direct gains as a result of issuing currency, the savings on the government interest bill, and the potential gains from the inflation tax. For Canada and the US, the value of seigniorage is small relative to the size of their economies, though it has been more significant for Mexico.158 In general, adoption of the US dollar

158 Buiter, 8-9. Robson & Laidler, 12. In Canada, the seigniorage yield was only 1.3% of federal tax revenue is 2000-2001.

64 by Canada and Mexico would involve forgoing seigniorage.159 In a currency union, on the other hand, all countries could potentially retain some of the seigniorage revenue, and their central banks could be responsible for issuing the new currency as part of the arrangement. Mexico and Canada could gain from a negotiated sharing of revenue in a currency union, given that US seigniorage is very large as a result of the dollar’s international status.160 In any case, while they are a factor, seigniorage issues would be comparatively easy to resolve in a move to a single currency.

The Lender of Last Resort. A crucial role of central banks is the ability to provide funds to financial institutions when the potential for a liquidity crisis exists. This “lender of last resort” (LOLR) function, if managed prudently, is vital to the stability of a country’s financial system. If Canada and Mexico were to simply adopt the US dollar, however, they would give up this function. It would also not likely be assumed by the US Federal Reserve, which would have no supervisory or regulatory authority in the dollarizing economies.161 Responsibility for Mexican banks would be particularly unattractive in light of that country’s troubled financial past.162 In a currency union, on the other hand, the central bank would serve as LOLR for the entire area, though such an arrangement would require the difficult negotiation of uniform financial guidelines and supervisory systems. Ultimately, LOLR issues would be a major factor and potential

159 Chriszt, 32. However, recent legislation introduced in the US Senate proposes that the US return 85% of its net seigniorage gain to countries that dollarize, apparently in order to demonstrate that the US does not encourage dollarization as a means of revenue generation.

160 Buiter, 10-11.

161 Chriszt, 34. Laidler and Poschmann, 15-17. In 1999, US Deputy Secretary of the Treasury Lawrence Summers pointed out that the US would not be inclined to assist dollarizing countries or take their policy needs into account.

162 In recent years, the Mexican government has spent $100 billion of public money (over 20% of GDP) bailing out domestic banks. As pointed out by De La O, “this memory alone should be enough to discourage any foreign central banker from contemplating being even a //de facto// lender of last resort to Mexico.”

65 obstacle in discussions of a single currency in North America. None of the countries would be inclined to go without some form of LOLR, nor would the negotiation of a common LOLR be straightforward.

4.5. Conclusion: A Weak Economic Case

Having explored some of the economic issues surrounding a potential single currency in North America, the economic case for such an arrangement is by no means overwhelming. To begin, it seems technically possible for Canada, the US, and Mexico to adopt and probably sustain a single currency through either dollarization or currency union. However, the potential economic gains from such an arrangement are not well defined. Mexico would clearly benefit from increased investor confidence and lower interest rates, but the gains for the other countries in terms of dynamism and trade remain unclear. Over the past decade, North America has done very well in this respect without any monetary integration. In addition, the costs of a single currency could be significant, at least in the near term. Recent movements in North American exchange rates suggest that they continue to play an important adjustment role. While the continent does have the potential for other types of regional adjustment if flexible exchange rates were to be abandoned, shock asymmetry and different levels of development could still pose a serious problem. Key adjustment mechanisms such as fiscal transfers and labour mobility, not to mention the lender of last resort function, would also depend heavily on political arrangements that seem difficult to come by at the present time.

Indeed, given that the economic case is not particularly strong, political concerns will dominate any discussion of a single currency in North America. The economic case for the creation of the Euro was also not overwhelming, but 12 European countries chose to accept the risks as a matter of politics. Would Canada, Mexico, and the United States be willing to do the same in the foreseeable future? It is to the political aspects of North American monetary integration that the next chapter will turn.

5.3. Canadian Politics

In economic terms, Canada has much less to gain from a single currency in North America than does Mexico, although certain benefits might exist. More important for Canada than the economics is the political calculus. The simple adoption of the US dollar is probably out of the question for Canada, at least in the foreseeable future. The potential gains of such a move are not well defined, while the costs would be obvious. It would be humiliating for Canada, as a prominent industrial nation, to give up an essentially sound monetary regime and hand most of the keys to the Canadian economy over to the Americans. On the whole, the Bank of Canada has done well over the past decade, as has the Canadian economy, and there is no economic reason so pressing that Canada would want to adopt the US dollar and suffer the political costs. If monetary integration is desired, a currency union would make more sense, theoretically allowing Canada to maintain some economic and political sovereignty in addition to keeping a lender of last resort and seignorage revenue. For these reasons, currency union has been the preferred option of Canadian economists who favour monetary integration. 75 As far as Canadian sovereignty is concerned, however, how different would a currency union actually be from dollarization? As Canadian economist and politician John McCallum has summed up in a simple equation, “North American Common Currency = US dollar.”172 In discussing the political realities of monetary integration, it must never be forgotten that the United States and its economy dominate the North American continent. Some observers have suggested that in terms of maintaining economic sovereignty, the best Canada might be able to hope for in a currency union would be to form the 13th US Federal Reserve District.173 In reality, Canada would likely be divided into more than one district or added to existing districts to avoiding coinciding with significant political boundaries, as has been the tradition in the US.174 In any case, a major voice for Canada in monetary policy decisions would be unlikely, given that a state like California, whose economy is larger than Canada’s, is not guaranteed a voice of its own. In this light, it is obvious that like Mexico, Canada’s influence in a prospective currency union would be small indeed, and the economic sovereignty retained over and above a dollarization arrangement would be mainly symbolic. This fact is significant, given Canadians’ historical concern with sovereignty in their relations with the United States. Canada largely defines itself by being separate and distinct from the US, and a serious proposal for a currency union entailing the loss of economic and political sovereignty might well raise Canadian hackles. This was the case prior to the signing of the CUSFTA in the 1980s, as has been discussed. On the other hand, there is increasing evidence to suggest that Canadians are coming to accept the idea of deepening integration and the erosion of sovereignty that

172 McCallum (2000), 1.

173 Canada’s GDP also happens to be about 1/13 of US GDP.

174 Forsyth, 30 June 2003. Graboyes.

76 goes with it. As pointed out in a recent issue of //Maclean’s//, Canada’s leading newsmagazine, recent data on US ownership of Canadian businesses “would have had Canadians leaping to the barricades a couple of decades ago. Today, it barely elicits a yawn.”175 Perhaps as part of a global trend of interdependence and redefined sovereignty, Canadians no longer seem as nationalistic in relation to the US as they once were, particularly on the economic front. Indeed, the CUSFTA and the NAFTA are now popular in Canada. The opponents of those agreements have been proved wrong in their dire predictions of catastrophic losses of sovereignty and identity. Today, no such movement has yet reacted to the budding discussion of currency union in North America. Either the opposition simply does not exist, or would-be opponents, having “cried wolf” in the 1980s,176 are hesitant to risk doing so again, lest they not be taken seriously. In any case, recent hard evidence shows Canadians as being increasingly open to the idea of integration with the US, and monetary integration in particular. First, although September 11 drove administrative wedges into North American integration, it led to greater feelings of affinity between North American peoples. Economically speaking, a recent poll showed that 66% of Canadians would like to see the federal government foster even closer economic ties with the United States, while only 5% were adamantly opposed.177 Separate polls conducted in 2001 showed 39.9% of Canadians in favour of adopting the US dollar,178 and 55% in favour of a common currency, up from 43% in 1992 and 46% in 1999.179 Perhaps most striking is Canadians’ sense of inevitability on

175 Gatehouse, 21.

176 Forsyth, 29 May 2003.

177 Gatehouse, 19.

178 Leger Marketing.

179 Centre for Research and Information on Canada.

77 the issue: in 1999, 77% thought that North America would have a common currency within 20 years. If the public is at least willing to consider the idea, what has been the position of Canadian politicians and authorities? Thus far, the Bank of Canada, the Prime Minister, and the Finance Minister have roundly dismissed the idea of a common currency for North America, citing the economic and political benefits of an independent Canadian dollar. In addition, a motion to study alternative currency options was quickly shot down in the Canadian parliament in 1999.180 It therefore seems unlikely that the current Canadian regime would be willing to initiate any discussions with the US or Mexico regarding monetary integration. And, as with Mexico, it must be Canada who would initiate the discussion with the US, bringing demands and incentives to the table to motivate the Americans to respond. Despite the long-term softening of the Canadian mood toward integration, moves toward a currency union might only be accepted by Canadians if they came from Canada. It was Canada who initiated the CUSFTA talks in the 1980s, having rejected such ideas from the US a few years previous. As summed up by Hart, “the combination of US chauvinism and Canadian paranoia dictates that any initiative must emanate from Canada.”181

If the political climate is crucial to any moves toward a single currency in North America, very recent developments in Canada-US relations are worth mentioning. Despite the long-term trend towards Canadian openness to integration as well as close Canada-US cooperation following September 11, other events have since led to rather

180 The motion was introduced by the Quebec separatist party, the Bloc Quebecois, who have their own agenda in promoting North American monetary integration. Among the obstacles faced by separatists is uncertainty over Quebec’s monetary arrangements in the event of separation. Another effect of a common currency would be reduced Canadian financial and economic influence in Quebec.

181 Qtd. in Pastor, 112.

78 cooler relations. Among the recent difficulties have been poor personal relations between Jean Chrétien and George W. Bush, Canada’s stance on the Iraq War, US friendly-fire killings of Canadian troops in Afghanistan, US duties on Canadian softwood lumber, a US ban on Canadian beef, and a series of hostile comments made by prominent individuals on both sides of the border.182 At present, both the Canadian and US public hold a less favourable view of each other than they did a year ago. These kinds of issues will eventually be resolved, as they have been in the past. However, the prevailing environment is not conducive to new forms of political and economic cooperation (much to the chagrin of the Canadian business community), let alone serious discussions of shared sovereignty. Thus, it seems that short-term fluctuations in the political climate can affect the likelihood and timing of any moves toward monetary integration in North America. From the above discussion, it can be concluded that the most likely course of action for Canada is inaction. Dollarization is unattractive since the economic arguments for a single currency are not overwhelming, and a currency union may not be all that much more enticing, particularly where sovereignty is a concern. This is particularly true in the minds of Canadian politicians, even if the public is not wholly opposed. Interestingly, however, the recent rise of the Canadian dollar against the US dollar has reignited discussion of monetary integration, as did the fall of the Canadian dollar in the late 1990s. The conclusion of several recent observers is that Canada must at least be open to debate and research of the options, particularly at a time of upcoming political transition. If and when monetary integration appears on the North American agenda,

182 //The Economist//.