The Loonie’s Dive.
One of the bees in the bonnet of the late Gen. Charles de Gaulle was his belief in a return to the gold standard. The idea did not appeal at all to the Anglo-Saxons, who are an imaginary race discovered by the French, made up mostly of British and Americans, and Canadians too, the Québecois excepted. The United States eventually cut the greenback loose from gold, and gold became an impractical metal, good for teeth fillings and jewellery, but unimportant for international finance. Yet gold has continued as a measure of purchasing power, unaffected by the inflationary bumps and grinds of paper money. The loonie, if measured against the American greenback, has demonstrated that it is aptly named, for the loon is an efficient diving bird. But measure it against gold and the picture is different. The loonie has been appreciating against gold since 1996. Canadians would be better off if the world of international finance had listened to DeGaulle’s wisdom.
The loonie’s dive relative to the U.S. dollar has resulted in the coinage of a new word: “dollarization”. The result of dollarization would be the end of the loonie, and the adoption of the U.S. dollar in Canada, and the gurus of international money markets warn us that if nothing is done, the loonie’s demise is inevitable. The latest expert to issue a warning is Jeffrey Rubin, the chief economist of CIBC World Markets, who is quoted in the Financial Post prophesying that unless Ottawa acts to prop up the loonie, Canada must inevitably become the 13th district of the U.S. Federal reserve within five years. But economists citing inevitability should be regarded even more warily than Greeks bearing gifts. Trends are presented as inevitable only when there are no better arguments for them. Before Canadians embrace dollarization, there are two hard facts to consider.
First, if a Canadian with $50,000.00 in his deposit account were to awaken tomorrow and discover that Canada had adopted the greenback overnight as its currency, he would find his bank balance was only $32,750.00, give or take a few dollars. Ah, yes, interject the advocates of dollarization, but they would be American dollars with greater purchasing power, and so Canadians would be no worse off. But that assumes PPP, that is, Purchasing Power Parity. If PPP exists, the purchasing power of a currency within its own country tracks exactly its exchange rate on international money markets. Thus a computer imported from Taiwan which costs $1,000.00 in the United States should cost $1525.00 in loonies. But it doesn’t. It costs less. The purchasing power of the loonie within Canada is overvalued relative to its exchange rate with the U.S. dollar.
Once a year, the Economist tracks the oddity of purchasing power out of sync with the exchange rate by means of its Big Mac Index. A Big Mac is a good commodity to track, for it is essentially the same wherever we find the Golden Arches. Take the cost of a Big Mac in a dozen countries and convert it into U.S. dollars and the result is a valuable index of purchasing power. The Big Mac index showed that the loonie’s purchasing power was undervalued by 17% relative to the greenback. In fact, the Economist understated, for I checked the cost of a Big Mac the next time I visited a Macdonald’s in Vancouver and found that it cost less than the Economist claimed. The Big Mac’s estimates must be rough, but probably the US$32,750.00 which our sample Canadian would get for his $50,000.00 Canadian bank account would have the purchasing power of about 40,000.00 loonies.
The second fact is that there is an inevitable law of economics that what goes up must come down unless its underpinnings are sound. The lofty U.S. dollar is not the product of a favorable trade balance. For the year ending April (2001) the American trade deficit was $458.2 billion. Canada’s trade surplus by contrast was $45.8 billion. The U.S. government’s budget has shifted from deficit to surplus, though the Bush administration’s tax cuts may change that, but private sector net saving in the United States has plunged into deficit since 1997. What has lofted the American dollar into the stratosphere is foreign investment. Even the Chinese have joined in: in the year ending in April, Chinese financial institutions bought almost $30 billion U.S-denominated paper. The United Kingdom sold off a large chunk of its gold reserves and bought American securities instead. The euro has lost 40 percent since it was introduced, and the pound sterling may start to wilt, to the relief of British manufacturers, if Britain moves towards adopting the euro. The American dollar is the one safe haven left.
But the U.S. economy is in recession and the strong dollar is hurting American exports. The United States is in a bind: weakening the dollar may be needed to revive the economy, but let foreign investors see the value of their dollar-denominated securities decline and their exit from the U.S. dollar could become a mad rush. Not immediately, for at the moment, they have no better place to go than the U.S. dollar. The euro, which might have been an alternative, has yet to prove itself. But like the dot.com bubble which came down when investors took a hard look at the props holding it up, the American dollar will float down eventually when investors take a hard look at its underpinnings. It could even have a hard landing, given the size of the U.S. trade deficit.
So for the advocates of dollarization in Canada, the right answer is not now, if ever. There must be a better argument for it than inevitability.
Ottawa Citizen (2002)
The Canadian Dollar and the Greenback.
These two op-ed articles appeared in the Ottawa Citizen shortly after the election of George W. Bush as president, and his tax cuts, which are due to expire in 2011 unless the U.S. Congress extends them. The Clinton years in the United States had ended with a budget surplus, and Canadian dollar had declined about 30% against the U.S. dollar from its high point in 1970. Some Canadian economists were suggesting that Canada adopt the U.S. dollar. It was against that backdrop that I wrote the following piece nine years ago.
‘AMERICANS MIGHT BE WILLING TO CREATE A MONETARY WITH CANADA AND MEXICO FOR A NUMBER OF EXCELLENT REASONS’ headlined an OpEd article in the National Post by Herbert G. Grubel, professor emeritus at Simon Fraser University and a Fraser Institute man, a think-tank headquartered in Vancouver. Grubel urges Canada to lobby the United States for a shared North American currency, and even suggests a name for it: the ‘amero’. He admits that there not much enthusiasm for the ‘amero’ in the United States. In fact, there is none at all. Americans, except for a very few who have Canadian contacts, are quite unaware of the idea. But if and when they learn of it, their reaction will be ‘No way!’
The reason is not merely that Americans are attached to their greenback, though, as any numismatist can attest, people are conservative when it comes to the shape of their currency. But there is another good reason, too. The U.S. dollar is now the reserve currency for the countries of the world, taking the place that gold once had. Foreign demand for U.S. bonds has made it possible for the United States to sustain a trade deficit of about a billion dollars a day. Tampering with the U.S. dollar could have repercussions far outside North America. The U.S. Treasury Department would be wise to move cautiously.
Yet, even though the ‘amero’ has no future in my lifetime, I did note with interest the economic advantages for Canada which Dr. Grubel thought would follow in its wake. Number one was that the ‘amero’ would bring about superior performance of the Canadian economy. Let us omit from the argument the fact that at the moment, the performance of the Canadian economy is better than its American counterpart. The superiority may not last. What informed Dr. Grubel’s ‘superior performance’ argument was the belief that the productivity of the U.S. economy is far better that Canada’s.
The statistics seem to prove it. It is an axiom of the commentators whose columns fill the financial pages of our newspapers. But as anyone who has mastered elementary arithmetic knows, in calculating an average, a group of numbers which are just below the mean can be offset by only a few that are very high. In the United States, productivity in the computer industry, both hardware and software, is exceptionally high. Manufacturers like Compaq and Dell raised their annual rate of productivity by 41.3% between 1995 and 1997, and if that were not enough, since 1996 the U.S. Commerce Dept. has made the climb steeper by treating computer software no longer as a business expense, but as an investment and thus part of the Gross Domestic Product. Was it coincidence that about the same time, U.S. productivity leaped in the year 1995-96 to 2.5 percent annually from the more modest rate of 1.5, which prevailed from 1980 to 1995? Whatever the truth, the productivity in the U.S. computer industry is high enough to offset the steel and automotive industries where Canadian productivity equals or outranks the United States. The ‘amero’ will do nothing to change that.
But there is another factor at work as well: the U.S. Commerce Dept. has introduced a unique method of measuring the computer industry productivity, which takes into account ‘hedonic pricing’. Call up ‘Google’ on the Internet and type in ‘hedonic’ and you will find several explanations which will confuse you. The term comes from the Greek word for ‘pleasure’, and ‘hedonic’ pricing gives a more pleasurable picture of the Gross Domestic Product than does the common garden variety. To put it simply: a computer worth $2,500.00 five years ago might have a computing capacity we can designate as ‘x’. A computer costing exactly the same in 2002 might have a capacity of ‘4x’. So the Commerce Dept’s statisticians argue that the 2002 computer has greater value than the computer of five years ago with merely ‘x’ capacity, and they allow for this, even though the 2002 computer and the 1997 computer both cost $2,500.00. So in calculating the real Gross Domestic Product, the 2002 computer is reckoned at $2,500.00 plus a dollar figure that recognizes its greater computing power.
Whether this is Enron-style accounting or not, I leave to those better qualified than I to judge. But it does mean that there is an element of ‘interpretation’ to productivity statistics from the U.S. Commerce Department. It also means that making simple comparisons between Canada and the United States is a risky business. It’s not enough to compare statistics. We must ask what methods the statisticians use.
Yet even granting that average productivity in Canada is lower than in the United States, would monetary union help? The lower Canadian dollar acts somewhat like a tariff protecting weaker industries from the chilly winds of competition. To the disciples of Adam Smith who believe in free trade, tariffs are the enemy of productivity. Yet the verdict of history is ambiguous. From 1848 until after World War I, the United Kingdom had no tariffs. For many British statesmen in the Victorian period, free trade was a religion. Britain’s trade rivals, Germany and the United States, both sheltered their industries with tariffs. Did British productivity soar while productivity in Germany and the United States languished?
Quite the opposite. Industry in countries with tariffs attracted new investment because investors knew that they had a protected market for their goods. New investments paid for state-of-the-art plants that increased productivity. Britain, meanwhile, exported her capital to more profitable centres and her own industrial plant fell behind. Adam Smith did not understand such things. He lived at the beginning of the industrial revolution, before hedonic pricing and state-of-the-art industrial plants.
Ottawa Citizen 2002