The Case for the Amero: The Politics of Monetary Union

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How likely is that a North American Monetary Union will be created during the coming decade or so? To answer this question, it is useful to consider why there is so much academic and public interest in the subject in 1999 when there was not much interest before. There are three important reasons.

Immediate causes of current interest in monetary union

The launch and early success of the euro

The launch of the euro in January 1999 has made many Canadians ask whether such a monetary system could be arranged for North America or at least between Canada and the United States. The creation of the euro affects people very directly and personally, especially for the many who have family links with Europe or travel there for holidays. People will no longer think about francs, marks, and lira in connection with these countries. They can travel in Europe without having to change currencies and make calculations about prices in Canadian dollars. These changes are momentous and suggest the existence of some major benefits while also raising questions about accompanying costs. Canadians want to know more and wonder whether a similar arrangement can make travel and business with the United States easier.

Economists are similarly intrigued by developments in Europe. After I had studied and lectured about the merit of the euro in my university courses for a number of years leading up to its introduction, my natural inclination was to think through the possible creation of such a monetary union in North America. In 1992 and 1993, I presented papers at conferences making the case contained in this study, albeit at a less detailed level.43 Richard Harris and Tom Courchene, in the course of analyzing the cause and effects of the declining dollar, suggested that a fixed exchange rate was desirable for all the reasons noted above. The idea of a permanently fixed rate implicit in a monetary union was a logical outcome of their work on exchange-rate dynamics. They support monetary union in principle but do not think it politically feasible, especially since it brings few benefits for the United States, which therefore is unlikely to support it.

The decline in the value of the Canadian dollar

The second reason for the high level of public interest in the proposal for monetary union is the decline in the value of the Canadian currency, especially against the US dollar. As figure 2 shows, this decline is secular, even though there were short periods of recovery. During the summer of 1998, the exchange rate fell at a rapid rate and reached historic lows. On August 27, 1998, it reached a record low of .634 cents to the US dollar. At that time an item that cost US $100 required CDN$157.65.

Many Canadians have experienced reductions in their living standards as a result, especially when they visit the United States as tourists or shoppers or live there for prolonged periods as "snow birds" in the winter. While the exchange rate has since recovered from this low, the public is not convinced that the historic downward trend has stopped. Many Canadians are deeply disturbed about the implications of this trend for their own living standards and that of their children and grand-children.

Recent developments in the exchange rate have been accompanied by a decline in the average, real after-tax income of Canadians at the same time that American incomes have soared. Canadians' wealth has shrunk relative to that of Americans largely because Canadian equity markets performed much more poorly than American markets. At the same time, Canadian unemployment rates have remained at levels nearly twice those prevailing in the United States. The dynamism and lower taxes of the United States have resulted in a brain drain of the best and brightest Canadians.

Favourable experience with free trade

The third reason for public interest in monetary union in 1999 is that enough time has elapsed to permit an assessment of the success of the North American Free Trade Agreement. Since its signing in 1992, the level of export and surpluses with the United States have risen much more rapidly than has Canada's trade with the rest of the world. Much of the economic growth experienced by Canada since the middle 1990s has been driven by these exports. The low exchange rates have facilitated this growth but the existence of the free trade agreement has helped prevent American trade restrictions that in the past have tended to arise in response to the rapid growth of imports to the United States.

Prime Minister Jean Chretien in 1993 had campaigned on the promise to alter the free trade agreement substantially. After he came into office, he realized the benefits of that agreement. He negotiated some face-saving minor changes but thereafter has often praised its many positive effects for Canada. Other opponents of the agreement who had predicted dire consequences for culture and social programs have been silenced by the absence of any such problems.

These favourable experiences with the free trade agreement have aroused interest in opportunities for further strengthening of commercial relationships with the United States. The possibility of creating a customs union was reported to be on the agenda for a cabinet meeting of the government in August 1999. A customs union would retain the existing free trade arrangements. In addition, it would harmonize the external tariff structure of the two countries. As a result, imports from other countries entering either Canada or the United States could cross the border between the two countries without paper work or the payment of duties. Delays and costs at the border will be reduced substantially.

Most important for the purposes of the present analysis is the report that cabinet at that meeting will also discuss the merit of monetary union. After the publication of this report the government denied that the subject was on the agenda for the cabinet meeting though it did confirm that the future of relationships with the United States was. It seems to me that any discussion of possible closer economic links between Canada and the United States must inevitably include the subject of monetary union. Official reports about the discussions in the cabinet meeting made no mention of these alleged agenda items. Instead, there was an announcement that Canadians would be exposed to an advertising program touting how much better the Canadian quality of life was than that in the United States.

Support for, and opposition to, monetary union

Academic and media interest

The preceding analysis explains the surge of public interest in the possibility of creating a North American Monetary Union, which in turn stimulated a number of activities. Foremost of these has been a flurry of newspaper editorials and stories (Brenner 1999a, 1999b; Courchene and Harris 1999c; Corcoran 1999; Coyne 1999; Crow 1999; Grubel 1999; McQueen and Nankivell 1998). Tom Courchene, Rick Harris, and I have given many interviews on radio and television and appeared on talk-shows. There have been numerous letters to the editor and callers on the phone-in shows. On June 26, 1999, the Canadian Broadcasting Corporation dedicated to the subject of monetary union its weekly national phone-in program hosted by Rex Murphy.44 I am certain that there were many other such events of which I am not aware.

On April 30, 1999, Professors James Dean and Steven Globerman held a conference on monetary union at the University of Western Washington. It was attended by professors from both countries, as well as John Murray from the Bank of Canada and John McCallum of the Royal Bank. Professor Robert Mundell presented a keynote speech. The papers presented at that conference will be published.

Mundell has organized a meeting of the Bologna-Claremont Monetary Conference Series in Gvanajuato, Mexico at the beginning of October 1999. A number of distinguished economists from Canada, the United States, and Mexico will discuss the issue of monetary union for North America.

On March 25, 1999 the Senate Committee on Banking, Trade, and Commerce invited five economists to give their views on the prospects for a common currency for North America. At that Senate committee hearing, I presented a summary of the analysis in the present study. The second witness, Professor Courchene agreed with my reasons for having a common currency but argued that a commitment to a fixed exchange rate at this time would be the only politically feasible alternative. Professors Jack Carr and Bernie Wolf also agreed that fixed exchange rates and a common currency would bring the micro-economic benefits outlined above. However, they held that the macroeconomic costs might be greater than I had made them out to be. Pressed by presiding Senator Michael Kirby they went on record as mild supporters of the idea for fixed exchange rates.

Only witness John Crow, the former governor of the Bank of Canada, was totally opposed to the idea. He said that my views were typical of those made by theoretical economists who are lampooned by the story of scientists stranded on a deserted island. They had a can of food but no means of opening it. The economist offered the solution "Let us assume that we had a can-opener" (see Carr et al. 1999).

At the annual meetings of the Canadian Economist Association at the University of Toronto in June of 1999, a special panel discussion dealt with monetary union and fixed exchange rates. There was a confrontation between Courchene and Harris in favour while Crow and Professor David Laidler from the University Western Ontario were against such a union. The discussion attracted much interest from other economists at the meeting.

Private-sector dollarization

While the debate over the creation of a common currency for North America proceeds, the private sector in Canada is moving rapidly in this direction by what I referred to above as private dollarization of commerce.

The assets and liabilities of Canadian banks denominated in foreign currencies have increased greatly in recent years. In January 1989, foreign currency liabilities were 35 percent of total liabilities. In January 1999, they were 46 percent (Bank of Canada Review, Spring 1999: table C4). While the growth in these assets and liabilities reflects the growth in the international business of Canadian banks, the following is more ominous. In April of 1989, Canadian residents other than banks held $8 billion in deposits denominated in foreign currencies. By February 1999, this sum had risen to $51.4 billion. These foreign currency deposits grew, as a percent of total deposits held by the general public from 3.2 percent to 10.8 percent (Bank of Canada Review, Spring 1999 and May 1991: table C2). The move by the Canadian public to foreign currency holdings, the bulk of which is US dollars, reflects a desire to protect its wealth against the depreciation of the Canadian dollar. This move has been facilitated by the ready availability and even by promotion of such deposits by Canadian banks.

Eric Beauchesne (1999) in a brief article reported more evidence on the private dollarization of the Canadian economy.45 He found that an increasing number of Canadian firms have listed their shares in US dollars on American stock exchanges. To meet listing qualifications, their financial reports are issued in US dollars.

The salaries of top Canadian employees working for multinationals operating in Canada are paid in US dollars. The athletes in the premier baseball, basketball, and ice-hockey leagues are paid in US dollars. The same is true of the referees working in these best leagues.

Canadian manufacturing production going into or through the United States was 20 percent in 1980. In 1999, it is 55 percent. Most of these exports are priced in US dollars, with producers requiring increasingly that their suppliers also price their goods in US dollars.

Courchene and Harris considered private dollarization in Canada and noted that it "would tend to be self-reinforcing and to lead to unpredictable political dynamics . . . it would be a major mistake on the part of Canada's monetary authorities to assign a zero probability to a dollarization scenario" (1999c: 21) At the meetings in June, 1999 of the Canadian Economics Association in Toronto Courchene and Harris suggested that increasing private market dollarization in Mexico and Canada would lead to a common currency without formal agreement. If this happens, Canada will have all of the macroeconomic problems emphasized by critics of monetary union. At the same time, there would be the loss of seigniorage and of the opportunity to have formal representation on the board of a North American central bank that a monetary union of the sort described above would allow.

The road to political action

Let me conclude my analysis by considering the prospects that the widespread interest in the issues of monetary union will translate into political actions that will persuade Canadian politicians to take up the cause.

Hefeker (1995) in his analysis of the politics of monetary arrangements concludes that the interest group of domestic producers is the most likely to take up the cause for monetary union. The reason is that industry likes exchange-rate stability, which facilitates long-range planning and lowers the costs of doing business abroad. The process of private-market dollarization discussed in the preceding section shows that if there is no formal agreement, business tends to act on its own and switch to the currency of the dominant trading partner--in Canada's case, the US dollar. In addition, as noted above, Canadian business should also support monetary union because it promises to bring lower interest rates, though I am not sure that this consequence of the union is understood well.

If the interest of business in monetary union is due to its involvement in trade, then the growth of that trade in recent years should have stimulated such interest. Grady and MacMillan (1998) found that between 1989 and 1997 exports from Canada to the rest of the world rose from 26.1 percent to 40.2 percent of national income while interprovincial trade declined from 22.7 percent to 19.7 percent of national income. These growth rates of Canada's international trade are unprecedented in peace-time.

Nevertheless, there is a well-known reluctance by basically conservative business interests--and the general public--to make major changes to important, existing public institutions like the central bank. New arrangements must be seen to be clearly superior to those they will replace and there must be a crisis that triggers an interest in such a change. The 1990s seem to have brought such conditions: Canada's unemployment rate has been high (especially in comparison with that of the United States), economic growth has been slow, exchange-rate instability great, stock-market growth anemic and there have been many sales of well-known Canadian firms to Americans.

Canadian business, therefore, may well be inclined to favour monetary union with its largest trading partner. However, there is one factor that could reduce this enthusiasm. The decline of the dollar has helped this trade expansion, especially in the case of firms harvesting natural resources.

The advantage of a falling dollar is much weaker in the case of firms that have a smaller Canadian value-added and rely on many imported inputs, the price of which rises with the fall in the exchange rate. The most outstanding example of such firms are the assemblers of computers, automobiles, and other consumer products. A lower exchange rate brings more Canadian dollars for sales abroad but raises the costs of components required for assembly by these firms. Profits rise and stay high but only as long as labour costs do not increase correspondingly.

It remains to be seen whether, and to what extent, Canadian business will look beyond the short-term dynamic benefits from lower exchange rates and appreciate the long-term benefits from exchange-rate stability. I would predict that opinion in favour of monetary union will gain momentum when the exchange rate appreciates. Such an increase in the exchange rate is likely to happen eventually, as it has done periodically during the postwar years. Figure 2 clearly shows these episodes.

When the exchange rate rises, Canadian producers of commodities will be upset because the increases in the world prices of their exports will be offset in part by the appreciation of the exchange rate. They will be upset especially if, during the preceding slump, they have allowed wage rates to rise and did not enjoy gains in labour productivity to match the higher pay.

Canadian firms other than commodity producers will also face problems when the exchange rate appreciates. They will have to lower their export prices in Canadian dollars to maintain market shares. While the resultant financial squeeze will be dampened by the lower costs of imports, they too will suffer if they have raised wage rates during the preceding period when the exchange rate was low.

In sum, if Hefeker's analysis of history and other countries is correct, Canadian firms and their employees will become supporters of a move to monetary union when the next, inevitable rise in the Canadian dollar causes them to suffer economically.

The general public in Canada and most importantly consumers will welcome monetary union after the prolonged period of currency depreciation and unemployment that Canada has experienced through the 1990s. Growing international travel fuelled by low-cost jet planes and increased awareness about the outside world via television and the internet have made Canadians aware of the decline in the value of their dollar as never before.

The big question is the extent to which the general public will be driven to take political action. There is a well-known lack of interest and organization for a number of reasons. People are too preoccupied with every-day problems of work, health, and family to find time for political activism. There is widespread cynicism about the ability of the general public to influence government policies. The media, which thrive on controversy, give much play to the arguments of some like nationalists and groups that stand to lose from monetary union. These arguments leave the public confused.

However, the public can be mobilized to produce political action if three conditions are met. First, the case for monetary union must be sound economically and in the light of recent developments. I think that the preceding analysis has made such a case.

Second, the media must disseminate the main facts and analytical conclusions because publications by academics and think tanks never reach enough Canadians directly. The basic messages must be explained simply and repeated often. The media must keep the dialogue alive by follow-up reports and stories, especially by exposing the suffering of individuals and by pressing politicians to take a stand on the issues. In the middle of 1999, there are encouraging signs that this process has begun. There was the large amount of media interest--William Watson (1999) called it a frenzy. Some members of the government and parliament declared their positions on the issue; Martin and Thiessen would not have registered their opposition to monetary union if there had not been substantial public interest in the issue, interest that has the potential of translating into votes at the next election.

Third, the issue requires leadership from politicians and parties. The debate over the North American Free Trade Agreement gained enormous momentum when John Crosbie, an influential cabinet minister from Newfoundland in the Brian Mulroney government made free trade the centre-piece of his campaign for the leadership of the Progressive Conservatives. While Crosbie did not win the leadership, the public response to his campaign was so positive that Brian Mulroney, who had previously opposed free trade, made it a centre-piece of his election campaign in 1989.

As another example of political leadership taking advantage of crystallizing public opinion, consider the deficit and debt crisis in the early 1990s. Established parties downplayed the importance of this problem during the 1993 federal election campaign. Only the newly founded Reform Party under the leadership of Preston Manning made the deficit and debt major parts of its election platform.46 The Reform Party's electoral success to a considerable degree was due to its stance on fiscal issues and voters' concerns.

There are some signs that monetary union may become a political issue like free trade and fiscal responsibility. In March of 1999, the youngest MPs from the opposition Reform Party and the Bloc Québeçois47 spearheaded a debate in parliament over the issue of monetary union for North America. In the process, they asked the Prime Minister to form a committee of parliament to study the subject. The leaders of the Reform and Bloc Québeçois appear not to share the judgement of their younger caucus members that the issue has the potential to become an important, winning issue for them in the next federal election.

While there are these encouraging developments in Canada, the biggest obstacle to a North American Monetary Union will be indifference in the United States. The academic and public interest in the subject in Canada in 1999 has not spilled over into the United States. Government officials who have been prodded by journalists have said that American monetary independence will never be compromised, especially since it has produced such a superbly performing economy during the 1990s. We shall never know how the American public, politicians, and the government will react to the plan for a North American Currency Union unless we Canadians ask them. But we have to do our homework, develop a well-considered position, and build strong support in Canada before we take such an initiative.

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