Why Dollarization is a Canadian Affair

Op-ed by Christopher Sands and Sidney Weintraub appearing in the Globe and Mail.

Why dollarization is a Canadian affair
Sidney Weintraub and Christopher Sands Many Canadians are unhappy with the U.S.-Canada exchange rate. Talk in Canada of adopting the U.S. dollar -- usually referred to as dollarization, although this is an ambiguous term since Canada's currency is also a dollar -- has increased as the Canadian dollar has fallen to historic low values against its U.S. counterpart in recent months. Canadians may opt for the U.S. dollar if they choose, but what would be the reaction in the United States? The Canadian economy is far larger than that of Ecuador or El Salvador, two countries that recently adopted the U.S. dollar, and this makes the switch more complex. But unlike Argentina, which linked its peso directly to the U.S. dollar and discussed moving to full dollarization, Canada has an economy that is closely linked to the U.S. economy through trade, investment, migration and cultural affinities. To a certain extent, this would make Canada's use of the U.S. dollar easier to understand. A lower value for the Canadian dollar helps Canada to sell its goods and services to the United States, and attracts U.S. tourism. But it also helps U.S. firms, which benefit from lower Canadian costs and can acquire Canadian firms and other assets more cheaply. Generally, the use of the U.S. dollar by Canadians would not be objectionable, but is not a condition sought or desired by the United States. Trade between the two countries is already conducted mainly in U.S. dollar terms. A large proportion of bilateral trade is intrafirm -- between units of the same or related companies. The costs of short-term exchange-rate volatility can be minimized through adjustments in transfer pricing. The Bank of Canada estimates that 50 per cent of Canadians have a U.S. dollar-denominated bank account. Simon Fraser University economist Richard Harris has called this situation "market dollarization," and contends that it is intensifying. Since the United States has nothing tangible to gain from the formal Canadian adoption of its currency, Washington policymakers will be leery of offering any encouragement to Canada that could serve to draw the U.S. government into a domestic Canadian debate over sovereignty. However much some Canadian nationalists may wish to view the United States as a remorseless opponent of Canadian sovereignty, this is not the case, and participation in this tiresome mythology holds no interest for Washington. Should Canada wish to switch to U.S. dollars, it must take this decision alone. Canadians should not expect to gain favours or special leverage from a decision to use the U.S. dollar. Some have suggested that Ottawa would insist on a seat for Canada on the Federal Reserve Board and a voice in U.S. monetary policymaking if it replaced its currency with the U.S. dollar. Yet California, with an economy larger than Canada's, is not guaranteed a seat of its own. Why should Canada receive preferential treatment? Looking to the euro, some Canadians have suggested that a new North American currency unit might be created as an alternative to either the Canadian or the U.S. dollar, and might replace the Mexican peso as well. This would have little appeal to Americans, who are happy with their dollar. Unlike Europe, North America has one large, one medium, and one emerging economy. Monetary union in North America, if it comes, is likely to be U.S.-dollar based. The only realistic option for Canada if it wants to abandon its dollar is the unconditional adoption of the U.S. currency with no special voice in the management of monetary policy. It is possible, but unlikely, that the U.S. government would consent to share seigniorage with Canada if the latter adopted the U.S. dollar. Canada, if it chose the U.S. dollar, would have to decide the rate to use for the changeover.

For those Canadians with memories of the early 1990s, this scenario will have obvious drawbacks. Then Bank of Canada governor John Crow was sharply criticized for maintaining the tight money that Ontario needed, while resource-driven economies such as Alberta's and Newfoundland's cried out for loosening to allow them to recover from recession. Setting monetary policy for diverse regions is difficult, and logically the largest economies within a federation have a proportionately large voice in monetary policy. How would Canada fare under the Federal Reserve? Ontario would likely find Fed policy congenial, but other parts of Canada might be less content. At least they would have the cold comfort of being able to blame the Americans for their troubles. Canadians can adopt the U.S. dollar in any event. The independence of Canadian monetary policy is already constrained by the financial weight of its elephant neighbour. As services and high-technology supplant natural resources as income earners for most provinces -- a trend related closely to growing trade relations with the United States -- adoption of the U.S. dollar may prove attractive to those outside Central Canada. Our stress is the following: This is a debate for Canadians. Individual Americans will speak up, but the U.S. government will almost surely -- and wisely -- remain silent. Sidney Weintraub is director of the Americas Program and holds the William E. Simon Chair in Political Economy at CSIS. Christopher Sands, a fellow of the Americas Program, is director of the Canada Project at CSIS.