Five reasons why Iceland should adopt the Canadian dollar

 

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Five reasons why Iceland should adopt the Canadian dollar

Fyrst birt í Globe and Mail 05. marz 2012.

 

 

Michael Babad.

                                   
The idea of Iceland adopting the Canadian dollar isn’t as nutsy as it might seem to some.

Indeed, says Justin Wolfers, a prominent U.S. economist, if Iceland really wants to do it, Canada should go for it. And if we don’t, maybe the Aussies will.

It also appears there’s nothing to stop the Icelanders from doing it on their own, by the way.

The suggestion, which has been tossed around in some quarters in Iceland over the past several months, picked up steam late last week when Canada’s ambassador to the tiny nation, Alan Bones, said Ottawa is open to talking about it if Iceland makes the request.

“What we know the nature of the final agreement is will depend very much on the expectations of both countries,” Mr. Bones told a broadcast interviewer in Iceland. “But in a straightforward unilateral adoption of the Canadian dollar by Iceland, where it is clear that there’s no input into monetary policy, then we’d be certainly open to discussing the issue.”

Mr. Bones had actually prepared to take it further, and was planning to deliver a similar message Saturday to a conference on Iceland’s currency, the krona.

But, as The Globe and Mail’s Barrie McKenna reported, Canada’s Foreign Affairs and International Trade Department pulled the plug at the last minute. Coincidentally, that happened just a few hours after my colleague’s story was published online, picked up by other media and flashed around the world via Twitter.

Canadian officials said Ottawa won’t talk about the currencies of other countries (though that didn’t seem to be an issue when the G7 intervened to stem a surge in the yen a year ago) and that it wouldn’t have been right to make such comments at a political event, in this case one held by Iceland’s opposition Progressive Party.

I agree it wasn’t the venue for it, particularly given that Iceland’s government is officially preparing to join the 17-member euro zone, but it does seem clear that someone somewhere has been talking about this. It’s highly unlikely that Mr. Bones went rogue.

Iceland, of course, was the original poster child of the meltdown, suffering a banking collapse, an economic mess and capital controls.

“An independent currency for a country with the population of the size of a decently sized Canadian city was always going to be a problem,” said Sebastien Galy, senior currency strategist at Société Générale.

“Having that country run a financial bubble while offering very high yield was a recipe for a very rapid rise of a financial empire followed by a catastrophic collapse, with the currency ceasing to have a market at one point. The past few years have been of picking up the broken pieces, and a move to a new currency would help to bring credibility while forcing adjustments in internal prices.”

Should that new currency be the loonie, as it’s known in Canada?

“While both currencies share some commonality with their exposures to energy and commodities, it is a reaction to the government negotiating and preparing for the eventual introduction of the [euro],” Mr. Galy said of the weekend discussion in the opposition camp.

“Neither currency is optimal for this country and it is a tug of war between Iceland’s European and more independent Nordic roots.”

Mr. Wolfers thinks the Australian dollar would be a better fit for Iceland. But from Canada’s perspective, it would be a “no-brainer,” the associate professor of business and public policy at the Wharton School of the University of Pennsylvania told me.

“Honestly, other countries should compete with Canada for Iceland’s business,” said Mr. Wolfers, also a visiting fellow at Princeton, citing Australia in particular.

This followed his comments Friday on Twitter, to which Australian MP Andrew Leigh, a former economics professor, responded that, indeed, Iceland would be better off adopting the Aussie dollar. So maybe we can get a competition going.

Mr. Wolfers was referring to what is known as seigniorage, which is how Canada could benefit should Iceland actually ever ditch the krona for the loonie.

I’m not talking about a currency union here, just Iceland using the loonie. Here are five things to consider:

1. Seigniorage.

This is the biggie, if a bit complex.

Seigniorage is the difference between the cost of printing a currency and its value. As the Bank of Canada explains it, it’s the difference between the interest the central bank reaps on a portfolio of government securities, in turn basically the same amount as the value of outstanding bank notes, and what it costs to issue, distribute and replace the bills.

On its website, the central bank uses the example of a $20 bill, which has an average lifespan of three years and is the most commonly used. If it invests the proceeds of issuing that note in a government security that yields interest of 5 per cent, the bill yields $1 a year. Producing that bill costs 9 cents. Given the three-year lifespan, it costs an average of 3 cents a year to produce the note. Add 2 cents a year to distribute it, and the annual cost is 5 cents, which means revenue for the central bank of about 95 cents a year for each $20 bill that’s out there.

More than $50-billion has been circulating at any given time, though that can and does change. Generally, the central bank says, it reaps about $2-billion a year. Some is used for general expenses - $366-million in 2009 – and the rest goes to government coffers.

Given Iceland’s small size – its population is just 320,000 – and the fact that its people have embraced electronic banking, we’re not talking about a seigniorage windfall here. But Canada’s Finance Minister Jim Flaherty is looking to get his hands on whatever he can.

“Printing money is a good thing for Canada,” Mr. Wolfers said. “Every dollar in circulation is on the debit side of the central bank’s balance sheet, and they’re effectively borrowing from the Icelanders at a zero-per-cent interest rate.”

So if there are no strings attached, why not? Or, as Mr. Wolfers put it, referring to Iceland, “as long as you’re a bastard, it’s all profit”

2. A stable currency.

Iceland could of course benefit from a devalued currency. Instead it would get a strong, stable currency that has been something of a haven during this post-crisis period of uncertainty. While strong, exporters at least know what to expect.

Consider, too, that the Canadian dollar is liquid. The krona was "blasted through smithereens and very few banks can trade [it] in anything else than very small amounts," Mr. Galy noted.

The dollar (CAD/USD-I1.01-0.007-0.69%)has been hovering around par with its U.S. counterpart and is expected to remain there, at least through the end of this year.

I’m not sure Ontario Premier Dalton McGuinty would agree, but Mr. Galy believes that the Bank of Canada has held interest rates below where they should be to hold the loonie down and give exporters more time to adjust to the currency’s strength. So that’s at least something for Iceland if you take that view.

“This soft approach means that capital may be increasingly misallocated at too low a rate (e.g. potentially housing),” he said.

“The more German approach, familiar to many German communities in Canada, is to get down and fix the productivity issue, irrespective of any short-term pain. There is a fine balance between the easy and hard way, we must all tackle whether in Iceland, Europe or Canada.”

3. Respected central bank.

Iceland would of course have no say in monetary policy, but it would have a currency overseen by a very strong central bank and governor, who led Canada out of the recession admirably.

Mark Carney is also respected on the global stage, having recently been named to head up the Financial Stability Board.

"Dear Canada: If Iceland wants you rather than their own inept central bank to earn their seigniorage, accept the deal," Mr. Wolfers said on Twitter.

4. Fiscal, economic stability.

Iceland has no reputation in the wake of its banking collapse.

Who would you prefer at that point, a euro zone crippled by recession and a two-year-old debt crisis, or Canada?

With Canada, you get a stable, if lukewarm, economic outlook, a government that’s still rated triple-A, and a fiscal standing to die for (if you’re Greece or Portugal).

And, we can count.

5. Our glowing hearts.

For Iceland, do not underestimate friendship in this post-crisis era of currency manipulation and mounting trade tensions.

We’re a wonderful people, they’re a wonderful people. We’ve got a beautiful country, they’ve got a beautiful country. True, it gets cold in Canada in the winter, but remember we’re talking about Iceland.

 

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