Editor-in-Chief
So, the news-feeds are abuzz with the idea that Iceland may Loonie-ize its currency. CNN even has a story asking, ‘Is Canada the World’s Next Superpower?’
Well, the short answer to that question is easy: No. But the more interesting question is why would Iceland even consider this move, and what does it say about the Canadian economy? (Note: what follows is not ‘expert’ commentary, but rather observations from some pretty astute people who I have taken care to cite. As such, any errors are mine, and mine alone.).
Why Iceland Would Want the Loonie
Well, there are some valid reasons for Iceland’s move. Its currency is basically worth nothing. (As Canada’s the Star points out, “The Icelandic krona is worth less than one Canadian cent at current exchange rates). Second, El Salvador and Ecuador have done the same thing—but with the American dollar. Both these countries, as a result, found that there banking systems improved. For Iceland, this result would be a godsend: three of the nation’s largest banks crashed, requiring serious confidence rebuilding in the international markets. Why was this so much worse in Sweden than in the United States? Well bank deregulation, which allowed banks to start going into the investment business, allowed Icelandic banks to borrow money to then investment, allowing them to grow their holdings--and offer a pretty whopping interest rate. The problem? They borrowed more than they had assets to cover (something that typical 'prudential' style banking regulation in the U.S. does not allow). When the economy starting quaking, people wanted their money back from the banks, and guess what? The banks (a) didn't have it and (b) couldn't get anyone else to lend to them. And, even worse, they couldn't look to their own country to bail them out. Why? The banks had become 10 times bigger than the entire Icelandic economy.
And what does Canada get? Well, first it seems unclear whether Canada could stop Iceland from Loonie-izing their currency. Official dollarization happens when a country officially pegs its currency to that of Canada and cedes its power to print money or set interest rates to that country’s Fed. Second, Canada does get money from seigniorage—basically while it costs money for nations to print money, nations also make money by you holding their cold, hard cash. How? Well, basically Iceland would be paying Canada to hold their currency. It’s like any other financial instrument—Iceland is still buying Canadian dollars, it’s just in addition to that pegging their currency to Canada’s—ceding their monetary policy. But unlike, let’s say Iceland buying a Canadian bond, the cash isn’t collecting interest. Hence, the difference between that ‘interest-free loan’ and the cost of printing the Loonie equal seigniorage. And with Iceland’s population so GDP so smalled compared to Canada, 300,000 and 1% of Canada’s GDP, it’s not like Iceland buying up Loonies is going to cause a big shift in Canada’s monetary policy.
But, returning to the bigger picture, there are some problems—and less economic-based reasons—with Iceland adopting the Loonie. First, Nick North of Carleton University asks six very pointed questions about the wisdom of Canada permitting Iceland to Loonie-ize:
And this story is only getting play because the Canadian ambassador to Iceland, Alan Bodes, stuck himself in the middle of this Icelandic domestic political affair by stated Canada’s openness to permitting Iceland to Loonie-ize. Naturally, the currency speech Bodes had apparently planned to give was cancelled by the Canadian government.
Conclusion: No One Knows, And Some Concluding Questions
Well, there are some valid reasons for Iceland’s move. Its currency is basically worth nothing. (As Canada’s the Star points out, “The Icelandic krona is worth less than one Canadian cent at current exchange rates). Second, El Salvador and Ecuador have done the same thing—but with the American dollar. Both these countries, as a result, found that there banking systems improved. For Iceland, this result would be a godsend: three of the nation’s largest banks crashed, requiring serious confidence rebuilding in the international markets. Why was this so much worse in Sweden than in the United States? Well bank deregulation, which allowed banks to start going into the investment business, allowed Icelandic banks to borrow money to then investment, allowing them to grow their holdings--and offer a pretty whopping interest rate. The problem? They borrowed more than they had assets to cover (something that typical 'prudential' style banking regulation in the U.S. does not allow). When the economy starting quaking, people wanted their money back from the banks, and guess what? The banks (a) didn't have it and (b) couldn't get anyone else to lend to them. And, even worse, they couldn't look to their own country to bail them out. Why? The banks had become 10 times bigger than the entire Icelandic economy.
Also, Iceland and Canada share unique ties: (1) there are nearly as many Icelanders in Canada as in Iceland, and (2) both countries (Canada more recently) are northern resource-rich economies.
3/7/12 Update: More on Canada and Iceland's cultural ties, courtesy of Government of Canada:
3/7/12 Update: More on Canada and Iceland's cultural ties, courtesy of Government of Canada:
The vibrant community of Icelandic descent in Canada (concentrated mainly in Gimli, Manitoba) plays a large role in keeping cultural ties strong and dynamic. The Icelandic National League of North America (formed in Winnipeg in 1918) plays a leading role in most cultural activities among the Icelandic people in Canada and the United States. As well, the Icelandic-Canadian Friendship Clubs in Montreal, Ottawa, Toronto, Winnipeg, Calgary, Edmonton and Vancouver offer various Artist Exchange Programs aimed at fostering two-way artistic links.
The Benefits to Canada: Unclear if they can stop it & seigniorage (not to mention an ego boost)
And what does Canada get? Well, first it seems unclear whether Canada could stop Iceland from Loonie-izing their currency. Official dollarization happens when a country officially pegs its currency to that of Canada and cedes its power to print money or set interest rates to that country’s Fed. Second, Canada does get money from seigniorage—basically while it costs money for nations to print money, nations also make money by you holding their cold, hard cash. How? Well, basically Iceland would be paying Canada to hold their currency. It’s like any other financial instrument—Iceland is still buying Canadian dollars, it’s just in addition to that pegging their currency to Canada’s—ceding their monetary policy. But unlike, let’s say Iceland buying a Canadian bond, the cash isn’t collecting interest. Hence, the difference between that ‘interest-free loan’ and the cost of printing the Loonie equal seigniorage. And with Iceland’s population so GDP so smalled compared to Canada, 300,000 and 1% of Canada’s GDP, it’s not like Iceland buying up Loonies is going to cause a big shift in Canada’s monetary policy.
And, of course, there's just the ego boost from knowing that a country prefers to peg to your currency than the Euro or the American dollar.
So a Strong Currency Is Someone We Should All Want? Not So Fast...
But what does this say about Canada’s currency? Well, first, the obvious: that Canada’s currency has essentially become closer to a petro-dollar (though, really, the economy—as any quick glance will show is diversified), and with energy costs increasing the currency is strong—again at near parity with the United States. But, even more attractive to Iceland, is that Canada’s GDP robust and debt is low—something that Europe and the United States would be happy to have.
Yet, a strong currency shouldn’t be read always a ‘good’ currency. As pointed out by another Star Report, a stronger currency can make it harder for domestic industries to compete internationally—and Canada, at least according to a recent IMF report, can attribute some of the 500,000 lost manufacturing jobs to this phenomenon. The result: manufacturing-based provinces (Ontario) aren’t thrilled with Alberta’s energy reserves pumping up not only oil but the Loonie:
On Monday, the Ontario premier ruffled the feathers of his Alberta counterpart, Alison Redford, by suggesting the strong “petrodollar” had hobbled his province’s manufactured exports.
“If I had my preferences as to whether we had a rapidly growing oil and gas sector in the West or a lower dollar, I’ll tell you where I stand — with the lower dollar,” McGuinty said.
But what does this say about Canada’s currency? Well, first, the obvious: that Canada’s currency has essentially become closer to a petro-dollar (though, really, the economy—as any quick glance will show is diversified), and with energy costs increasing the currency is strong—again at near parity with the United States. But, even more attractive to Iceland, is that Canada’s GDP robust and debt is low—something that Europe and the United States would be happy to have.
Yet, a strong currency shouldn’t be read always a ‘good’ currency. As pointed out by another Star Report, a stronger currency can make it harder for domestic industries to compete internationally—and Canada, at least according to a recent IMF report, can attribute some of the 500,000 lost manufacturing jobs to this phenomenon. The result: manufacturing-based provinces (Ontario) aren’t thrilled with Alberta’s energy reserves pumping up not only oil but the Loonie:
On Monday, the Ontario premier ruffled the feathers of his Alberta counterpart, Alison Redford, by suggesting the strong “petrodollar” had hobbled his province’s manufactured exports.
“If I had my preferences as to whether we had a rapidly growing oil and gas sector in the West or a lower dollar, I’ll tell you where I stand — with the lower dollar,” McGuinty said.
His comments drew a swift attack from Redford and Saskatchewan Premier Brad Wall, but is somewhat backed by a 2008 report from the Organization for Economic Co-operation and Development that referenced the phenomenon known as “Dutch disease.”
The term was coined in 1977 by The Economist magazine to describe what happened when the Netherlands first began rapid expansion of a natural gas field in 1959. As the export of gas climbed, so did the Dutch currency, the guilder, making that country’s exports less competitive and leading to a collapse of jobs in other sectors.
…
Looking at the historical record, periods of Canadian dollar strength have been associated with some of the weakest productivity gains, while the strongest increases have come during periods of loonie weakness,” Porter said.
And Canadians haven’t gained as much in terms of lower consumer prices as conventional wisdom suggests, possibly because retailers haven’t fully passed through the benefits of cheaper imports.
Porter also notes that average inflation has been a bit higher in the past 10 years at 2.1 per cent than in the previous decade, at 1.6 per cent.
But, again, the key is balance: while some manufacturing jobs may be lost, foreign goods should be cheaper in Canada—thus spurring more income for investment of spending.
Is Iceland Really Going to Loonie-ize Itself? Six Important Questions and Icelandic Domestic Politics
But, returning to the bigger picture, there are some problems—and less economic-based reasons—with Iceland adopting the Loonie. First, Nick North of Carleton University asks six very pointed questions about the wisdom of Canada permitting Iceland to Loonie-ize:
1. Is Canada+Iceland an Optimal Currency Area? Is Canada one of Iceland's main trading partners for imports and exports? Is there high labour mobility between Canada and iceland, so that unemployed Icelanders could easily get jobs in Canada, and unemployed Canadians could easily get jobs in Iceland? Are macroeconomic shocks to Canada and Iceland highly correlated? None of these claims sound very plausible.Also, Iceland’s flirtation with the Loonie may have more to do with domestic politics than long-term thinking. Naturally, the most obvious choice for Iceland is to join the Euro. But, as the Greece situation plays out, it’s tough to imagine politicians silly that to an already currency-weary electorate. And guess what? Iceland is having elections in 2013—and selling Icelanders on the Loonie is apparently doing far better than the euro, especially for the opposition parties.
2. Who does Iceland imagine would act as lender of last resort to Icelandic banks? In 2008 Iceland's banks defaulted on their foreign currency liabilities. I am very glad that the Bank of Canada was not obliged to act as lender of last resort to Icelandic banks in 2008. Does Iceland think it can manage without a lender of last resort to its banking system? It didn't work so well in 2008.
3. The government of Iceland would presumably be issuing Loonie bonds. Given the recent experience of the Eurozone, governments borrowing in a foreign currency -- which they cannot themselves print -- does not look like a very stable arrangement. If the Eurozone has very weak fiscal relations, those between Iceland and Canada are non-existent. Would Canada be expected to play Germany to Iceland's Greece?
4. If there were a financial crisis in Iceland, is there any possibility that could spillover and affect Canada's financial markets and the exchange rate? Would the Bank of Canada be forced to act as lender of last resort to Iceland's government or banks in order to protect Canadian financial markets and the exchange rate from the fallout?
5. If Canada decided that it was not in Canada's national interest for Iceland to adopt the Loonie, is there anything Canada could actually do to prevent Iceland unilaterally adopting the Loonie?
6. (Update) One clear benefit to Canada would be the extra seigniorage revenue. Assume Iceland's GDP is 1% of Canadian GDP, the currency/GDP ratio is 5%, and the long-term nominal interest rate is 4%. The extra seigniorage from iceland adopting the Loonie would be 1% x 5% x 4% = 0.002% of Canadian GDP (somebody check my math please).
And this story is only getting play because the Canadian ambassador to Iceland, Alan Bodes, stuck himself in the middle of this Icelandic domestic political affair by stated Canada’s openness to permitting Iceland to Loonie-ize. Naturally, the currency speech Bodes had apparently planned to give was cancelled by the Canadian government.
Conclusion: No One Knows, And Some Concluding Questions
Thus, getting to the main question: its really unclear whether Iceland will adopt the Loonie or not, let alone if Canada would approve of such a move--or even if they could do anything about it.
In any case, I have two outstanding questions to the possibility of Iceland adopting the Loonie. First, what impact does this, coupled with the emerging EU-Canada free trade agreement, have on Canada’s ability to trade in Europe, especially compared to the United States? Second, can Iceland just Loonie-ize without Canada’s permission?
But, in any case, whatever the reasons or the long-term wisdom of Iceland currency flirtation, Canada should bask in the Loonie's moment in the (Icelandic) sun.
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