Friday, March 9, 2012

Canada and Iceland

Iceland wants to adopt the Canadian currency, eh? What's that aboot?

Iceland, which had to bail out its banking system in 2008, and therefore now has massive sovereign borrowings and diminished currency stability, has recently been looking to adopt a more stable currency from a strong economy, to regain its standing and respectability to the world. The big winner for most of its inhabitants, it seems, is the Canadian loonie. Iceland, which has about 300,000 population, is easily buffeted by currency headwinds, most especially after the 2008 crisis.  And since they already have 59 billion euros foreign denominated debt stemming from the crisis, adopting another foreign currency as their default currency is a problem that's probably moot to most Icelanders.

In general, by adopting the Canadian currency, Iceland imports the Canadian monetary condition (highly stable compared to other countries as of the moment). However, only the Canadian government and Canadian-chartered banks can issue this money. How will local Icelanders get hold of this money, for it to be widely-held enough to be their default currency? In all likelihood, Iceland as a whole will have to incur lots of trade and capital surpluses vis-a-vis Canada.  That's the only way the Canadian currency will make its way into Icelandic economy in large amounts. With sufficient amount circulating in their economy, it will then be the currency that Icelanders use to buy daily necessities and pay for their obligations, including borrowings, which will now be Canadian-denominated, and borrowed from Canadian banks.  Canada will begin to enjoy the exorbitant privilege the U.S. has had globally, at least with regards to Iceland. For this to work, Canadians will have to massively spend into the Icelandic economy.

I don't think this will be detrimental to Canadians monetary-wise, since as people who've read into MMT know, a monetarily sovereign nation that issues its own currency can issue as much as is necessary to clear all transactions. If it spends more than it earns vis-a-vis a foreign trading partner, what it gets are real goods and services that people will sell in exchange for their fiat currency.  There could be a glut of Icelandic products and services into the Canadian economy. Salmon? Fisheries? Aluminum? Spa tourism?

By having the same currency, it makes it easier for Iceland to do business with Canada.  It will spur Canadian business investment into Iceland, since there will be no more forex risk.  More Canadian-owned factories and shops will sweep into their economy. I can imagine Weston, Metro and Shoppers Drugmart setting up shops all over, without worries of losing on foreign exchange whenever they replenish inventory and repatriate profits. Canadian banks will race to set up the first branch in every desirable corner of Reykjavik, and their corporate parent will have stronger, wider funding base than local Icelandic banks.  Ditto for consumer investment to the Iceland economy.  If Canadians ever tire of the escalating house prices in Canada's metropolitan cities, they can instead buy a cottage overlooking Mt. Eyjafjallaj√∂kull? (I kid) And with the convenience of having the same currency, there would be more Canadian tourism to Iceland, which is 3,700 kms away.

Most importantly, people from outside of both Iceland and Canada, who would shy away from investing in Icelandic krona right now, but would gladly put money in Canadian-denominated investments, would be more open to putting money in the local Icelandic banking system, thereby helping to diminish the still-large risk of bank run similar to what happened in 2008. (However, in the event that investor aversion shifts towards Canadian-denominated assets, Iceland-based banks will suffer as much as those in Canada).

The biggest risk to Iceland adopting the loonie is the loss of currency sovereignty and monetary policy control. By adopting a foreign currency, it's putting itself in the same position Greece put itself in when it decided to adopt a currency its government does not issue. Since it will no longer be issuing its own currency, Iceland will lose its ability to enact large countercyclical programs during recessions. Whenever its government has to deficit spend, it will have to borrow in this foreign-issued currency. 

Also, the currency's value will be affected by events happening in economies much larger  than its own and in places thousand of miles away. Right now, the strong Canadian currency is buoyed by its most productive and successful province, oil-rich Alberta. Just ask the manufacturers in Ontario, or the fishing industries in the Atlantic provinces, how that's going for them. A stronger currency due to oil exports also makes their own exports more expensive. Unfortunately, unlike oil, what they do export are also sold from places with cheaper currency. But if enough economic integration happens, who's to say that there won't be further integration later on, since economic integration leads to greater need for labour mobility, to make up for the economic dislocation integration creates. Looking at history, Newfoundland adopted the loonie first before it eventually became a Canadian province. 

I don't know whether this currency adoption plan will go much further than the talk made so far. The Canadian government has discouraged its ambassador to Iceland from making the speech that was supposed to acknowledge this Icelandic plan. After all, publicly talking about another country adopting your currency seems  a bit like gloating, and Canadians think it's not polite. But in any case, should this adoption ever happen, perhaps there comes a day when Icelanders also adopt the Canadian obsession of going shopping in the US whenever the loonie gets stronger.


Mario said...

great post here Rogue. Thanks for taking on this topic.

Hey I can't seem to elect to have comments emailed to me you know how to do this by chance?

Rogue Economist said...

Thanks Mario.

By comments are you talking about receiving emails of replies to your comment? I still receive the comments by email but probably because I'm the admin. I haven't changed any comment settings. I do notice that blogger has changed styling, maybe they changed that too.

Let me know if this feature is no longer available for commenters, I can start using disqus here instead.

Mario said...

yes. emails of replies. I see no place to choose to get emails of continuing comments. perhaps make up a fake email and give it a whirl and see if you see anything.

I am having the same problem over at mikenorman's too.

What do others say? (not that I'll get notified or anything!!) LOL ;)

David said...

This proposal is theoretically feasible, on the other hand Iceland exports most of its goods to European Union so even from this point of view it makes more sense for them to adopt Euro. On the other hand, it would by nice paradox if one of (future) members of EU was using our currency.