Monday, September 3, 2012

National Post makes hasty generalization from EZ to QC separatism

QC separatism is an interesting hypothesis in monetary economics.  David Frum makes some valid points about its consequences while staying within a CAD union, given the hindsight of EZ’s failure (National Post). But he overplays it by tying the fates of failing countries in the EZ to that of QC under that option. Having its own currency, OTOH, is presented as yet another calamity. Neither of these doom predictions are fatalities because QC  starts from a reasonably good standing  and its options are open.

The Euro was sold on the idea that flexible exchange rates hamper trade and investment from non domestic sources. Unfortunately, this is but a facet of the whole picture. The failure of the EZ was largely anticipated in academic circles with one ironic exception, OCA inventor himself, R. Mundell (DebtDefl). That’s because there is neither labor mobility nor a federal budget, each of which operate as stabilizers across regions in case there is a recession. It is powerful ideologues like Trichet that have led the forced march to an unsustainable currency union.

Labor mobility exists in Canada. Natives of QC are found working on the oil fields of AB. But that isn’t the major criticism of the article. The big difference with the EZ situation, or AG for that matter, is that QC does not start from a situation as a member of a failed currency union for lack of a federal state. Initial conditions matters.

New currency

AG devalued and defaulted in 2001—it’s last option, after obstinately suffering 10 years of wrongful medicine administered by the IMF, including maintaining a peg to the dollar against all odds. Hence the magnitude of the devaluation, painful in terms of importing purchasing power, but successful in bringing the country back on a path to recovery.

QC hasn’t been trying to maintain a peg against all odds in the past 10 years, so, if it were to enact its own currency, why should it go down the path of AG with an extreme devaluation, as National Post claims? It shouldn’t. Much would depend on the type and credibility of the mandate of the central bank QC sets up and even if a devaluation follows it wouldn’t be as dramatic as that of AG. And with its double digit unemployment it may well be a blessing.

Market solutions—currency hedging, can replicate the benefits of a currency union. Governments can thereby raise money in the foreign currency to attract non-domestic investors, and corporations do business in a foreign currency. Its cost—the insurance premium—is known in advance which is a plus since the objective is to reduce uncertainty.

CAD union

Let's assume QC separatists see greater benefits to maintaining a CAD union than suggested by the EZ experiment.  De-federalization (budget wise) can be gradual to ease the transition. CA would not want a problem on its doorstep, so it’s a concession that is likely to be granted.

At the end of the transition, however, no more checks from Ottawa when the recession hits harder than in other provinces (and therefore no strings attached, and also no more checks the other way either). Then, while still in a CAD union, QC would need a flexible mechanism to keep its competitiveness, unlike GR, ES etc. who have to rely on painful and slow ‘internal devaluation’.

One approach is Hans Wener Sinn’s opt-in opt-out policy (see below). The other approach is to have its own currency (no opt-in), but whose peg to CAD would be revisable to avoid the type of situation seen in AG in the 1990s. An experiment that proves the feasibility of such halfway approaches is ERM  II, to which Euro applicants are bound.


EZ is a worst case scenario that was accurately anticipated by those who stood outside the circle of decision makers. The latter, including Socialists Delors and Lamy, have been sold to neoliberal ideology in the past 20 years  (LExpress). The conventional wisdom was that bond markets would discipline countries, and that would take care of imbalances (see below on Trichet). Is beating Ottawa in a neoliberal contest the the driving force behind QC separatism? One would have to believe that to agree with the conclusion of David Frum’s article.

The lesson of EZ is that the laws of economic shouldn’t be an afterthought, whether to form a union or to secede from it. If peripheral countries exit the Euro we will know if the worse case scenario situation can be turned around. That may very well fuel the inspiration of other states in the EZ or populations a world apart that aspire to have their own state.

Also see:
  • Opt in opt out, by Hans Werner Sinn (FT)
  • Trichet vs Greenspan, a tie? (ECB-Watch)

1 comment:

  1. VoxEU - Mar 9, 2013 - European imbalances - By H-W Sinn and Akos Valentinyi.


    H-W Sinn sees opt-out as 'ruled out' and explores internal devaluation.