The Argument | The Counter-Argument | Notes

The Argument

May 1
The Bank of Canada released its semi-annual Monetary Policy Report. Bank of Canada Governor David Dodge appeared before the House of Commons Standing Committee on Finance. These events gave rise to run-of-the-mill news stories the next day with titles like “Bank of Canada trims growth estimate.”

May 3
Under the headline “ Rift opens over dollar’s future: Central banker speculates openly on eventual union with U.S. currency,” the National Post highlighted a story that Alan Toulin whipped up from a few words uttered by David Dodge.

Those key words were:

Now, it may well be in a decade or two decades or three decades, the structure of our economies will look much more similar, and in that case the advantages of a floating currency from a strictly economic point of view go down and the costs remain – and there are costs of having a separate currency.

The implication of the headline was that a rift had developed between Dodge and Minister of Finance Paul Martin. Other reporters jumped on the story. In the House of Commons, Canadian Alliance Leader Stockwell Day led off a round of questions about the governor’s remarks. Martin was obliged to deny the existence of such a rift and hence the next day’s headlines featured the likes of “Martin says he and Dodge agree dollar should stay” in the Post and “Martin deflects loonie uproar” in The Toronto Star.

The spin put on Dodge’s words by reporter Alan Toulin on May 3 was that: “The governor of the Bank of Canada says the Canadian dollar could disappear within a generation as the economies of North America become more integrated.” Alliance leader Day argued that “it seems strange” that Dodge “is publicly musing about the possible death of the Canadian dollar in as early as 10 years” (Les Whittington, “Martin deflects loonie uproar,” The Toronto Star) and even asserted that Dodge was floating a trial balloon for the government (Toulin, “Martin says he and Dodge agree dollar should stay,” National Post).

The Counter-Argument

All Bank of Canada Governor David Dodge claimed was that:

  • there are economic benefits and costs and political benefits to having a floating currency,

  • as two economies become fully integrated, the economic benefits or advantages of the floating exchange rate diminish, and

  • the economies of Canada and the United States may become increasingly integrated in coming decades.

It would be hard to find an economist who would disagree with any of these claims. And they do not amount to a positive prediction – they constitute a normative, analytical framework for judging the issue of the optimal exchange rate regime for Canada.

It seems unlikely the remarks represent a change in thinking at the Bank of Canada. In the opening statement by Dodge to the Finance Committee, the main statement on exchange rates was that: “a flexible exchange rate allows our economy to adjust to disturbances, such as changes in foreign demand for our products or changes in the relative prices of our exports compared with our imports. And it helps us to adjust with less overall fluctuation in output and employment than if the exchange rate did not move.” The Monetary Policy Report itself says little or nothing about exchange rates.

It seems even more unlikely that, as Day asserted, the Governor was floating a trial balloon for the government. Less than a month earlier the Post reported on an internal Department of Finance report stating that: “Dollarization is unacceptable to us. It would mean zero influence over monetary policy, zero democratic accountability and zero capacity to deal with crises.” (Alan Toulin, “Dollar dip ‘deviation,’ says report,” National Post.)

That said, a governor of a central bank should have enough sense to not to use words that were so easily twisted by the National Post and the Canadian Alliance. So there was a basis for the finance minister to urge the bank governor to watch his tongue, as suggested by NDP finance critic Lorne Nystrom, who asked Martin: “If the minister really believes in the future of the Canadian dollar, will he take David Dodge out to the woodshed and nip this in the bud now?”

A potentially more serious problem is that Dodge’s remarks were possibly triggered by an analysis of the Canadian dollar published the previous week by the TD Bank. As the May 3 Post story noted: “Mr. Dodge’s comments echoed those by TD Bank economists. In a recent report, the bank’s economists said that, in as little as ten years, the Canadian and U.S. economies could become so integrated that Canada may have to seriously consider adopting the U.S. dollar as its currency.

What the Post story didn’t mention is that the TD Bank’s chief economist is Don Drummond, associate deputy minister in the Department of Finance until about June 2000, and a long-standing junior colleague and advisor to David Dodge when he was deputy minister at finance.

Drummond is no longer a civil servant, but a representative of the interests of the banking sector, especially TD Bank. If he is still exerting an intellectual influence on Dodge (and Martin), it is hard to imagine his influence is in the public interest.

According to the Post, in analyzing the determinants of the value of the Canadian dollar, Department of Finance economists mention “fundamentals such as world commodity prices, the difference in inflation rates between Canada and the United States, and interest rates.”

But Drummond, seeking to curry favour on Bay Street, adds to these factors a laundry list of items dear to the business lobby, without producing evidence that tax cuts and lower government debt would have any measurable impact on the dollar. (Don Drummond, “How to boost the dollar,” National Post, April 26 2001.

The next week, we have not only the Bank of Canada governor seeming to repeat Drummond’s musings about the future of the Canadian dollar, we have the federal finance minister seeming to repeat Drummond’s questionable claims about exchange rate determination. According to the Post, “Mr. Martin said his economic policies of tax cuts and debt reduction support the dollar.”

This article is originally produced by Brian MacLean as Canada’s Economy in the Newspapers, which is available as an e-mail newsweekly (ISSN 1492-2274). Visit his Web page for archives, updates, and corrections.

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  • The initial Post story on Bank of Canada Governor David Dodge and the Monetary Policy Report is “Bank of Canada trims growth estimate; Monetary policy report: Solid economic expansion forecast for early 2002.

  • In his opening statement to the Finance Committee, Dodge declared:

    When my predecessor appeared before you in May 2000, our economy was growing vigorously, bolstered by strong domestic and U.S. demand. Indeed, with signs of emerging capacity pressures, and with the need to sustain non-inflationary economic growth in Canada, the Bank raised interest rates the day after our appearance before this Committee. These higher interest rates led to some cooling off in domestic demand in Canada. What we, and most other analysts, did not anticipate was the abrupt slowing in U.S. economic growth. This is the factor that has contributed to a greater-than-expected moderation in economic activity in Canada.

    But the U.S. slowdown was not all that surprising. The possibility was raised in a piece I wrote in March:

    Paul Martin is most unlikely to be undermined by interest rate hikes as reckless as those implemented by Mr. Crow, the Evel Kneivel of monetary policy. But smaller interest rate hikes could still produce a recession in Canada, particularly if U.S. growth drops off.

    There were clear signs a year ago that the Canadian economy was slowing, but the Bank of Canada chose to ignore them. As noted in my newsletter at the time, when then-Bank of Canada Governor Gordon Thiessen appeared before the House of Commons Finance Committee on May 16 2000, the NDP’s Finance Critic Lorne Nystrom tried to discourage him from an interest rate hike by citing statistics as follows:

    I’ll give you a few numbers and see how you respond to these. Statistics Canada has said very recently, for example, that economic growth might not be quite as robust as we previously expected. For example, the gross domestic in product in February fell for the first time in quite some time by 0.4per cent. The other interesting thing is that the unemployment rate in this country now has remained at 6.8per cent for the fifth consecutive month, unfortunately. In April, the help wanted index decreased 2.3per cent, the first monthly decrease since March 1996 which is also another interesting statistic. Also on May 8 of this year it was announced that department store sales fell for the second consecutive month to $1.48 billion. So we have a number of indications here showing that there might be a little bit of a slowdown in terms of the growth of the economy. Can you give us an idea what impact those numbers might have in terms of possible rate increases in this country regardless of what might happen in the United States?

  • Lorne Nystrom has spoken out for some time now against plans for a common currency between the United States and Canada.

  • The full TD study on the Canadian dollar is called “The Penny Drops.” Toronto Star columnist David Crane summarized the weakness of the study nicely:

    But this effort to compile a list of possible causes is a bit like the old high school exam question where you would be asked to list the causes of, say, the American Revolution, or the War of 1812. You could come up with lists, but clearly some causes are more important than others, and the same must be true for the reasons the TD economists give for what’s happened to our dollar. But there’s no attempt to weigh the significance of different possible causes to show which are more important.