Merrillecon.com

The Fraser Institute is a Canadian think tank that has some libertarian leanings. They most famously report the “tax freedom day,” where they calculate how many days into each year the average citizen has to work just to amass their tribute to their benevolent overlords. I was more than a little surprised when I saw this white paper that details conclusive support for a proposed American monetary union called the “Amero.” This proposed currency would be a cousin to the Euro. Over the last decade or so there have been many conspiratorial rumors that predict a surprise bank holiday that will launch the Amero into existence but as a clarification this is an academic rebuttal to this report.
The argument is framed as such: If every province in Canada or every state in America issued their own currency it would increase transaction costs, reduce trade and make contracts more difficult because of increased uncertainty. So by that logic it makes sense to have fewer currencies over a larger geographic area so “Trade among the members of the monetary union will be stimulated by the elimination of the costs of currency trading and risk. There will be greater price stability and, importantly, interest rates in Canada will fall by about one percentage point.”

Some of the alleged benefits of the Amero would include reduced foreign exchange risk, greater price stability and structure, and labor market discipline. What they mean when they say labor market discipline is tying the hands of unions because Canada is a commodity exporting country, and is sensitive to the business cycle. When the global economy is expanding, the commodities exporters reap high profits. The unions use these profitable times as a bargaining chip to arrange preferable treatment to the unionized labor in name of “sharing the wealth.” But the good times aren’t unending, and when the economy crashes the higher labor costs price them above the competition. This leads to a situation where the Canadian economy tracks the global economy downwards, but fails to get the full upside expansion. The claim is that the benefits outweigh the costs and justify the erosion of sovereignty. Besides, we have already engaged ourselves in multinational free trade agreements, the UN, WHO, WTO and so on; so what is a little more?
MY REBUTTAL:

I wonder if the author still supports this position given the state of the European monetary union? The author did actually say he preferred a gold standard but that it was not politically feasible and that the Amero is the next best thing. “The best chance for returning to a gold or commodity standard will be a really major inflation and economic down-turn caused by politicized monetary policy.” Well, in less than a decade after these words were published the events started to unfold in what may lead to a new monetary arrangement. So instead of only addressing his lack of support for a gold standard, I will also show why a multinational monetary union is ultimately self destructive. Some of my arguments he may have already given a nod to in the paper, but made the conclusion that the benefits were worth the risks.

Problem 1) Deposit Insurance

Deposit insurance creates enough problems in a national banking system. It creates the moral hazard of the bankers to make progressively risky investments to attract higher returns and more deposits. They know that if they fail catastrophically that the depositors will still get their money, the institution will be unwound and sold off over time and any losses will be socialized. The solution to this is either heavy regulation to limit the kind of investments that banks can make and the amount of capital reserves, or totally deregulate so that depositors, investors and bankers are more prudent.
Now imagine an environment where banks within a monetary union compete, and these banks may be subject to different regional regulations while holding assets such as mortgages or sovereign debt of their resident nation. The solvency of the entire banking and monetary union could be politicized by the public policies of the participating countries. America heavily subsidizes housing through many programs ranging from homeowner’s interest deductions, Fannie/Freddie, and FHA low income assistance. If policies were to be the driving force of property appreciation disproportionately in America, then American banks would have an unfair amount of new assets of which to bid for new bank notes issued by the central bank. This would either lead to inflation or curtailment of credit available to Canada and Mexico. So the incentives exist to skew policy in a way to distort the system to favor growth in their own country at the cost of the other members, at the same time the insolvency of the banking system created by the irresponsible country would be shared by all.

Problem 2) Sovereign Debt Crises

The mechanics of the impact of sovereign debt crises are similar to that of deposit insurance, but only more predictable. The added twist is that as governments flood the markets with debt, the interest rates necessarily rise. The rising interest rates spill over to other debt securities and markets.
As corporations and homeowners compete for credit they will also pay higher debt servicing costs and the economy suffers. This undermines the monetary policy of the central bank because the mandate is stable prices. Unlike the Federal Reserve which lends money into existence by purchasing US Treasury securities, the European Central Bank issues notes at auction to competing banks via repurchase agreements. The term is usually short, 2-8 weeks or so. The banks then use these reserves to make loans. To bid at the auction banks have to put up collateral such as mortgage debt or sovereign debt. If interest rates start spiraling higher because of governments, then the central bank has to issue new notes to suppress the interest rates and this is inflationary. As an unprecedented response to the recent crises in Europe the ECB has purchased sovereign debt of the PIIGS countries.

Problem 3) Price Stability

The ECB has a sole mandate of price stability. The Federal Reserve has price stability, full employment, consumer protection, and now systemic risk watchdog. So it seems conceivable that an ECB style union may be better for a stable currency. The problem though is that because of the problems I detailed of deposit insurance and sovereign debt, money creation and credit issuance is not uniform throughout the union and prices rise and fall at quite different rates throughout the union. Currently the Euro nations range from 1.5% inflation (Ireland) to 8.4% (Romania). Dealing with the aggregates, they are forced to adopt a one size fits all policy. Just a side note, Sarkozy from France has been critical of the ECB for not adopting full employment as a mandate as a reaction to the crisis. It is always possible that sound monetary policy bends to political pressure.

The solution: A Gold Standard

Why is it that economists universally agree that competition and markets bring about the best products except when it comes to money and interest rates? Nothing brings price stability and depoliticizes money like a gold standard. A gold standard absent a central bank allows interest rates to reflect true savings and time preferences and would minimize business cycles. Under the gold standard from the end of the US civil war until the creation of the Federal Reserve, we had the most stable prices and strongest growth in our history. Prices of goods fell by one half over this period of 50 years or so. Can you think of anything that is cheaper now than 50 years ago? People could keep their savings in the bank, and even if it earned no interest they were still earning a higher real rate of return then we do today. Major corporations were issuing bonds with 100 year maturities! The markets had faith that prices would be stable for the next century. The decision to return to a gold standard could be done unilaterally. We wouldn’t need some Bretton Woods type agreement to return to sound money. If we returned to a gold standard and fixed the value of the dollar to the current market rate of gold and allowed banks to issue notes redeemable in gold, the value of the dollar would still fluctuate against other floating currencies. Businesses who transact abroad currently keep cash abroad for reasons of taxation and waiting for a more favorable exchange rate (a depreciating dollar). If only the dollar were on the gold standard, businesses would have the incentive to repatriate their profits from abroad quickly because the value of the fiat currencies would be constantly depreciating against the dollar. This would solve the problem of “labor discipline” the author discussed. Profits of businesses operating under a gold money would not be subject to unit of account distortions and not have to share the “wealth” created under a monetary expansion period. Stable money supply trumps cyclical labor contracts.
Lastly, I see a huge difference between NAFTA and the Amero. An agreement to reduce the protectionist barriers amongst neighboring countries, and an agreement to create a new supra-sovereign currency is not the same thing. Constitutions would have to be amended.

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