Published in The Gazette, May 28, 2003
State Should Stop Trying to Set Value of Dollar
The Canadian dollar, which has been under 65 cents U.S. for the past two years, was hovering around 73 to 74 cents last week. Importers were complaining to the government when the currency was "too low"; exporters are now complaining that it is "too high" and asking for the Bank of Canada to lower interest rates. This would cause a net outflow of investment from Canada, and push the dollar down.
Many would-be philosopher-kings have given normative rulings on the Canadian dollar. But if the dollar is always too low or too high for somebody, perhaps it is time to think outside the box.
One can make a good case that the Bank of Canada should intervene to influence the value of the currency. One only has to assume that all Canadians have the same preferences and the same circumstances (so that nobody is more favoured by a falling than by a rising dollar), that the Bank of Canada can fix the interest rate and that the state can efficiently fine-tune the large system of simultaneous equations that the economy is. Then, the question of what the Bank of Canada should do with interest rates is meaningful and pressing.
But the picture is completely different if we drop these unrealistic assumptions and return to the basics and the real world. The Canadian dollar is nothing but a claim on what people who use Canadian dollars as their regular currency have produced or will produce. If you hold one dollar, it gives you a claim on one dollar of actual or future Canadian production. The Canadian dollar thus represents the estimated productivity and credit worthiness of people living in Canada. There are serious doubts as to whether any person, whether central planner or philosopher-king, can forecast what Canadian production will be worth in one week, one year or 10 years. The evaluation of financial markets is much more reliable.
But doesn't the value of the dollar determine Canadian competitiveness? No, because the causality goes the other way around. The more competitive Canadian producers are, the higher is the value of their production, and the higher the price of their currency. Making the Canadian economy more competitive by pushing down the Canadian dollar is absurd: It amounts to hiding the consequences of competitiveness under the name of competitiveness.
Monetary policy can build economic Potemkin villages; it cannot change the nature of the economic world. The central bank can certainly influence short-term interest rates by manipulating the amount of cash in the economy. But there are serious doubts that monetary policy can modify long-term real interest rates, which express the relative preferences of individuals for the present and the future. Monetary policy only creates short-term imbalances and fluctuations -- if not long-term problems.
There is no way to determine from the top whether high interest and exchange rates are better or worse than low interest and low currency. And any Canadian is free to hold assets and transact business in U.S. dollars if the benefits are greater than the costs. Although banknotes issued by the Bank of Canada are legal tender under the Currency Act, nothing legally forbids contractual parties in Canada from agreeing on any other means of payment, including foreign currencies. The greenback would become the major currency in Canada if a majority of Canadians decided to conduct their transactions in that currency. In other words, the reason why there is now a flexible exchange rate between the Canadian and the U.S. dollars, i.e., why two different currencies exist, is because market participants want it that way.
Moreover, how can anybody in his right mind believe that an organization (the state) that, say, has more hidden liabilities than Enron did, that tries to control crime by registering gun owners, or that spends $200 million a year on the anti-smoking jihad while real epidemics run rampant - how can anybody believe that such an organization suddenly becomes efficient when it meddles with global interest rates and foreign exchange rates? After three centuries of economic and political analysis, we should know that the state can fix interest or exchange rates only in an artificial and conflictual manner, by coercively favouring certain clienteles at the expense of others.