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May 19, 2001

U.S. Dollar could lift our economy 37%
Abandoning loonie would triple trade, raise incomes, American analysis suggests

Justine Hunter
National Post

OTTAWA - Canada's economy could grow by as much as 37% if it abandoned the loonie and adopted the U.S. dollar, a new report by two leading U.S. economists has found.

The startling results, drawn from an evaluation of bilateral trade between nations that share a common currency, is stirring the debate over the current flexible exchange rate regime that has seen steady declines for the Canadian dollar over the last decade.

"By raising overall trade, currency unions also raise income," concludes the study by international finance experts Jeffrey Frankel and Andrew Rose.

Their research, which estimates the effects of dollarization on 89 countries, found only a handful of countries topped Canada in potential benefits of adopting a currency union with the United States.

Based on an analysis of trade among 186 countries, the study found belonging to a currency union more than triples trade with the other members of the zone. And for every 1% increase in trade as a portion of the economy, per capita income climbs by at least one third of 1% over 20 years.

Mr. Rose says that although the figures seem improbably high, the model devised for the study has so far proved unbreakable. He has posted the methodology and the model on the Internet to invite critics to try it themselves.

"They seem far too large to be plausible, I'm the first one to say that. I've worked extremely hard to reduce them, and the amazing thing is, it is virtually impossible," he said in a telephone interview.

"I would be more comfortable if the results were weaker."

Mr. Rose, who holds both Canadian and U.S. citizenship, said the United States would benefit to a smaller degree from a currency union with Canada, but the results for Canada are too dramatic to ignore.

"We estimate having the Canadian dollar acts as a serious barrier to trade."

Many defenders of the floating currency, including Paul Martin, the Minister of Finance, argue that a floating dollar helps cushion a country's economy, making its exports more attractive when the value of the currency declines during economic downturns.

And although the Bank of Canada also rejects a currency union, David Dodge, the new governor of the Bank of Canada, said this month it could make sense if the two economies continue to become more similar.

"In a decade or so, it may well be clear that the Canadian and U.S. economic structures have converged sufficiently that there is little advantage to preserving the floating rate," he told Parliament's finance committee. "If so, we would have to give very serious thought to dollarization."

David Laidler, an economics professor at the University of Western Ontario, dismissed the Frankel-Rose findings.

"I don't believe these numbers," he said. "But it's a very interesting paper. No question the work they are doing is the kind of thing that is going to generate more research. It's controversial, it's a new tack, so for academics it's very nice. But I think they are being, to put it mildly, premature."

Mr. Rose is a professor of international trade at the University of California at Berkeley. Mr. Frankel is a professor at Harvard University's Kennedy School of Government and a former economic advisor to the White House during Bill Clinton's presidency.

Mr. Rose agreed the results should not change Canada's policy overnight. He is in France studying the impact of the Euro on trade in the European economic union and said that will prove to be the most significant test of the model over the next five years or more.

Don Drummond, TD Bank's chief economist, said yesterday a Canada-U.S. currency merger in the near future would not make sense.

"Even if Mexico came in, the U.S. would be 80% of that economic sphere. Can you ever see the U.S. federal reserve board saying, 'we better raise interest rates because the Canadian economy is quite hot even though the American economy is not'? I can't."

He added: "There is a little practical problem with dollarization that everyone seems to overlook: at what rate do you exchange the Canadian dollar for the American dollar? If you exchange them at the current rate, you forever and a day lock in the standard of living loss we've got with a 65 dollar."

But Simon Fraser University economist Herbert Grubel, a long-time proponent of North American-wide monetary union, said: "These figures are possible."

The debate, he said, has already been won on the merits, but he said the initiative will not come from the Bank of Canada or the federal government because of the political sensitivities.

Mr. Rose acknowledges there are costs associated with a currency merger that might make it unpalatable for Canada, despite the promise of economic growth.

"I would assume that any move toward dollarization would make the most sense from an economic and social perspective if they were accompanied by a strengthening of the social safety net in Canada," he said.

John McCallum, a Liberal MP and economist whose research is cited in the Rose-Frankel study, expressed doubt about the methodology because there are no pairs of large countries with any significant history of currency union to measure. "I'm agnostic. I don't think the experience of these tiny little countries proves anything for Canada," he said.

"The real evidence is going to come from the experiment with the Euro. If they are right, we should see a tripling of trade between France and Germany and Italy -- that would say something."

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