Iceland Considers Dollarization (Canadian $ That Is)

♠ Posted by Emmanuel in , at 3/14/2012 11:21:00 AM

More so in years long past, many countries used to adopt the US dollar as their own to assume the benefits conferred by the world's standard currency. Among other things, these included liquidity, price stability and being a reasonable store of value. While an independent monetary policy was forsaken--or at least "outsourced" to the Fed--many smaller economies came to the conclusion that adopting the US dollar outweighed the benefits. In recent years, of course, the dollar's uncertain status has begun to erode its advantages and hence the lure of dollarization.

For some time now, the small, open economy of Iceland has been looking to replace its krona with something less volatile in the wake of its financial crisis that eventually ended in tears via an IMF bailout. How do you quell the "violence of the market"? Being a small, open economy renders one's own currency more subject to the changing winds. As a European nation, Iceland naturally thought of joining the EU and particularly the EMU to solve this issue, but lately it's had second thoughts given the variegated PIGS implosions. That is, if many of those countries have gone to the IMF poorhouse anyway, what's the advantage for Iceland? In reality, the conditionalities applied there were less harsh than those in Greece or Portugal, allowing for populist measures to pass:
Not only are Icelanders taking note of the increasingly frantic efforts of politicians in countries hundreds of kilometres away to save the euro, they are finding that their own financial circumstances constitute less of an emergency. The conditions attached to their bailout by the IMF seem comparatively lenient.

The new government of 2009 was allowed to carry on borrowing and spending for another year before the cuts kicked in. In the meantime, devaluation - something impossible for eurozone members - meant all-important exports suddenly became competitive again. Unemployment is already falling. Many people's mortgages were quietly "re-negotiated" by the newly nationalised banks.

The richest 5-7% of the population have been subjected to a new wealth tax. The welfare state and the health service were shielded from the biggest savings and public sector workers have recently been awarded an above-inflation wage rise. Opinion polls suggest a clear majority of Icelanders now oppose joining the EU and the finance minister, overseeing all these changes, is among them. 
Now there is talk of adopting dollars instead of euros. But, the interesting this is that they're talking about Canadian dollars here. I've often thought of Canadians as the more civilized North Americans, on a far sounder economic footing than their restless, warmongering neighbours. These folks actually understand that deficits do matter. There are excellent reasons why the loonie (Canadian dollar) has strengthened so much against the play money used by those free lunch lovers across the border. You needn't wonder who's still got a triple-A debt rating, either.
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Accordingly, the Globe and Mail brings us five reasons for the improbable adoption of the loonie by Iceland. As it turns out, some Canadians are pushing for it with gusto:

1. Seigniorage: “Printing money is a good thing for Canada,” [economist Justin] Wolfers said. “Every dollar in circulation is on the debit side of the central bank’s balance sheet, and they’re effectively borrowing from the Icelanders at a zero-per-cent interest rate.” So if there are no strings attached, why not? Or, as Mr. Wolfers put it, referring to Iceland, “as long as you’re a bastard, it’s all profit.”

2. A stable currency: Iceland could of course benefit from a devalued currency. Instead it would get a strong, stable currency that has been something of a haven during this post-crisis period of uncertainty. While strong, exporters at least know what to expect. Consider, too, that the Canadian dollar is liquid. The krona was "blasted through smithereens and very few banks can trade [it] in anything else than very small amounts..."

3. Respected central bank: Iceland would of course have no say in monetary policy, but it would have a currency overseen by a very strong central bank and governor, who led Canada out of the recession admirably. Mark Carney is also respected on the global stage, having recently been named to head up the Financial Stability Board.

4. Fiscal, economic stability: Iceland has no reputation in the wake of its banking collapse. Who would you prefer at that point, a euro zone crippled by recession and a two-year-old debt crisis, or Canada? With Canada, you get a stable, if lukewarm, economic outlook, a government that’s still rated triple-A, and a fiscal standing to die for (if you’re Greece or Portugal). And, we can count.

5. Our glowing hearts For Iceland, do not underestimate friendship in this post-crisis era of currency manipulation and mounting trade tensions. We’re a wonderful people, they’re a wonderful people. We’ve got a beautiful country, they’ve got a beautiful country. True, it gets cold in Canada in the winter, but remember we’re talking about Iceland. And surely we can forgive them for Bj√∂rk.
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It's a fairly off-the-wall thing to do to adopt the Canadian dollar, but hey, the economic rationale seems to be straightforward once you get over the initial shock of the idea.