chapter for Colin Crouch, ed., After the Euro: Shaping Institutions for Governance in the Wake of European Monetary Union (Oxford: Oxford University Press, 1999)

Stephen Clarkson

The Joy of Flux:

What Europe May Learn from North America's Preference for National Currency Sovereignty(1)

Whatever Europe has learned from America over the centuries when the "new" world has stood as a beacon to the old, it seems hardly conceivable that its great experiment in monetary union has classes to take from across the Atlantic Ocean on currency policy. Indeed Charles Goodhart, the respected scholar of currency union, has stated that "the combination of a single market and floating exchange rates is untenable"(Goodhart 1995: 478) implying that it is the North American Free Trade Agreement that has lessons to ingest form Europe, not the reverse.

Few doubt the overall benefits of a single market within the EC, but there is reason to doubt that a single market with no exchange controls, and with free movement of factors, will be compatible with the ability of its constituent members to vary exchange rates autonomously and sharply.(Goodhart 1995: 478) In short Goodhart believes North America's three members will not long be able to enjoy the luxury of separate national currencies if they want to secure their continental market.

We thus start our reflection with a paradox. The members of NAFTA arguably comprise a more integrated economy than that of the European Union -- whether integration is measured by the hard indicators of capital and even trade flows(2) or by the softer measures of corporate struct (Blank 1995: 5-72) and cultural homogeneity.(3) Nevertheless, despite the historic steps taken in the past decade to harmonize trade and investment policy through economic integration agreements painfully negotiated first between Canada and the United States and then with Mexico, these partners show no sign of taking Goodhart's admonition seriously. No serious consideration has been given to the introduction of a North American Monetary Union (NAMU) with a continental bank that might in some way parallel the European Monetary Union (EMU) and the European Central Bank. Exploring this paradox should not just shed light on the specific features of North American integration but also bring into sharper relief some of its implications for the institutionalization of the EMU.

As a subject for analysis, currency union appears to belong squarely in the domain of economics, but as this conference's title suggests, politics cannot long be kept out of the discussion. Economists may have framed the debate in the academic literature, but it is politicians who have to take the legislative steps necessary for bringing the scholars' abstractions to concrete fruition. And, if the monetary union project comes to grief, it is in the political domain that the pigeons will come home to roost. Accordingly, we will first look at the somewhat arcane debate in the economics literature about currency policy options in North America before considering the more political arguments based on national interest. This will let us examine the relevance of the one continent's experience for the institutional deficits likely to result from monetary union in the other.

I The View from Economics

As the first non-conforming member of the Bretton Woods club -- Canada let its dollar float as early as 1950(4) as can be seen in Figure 1 -- it is not surprising that orthodox Canadian economists developed some

insert Figure 1: Canadian Real Exchange Rate in terms of US Dollars (1950-1998)

Source: Bank of Canada

comparative advantage in debating the merits of a floating versus a fixed exchange rate. There are five principal arguments in favour of fixing (and so against floating) the Canadian exchange rate -- and joining a North American currency union would simply be an extreme version of such pegging.

Fixer 1. Fluctuations of the exchange rate have had damaging economic effects in Canada.

Fx 2. Price stability would result from pegging a weaker Canadian to a stronger and more stable American coinage.

Fx 3. Adopting the American dollar would generate huge savings in debt servicing due to the lower interest rates that Canadian governments would have to pay.

Fx 4. Sheltering Canada's currency from speculative attacks provoked by intemperate mood changes among callow bond traders would reduce uncertainty for entrepreneurs and so increase both trade and investment flows.

Fx 5. Exporters, importers, and tourists would save the transaction costs involved in having to change from one currency to the other -- a significant factor in an economy whose bilateral trade with the United States runs at $1 billion per day.(5)

Each of these arguments put forward by the faction we will call the Fixers in favour of a pegged currency or a currency union has been challenged by the school we might name the Floaters. To wit::

Fl(oater) 1. Evidence that currency fluctuations have been damaging to the Canadian economy is inadequate.(6)

Fl 2. The price stability argument is not so much conjectural as conjunctural: recently Canada has achieved lower inflation rates than the US so that linking up with the Fed at this historical moment would entail taking on higher inflation rates.(7) See Figure 2.

insert Figure 2: Canadian and American Inflation Rates as Reflected in the Consumer Price Index (1950-1998)

Source: Bank of Canada

Fl 3. By the same logic Canada, with its lower short-term interest rates, would currently suffer higher, not lower debt-servicing costs by adjusting to American levels.(8) See Figure 3 and 4.

insert Figure 3: Canadian and American Short-term Interest Rates (1950-1998)

Source: Bank of Canada

insert Figure 4: Canadian and American Long-term Interest Rates (1950-1998)

Source: Bank of Canada

Fl 4. Historically, speculative pressures were a greater concern for Canada under the Bretton Woods system of fixed but adjustable exchange rates. Nowadays bracing oneself against possible speculative attack is more of a problem for a badly than a well managed economy, though policy makers' awareness of their vulnerability to global capital markets' capricious moods seems to have mitigated the problem considerably.(9) The prospect of currency meltdown is more pressing for economies emerging from state planning systems or hyperinflation than for relatively normal systems.

Fl 5. Transaction costs cannot be argued away but they can be put in perspective. The question becomes whether eliminating these charges is worth the costs involved in giving up currency flexibility.

It is in praise of this flexibility that the Floaters' logic is more compelling, particularly when their analysis focuses on how best to respond to shocks.

Fl 6. Economies are subject to major unanticipated disturbances that are either economic or political in nature, and that originate both from either inside or from outside the system. They can, for instance, be victims of supply shocks in which the availability of a needed commodity can be blocked by political cataclysm (civil war) or natural disaster (flood or drought), or its price can fluctuate widely as did that of petroleum in the OPEC crises of 1973 and 1979. Demand shocks can be equally disruptive, particularly for a resource exporting country like Canada. As foreign markets pass up and down the curve of the business cycle their import needs oscillate, causing shocks to the staple-exporting economy. The gyration in world prices for individual commodities produced by changing demand for, say, wheat can spell boom or bust for monocultural regional economies such as the Canadian prairie provinces which are heavily dependent on the export of a few staples. The jagged curve of Canada's terms of trade reflects these commodity price fluctuations.(10) See Figure 5. According to the Floaters, a flexible

insert Figure 5: Canadian Terms of Trade as Expressed by the Commodity Price Index (1950-1998)

Source: Bank of Canada's commodity price index (in US $) divided by the US GDP deflator

exchange rate remains an important device for governments trying to cope with shocks, whether generated internally or externally.(Lafrance and Van Norden 1994: 58) This currency elasticity affords a degree of policy independence which is not worth sacrificing in order to gain the relatively minor advantages offered by pegging.

Enlarging the field of vision from Canada alone to Canada and the United States, Floaters have little trouble showing that the North America defined by these two economies does not match their strict criteria for what should constitute an optimal currency zone.(11) Shocks in the US economy are distinct from shocks in Canada. Being a net importer rather than an exporter of resources is but one index of the US economy's different industrial structure, and helps to explain why it responds differently from the Canadian economy to the same external shocks. And if economic regions react asymmetrically to such disturbances they, by definition, do not form an optimal zone for the purposes of forming a currency union.(Lafrance and van Norden 1994: 52) For the area comprised by Canada plus the United States we come, in short, to another paradox. The Canadian economists who have been the most powerful advocates of economic integration between the two countries have all defended the notion of a floating Canadian dollar in the name of national, macro-economic autonomy, despite Canada itself not constituting an optimal currency zone -- Harry Johnson (1970), Harry Eastman (1971), Ronald Wonnacott (1987), David Laidler (1990) Richard Lipsey (1992), and Douglas Purvis (1992) .

Fl 7. The Floaters' argument about shock therapy goes further. A government's loss of exchange-rate flexibility following incorporaon in a currency union raises the question of what alternative policy tools are available for helping an economy adjust to major disturbances. With its central bank neutralized as the prime economic shock absorber, the country's treasury has to bear an increased load. This imposes a greater strain on fiscal policy which, has, in any case, become a counter-productive tool of macro-economic adjustment as capital becomes increasingly footloose. Imperfect or not, a currency union member's capacity to alter tax rates and levels of public spending becomes its last resort when facing substantial economic disruptions.

Fl 8. Beyond the policy argument in favour of flexibility, there is the practical consideration of what price would have to be paid to join a currency union. The immediate cost to the smaller economy in joining the larger currency zone is presumed by Floaters to be substantial since the former would have no choice but to accept the high conversion rate for pegging its currency that would be dictated by the latter. Italy's experience in gaining re-entry into the Exchange Rate Mechanism in 1996 reminds us that the demandeur typically has a weak bargaining position. Benefits from membership in the currency union may be expected in the long term, but, in the short run, the cost would be experienced in reduced export competitiveness and deflationary pressure. Bonn's decision to give the East German Mark parity with the Deutsche Mark clearly hurt the economic prospects of the eastern Länder.

Not surprisingly, these Floaters' arguments encounter refutation from our Fixers.

Fixer 6. In as regionally and sectorally heterogeneous an economy as Canada's, the utility of currency flexibility as a shock absorber can be questioned. Where the country's staples-producing region may suffer from a fall in commodity prices, its manufacturing region may prosper: a 'correction' of the currency may help one region but harm the other and, for this reason, is too blunt an instrument to respond to regionally specific changes in economic conditions.(12) The Fixers' argument becomes either that Canada, with a highly diversified economy, does not need exchange rate flexibility, or that the instrument is too insensitive to cope with its enormous regional variations.(Harris 1992) In other wordw, it matters that Canada is not an optimal currency zone.

Fx 7. Fiscal policy would certainly become more important as an instrument of adjustment to external shocks following entry into a currency union, but it is not the only adaptation mechanism available for policy makers. Since the locus of industrial policy is increasingly moving to the provincial and municipal levels,(Wolfe 1997) made-in-the-region policy-making is likely to be more responsive to local conditions, including the geographically specific fallout from general shocks. Other factors -- including other types of government policy -- could or would also come into play. Many tools of micro-economic policy can be targeted by sub-national jurisdictions to stimulate an economic region or sector in distress. While NAFTA prohibits some policies (particularly those that discriminate against foreign-controlled corporations) and the World Trade Organization (WTO) subsidy code rules out others (particularly those targeted at export promotion or import substitution), high unemployment or low income can justify government intervention that the WTO would otherwise deem protectionist.

Beyond the direct intervention of government, market forces can also work independently of exchange-rate responses to mitigate the impact of shocks. Wages, if they are flexible, cushion the impact of external disruptions. As trade unions lose power in response to globalizing forces and as wage rates consequently become less "sticky", wage flexibility makes economies more responsive to shocks, particularly where unemployment levels are high. Labour mobility -- which can be encouraged by industrial adaptation policies -- can also help depressed or manic regions adjust to (mis)fortune.(13) Foreign capital may also help an economy respond to shocks, whether positive or negative, though some types of foreign capital move faster and other types of capital are economically more productive. The inflow of speculative financial flows can only provide short-term relief while at the same time increasing an economy's vulnerability to future destabilization. Direct foreign investment can actually create economic activity, but transnational corporations' strategic decision-making is too slow for shock-buffeted economies to count on this factor as a means of achieving rapid adjustment.

Fx 8. Establishing the entry cost of a currency is a political decision to be sure, but does not necessarily work to the detriment of the new entrant. The entry level for the Canadian dollar and the Mexican peso to NAMU would have to be negotiated. It is not obvious a priori that, if the United States did want the monetary union, it would impose an economically -- and so politically -- unacceptable cost on its neighbours.(14)

Fx 9. Perhaps the most telling argument among Canadian Fixers over the years has been the scornful dismissal of the Bank of Canada's policy capacity as the "thirteenth district" of the Federal Reserve Board. For all its architectural splendour (the Bank of Canada building in Ottawa is a sublime superimposition of a 1970's romantic modernist glass cage around a massive 1930's art deco core) and for all the competence of its professional economists (sometimes dubbed the best and most orthodox economics faculty in the country) the Bank of Canada's margin of autonomy, Fixers maintain, is strictly constrained by its position in the shadow of the globe's financial hegemon.

Fl 9. Such, at least, was a view widely held among monetary policy sceptics in the 1970s. More recently, the Bank of Canada's critics have implicitly made the opposite case. If they were complaining in the early 1990s about a 'made-in-Canada recession', economists were crediting the Bank of Canada and John Crow, its steely, zero-inflation governor from 1987 to 1994, with the capacity independently to steer a route of monetary austerity more stringent than the Fed's.(von Furstenberg 1995: 23-4) Floaters concede that the Canadian system is closely interlocked with the American, but affirm that, though its room for manoeuvre is limited by the financial instruments the Bank of Canada trades (primarily short), its capacity for autonomy is effective precisely because the volume of North America's capital flows is so large that the Canadian section of the market is sensitive to the interest rate fine-tuning which the Bank of Canada can still practise. High Canadian/American capital mobility and easy asset substitutability mean that monetary policy can effectively, if indirectly, massage exchange rate levels through manipulating interest rates, and affect the market's judgment about resulting price stability. It is this capacity for sophisticated monitoring and adjusting which would be lost to the national economy from currency union.

Mainstream Floaters find support from more radical, structuralist economists who deem exchange-rate flexibility since 1970 to have "played a crucial role in protecting the competitiveness and viability of Canadian industry despite the notable rise in Canada's unit labour costs over the period relative to those in the US."(15) Labour laws and employment policies being more generous north of the border than in the USA, the depreciation of the Canadian dollar has helped the weaker economy sustain a stronger welfare state. (Stanford 1995) Beyond the economic priesthood there has also been a general recognition in the business press that the Canadian economy has only been able to survive the American competitive onslaught triggered by free trade because the Canadian dollar ultimately fell far enough that labour remained competitive despite the country's richer social wage.(16)

If the main thrust both of neoclassical and structuralist economists defended a Canadian dollar delinked from the American, what can be said about the 1990s, when the definition of North America was expanded to include Mexico? Is sauce for the Canadian goose also sauce for the Mexican gander? The consensus among the Floaters is overwhelmingly affirmative. For economies that react to external shocks asymmetrically a floating exchange rate offers a fast, flexible response mechanism.(Lafrance and van Nordern 1994: 56) Despite Mexico's catastrophic experience with exchange rate crises under an adjustable peg, Floaters maintain that the basic thrust of this argument holds there too.

Mexico strikes even the amateur observer as a third world economy.(17) Even if its state-sponsored import substitution industrialization and the autarchic, monopolistic structures that were erected after World War II have been rapidly dismantled in the past decade, it is patently vulnerable to much higher rates of inflation, unemployment, and currency volatility than its gringo neighbour.(18) Having had a peso fixed at the rate of 12.5 to the US dollar for two decades from the mid-1950s, it devalued in 1976 to 22.6 to the dollar. A few tumultuous years of oil price appreciation with the consequent increased inflation, foreign capital influx, external deficit growth, and ultimate debt crisis in 1982 resulted in a peso worth one 150th of a dollar. Five more years following the fall of world oil prices left the exchange rate at 2,281 peso to the dollar. An even greater peso crisis was in store following continuing high inflation which, together with rising US interest rates, massive intervention by the Banco de Mexico to maintain a high exchange rate, and the influx of long- and short-term foreign capital in anticipation of the new North American Free Trade Agreement, produced a peso so overvalued by 1994 that it was poised for a further disastrous crash. See Figure 6.

insert Figure 6: Mexican Exchange Rate in terms of US Dollars (1950-1998)

Source: Bank of Canada

Given this roller coaster history it might be thought that Mexico would be the first to apply for currency union for the same reason that France since the early 1980s has wanted identification with, if not actual membership in, the Bundesbank: Mexico would instantly gain the international credibility of its hegemonic neighbour along with its level of price stability. Because of Mexico's state-controlled union movement, wages can `flexibly' respond to a shock, allowing the economy rapidly to achieve a new `equilibrium' without having to resort to devaluation.(Lalonde and St. Amant: 105.)

For banking professionals, however, fixing Mexico's exchange rate would be extremely risky. For one thing, the period between the announcement of the plan to form a currency union and the actual moment of consummation would be perilous: a lone currency pegging to a stronger one requires very substantial international reserves to defend itself from the speculative rushes that would be unavoidable until the irrevocable had happened.

Moreover the differences between the Mexican and American markets' reactions to shocks are far greater than those between the Canadian and the US economy. Supply shocks account for more output fluctuation in Mexico than in any US region. Apart from its response to shocks, their nature in Mexico is different. Although there is a common component to North American supply shocks,(19) the size of real demand and monetary shocks is greater for Mexico,(20) leading to larger price shifts and greater changes in real balances.(21) What is more, political shocks can be even more disruptive to the economy. In the course of a single calendar year rural uprisings, political assassinations, and spectacular kidnappings linked to the ruling party's authoritarianism and the narcotics business shook the confidence of global capital markets and, combined with dubious monetary policy, culminated in the currency crisis of December, 1994.(Weintraub 1997: 54-68)

Once in NAMU, Mexico's problems would not be over. It would still suffer external economic shocks, whether those generated in the American economy through its fluctuating demand for Mexican products or from global economic changes. It can expect to continue to be shaken by those internal tremors that form part of the current process of radical economic liberalization, with its resulting widespread urban and rural poverty under conditions of reduced government control and increased violence.(Teichman 1997a) In either case, membership in a currency union would make it harder to offset the forces raising the Mexican level of unemployment. Blocking imports by higher tariffs to counteract a critical current account deficit and stimulating specific sectors with interventionist industrial policies targeted to promote Mexican companies are policies no longer available to the government under the restrictive provisions of NAFTA. Devaluation can at least stimulate exports, but with exchange and interest rates fixed not by the Banco de Mexico but by a continental central bank, the government would be forced to rely on fiscal policy, a tool even less useful for helping a developing economy react to external disruption than it is in a highly industrialized economy.

As in the Canadian case, this argument for currency autonomy can be questioned. The 1994 crisis was itself the product of a misguided, albeit autonomous, policy aimed at keeping the peso's exchange rate defiantly high.(22) However much these arguments can be contested, our opening paradox is nevertheless reaffirmed: policy makers who find in NAFTA a key to transforming Mexico from a third- to a first-world economy consider NAMU to be a formula condemning Mexico to remain a weak regional sister, the Newfoundland of North America.

II Politics and Calculating the National Interest

The fate of Newfoundland shifts the debate onto a different plane. If this bankrupt British colony floating by itself in the cold waters of the North Atlantic could never have been thought to qualify as a member of an optimal currency zone with the nine provinces comprising the Dominion of Canada in 1948, we must introduce the factor so far excluded from our analysis: politics. Prestige and patriotism -- one dare not speak of a Canadian version of Manifest Destiny -- motivated Canadian politicians to accept the burden of the fiscal transfers needed to bring Newfoundland's infrastructure and standard of public services up to the Canadian mainland's norm. Since a slim majority of Newfoundlanders considered the promise of these material gains to be worth the sacrifice of currency and policy autonomy, there was the making of a deal.

The case for or against currency union, in other words, cannot be left solely in the hands of neo-classical economists and bankers. At some point the national and social values of the potential partners have to be addressed. If we are to understand why North America has not moved to currency union, we must come to grips with the way each country sees its national interest.


We have already seen that the Floaters' economic critique of currency union has an implicitly political subtext: currency autonomy is necessary if the Mexican government is to have any hope of navigating through tumultuous seas. Thinking more broadly of the Mexican political culture, with its deeply anti-Yankee nationalism born of bitter military experience with US territorial expansion and direct American intervention in Mexican affairs over the years, the subsuming of the peso into a super-dollar can only be contemplated as an ultimate giant step in a long process of cultural integration in which Mexicans' national identity had become compatible with a superimposed North American consciousness.

The United States

Washington aims to maximize continental economic and policy integration but minimize the three states' institutional integration. Even though its neighbouring governments have less and less actual control over their important economic policy levers, it is in the hegemon's interest not to accept responsibility for their social and cultural problems.

Washington's concern about the peso is indirect: will instability on Mexico's currency market have a contagious "tequila effect," destabilizing other currencies, including the American? Will exchange rate swings swamp the effects of tariff reductions achieved by NAFTA? The American interest in the Mexican peso is therefore to achieve a stable exchange rate with smooth rather than catastrophic adjustments to future shocks. American politicians keep a watching brief on Mexico's performance, but, in the current circumstances of its underdevelopment and overpopulation, currency union is a nightmare, not a dream. The American goal is to extend the market's sphere (which it dominates) while reducing the reach of political institutions (where Mexican and Canadian policies could voice their demands). If currency union brought NAFTA a step closer to labour market integration, NAMU would nullify one of the chief objectives Washington had hoped NAFTA would achieve: a more prosperous Mexican economy generating enough employment for its own burgeoning population to reduce migratory pressure towards the north. Taking on the burden that could imply massive transfers of population over the Rio Grande from the south to the north, and perhaps massive transfers of social support funds from the north to the south, is not a US prescription for life, liberty, or the pursuit of happiness.

While discrete parts of the American economy may suffer from the import competition exacerbated by a peso devaluation, there is no national resonance to the battle cry against Mexico of "competitive devaluation!" analogous to France's angry response to Italy's depreciation of the lira in the early 1990s. Washington's apparent unconcern about competitive devaluation even relative to Germany and Japan is also due to the key American state agencies that deal with exchange rate policies being institutionally insulated from the industrial sectors that can suffer from global currency volatility (Henning, 1994). When the Canadian dollar is low, there are specific interests in the American political economy (forest cutters, grain farmers, auto workers, steel makers) who complain of unfair competition. But the US economy is so diversified that these losers are balanced by other winners (notably the consumers of lower priced imports). High levels of US corporate control in Canada also ensure that no powerful political force develops a platform to attack Canada's competitive advantage allegedly derived from exchange rate depreciation.

The Canadian economy has such high levels of American ownership and technological mastery, is so complementary to the US economy's needs, and is such a large market for US exports that political Washington has little sense of threat from it. There might be some public satisfaction from the thought that the domain of the US dollar would be expanded to cover the whole of the continent, but the American public would not likely be willing to pay for this increase in pride with any increase in financial burden.(23) American politicians' tenacious determination to retain every possible speck of national sovereignty would make it very hard to sell the idea that Canada and Mexico should be granted membership in a continentalized Federal Reserve Board.


For their part, Canadians seem to have no more political desire for such an eventuality than their neighbours. France may want a European central bank in order to have some control within the ECB's virtual-reality Bundesbank, but Canadians have no illusion that even a seat on the board of the Fed would give them "any more influence than Atlanta has," as one observer put it, referring to the insignificant role played by Atlanta in the deliberations of the present Federal Reserve Board. The disparity of power is too great for Canada to have a comparable rivalrous ambition -- as France nourishes towards Germany -- to keep the larger neighbour constrained through participation in its currency policy. Nor is there much potential for alliance with the rest of the hemisphere to offset American hegemony, a twenty-first century version of Britain's alliance against Napoleon. Although such a Lilliputian notion flickers at the back of Canadian policy makers' minds when they think of the ultimate implications of a Free Trade Area of the Americas creating a bloc from the Arctic to the Antarctic, this fantasy belongs more to the realm of social science fiction than to that of practical politics. There is no disastrous war within living memory whose resurgence needs preempting. There is no sense that NAFTA is a continental political system in the making, one in which a common identity should be affirmed with a common bank note in every pocket from Chiapas to the Klondike.

But times change. Seventeen years ago no one but the long-shot candidate for the presidency, California Governor Ronald Reagan, could talk seriously about a "North American accord" linking not just Canada and the United States but including Mexico. Is it possible that, seventeen years from now, NAMU could be not fancy but fact?

The prime precondition among neoclassical economists for NAMU is for the North American economy to approximate an optimal currency zone. While it would be unnecessary for all of the continent's regional economic differences to have become homogenized in terms of their mix of resource, manufacturing, and service industries, their developmental disparities would need to have narrowed. Most important in this regard would be a successful transition by the Mexican economy to first-world status. What would further condition symmetrical responses in Canada, the United States, and Mexico to common economic shocks would be a continuing continental integration through transnational corporate restructuring. Trilateral harmonization in the marketplace could generate such low tolerance for any currency fluctuations among market players that they might press to have NAMU put back onto the policy agenda.(24)

Approaching the condition of an optimal currency zone might not even be a necessary let alone a sufficient condition. Washington would need to be impelled -- possibly by a change in the global balance of forces -- to consider NAMU in its national interest. The US retrenches continentally when threatened globally.(Clarkson 1997: 4-6) In the mid 1980s, the United States embarked on the course that ultimately led to NAFTA because of its apprehended decline in global hegemony. If by the 2010s, the Euro has successfully challenged the US dollar as a reserve currency, Washington might again look to North America as a means to buttress its competitive position on global capital markets.

It is hard to envisage such continuing economic integration taking place without pressures for a parallel political deepening of the NAFTA system. Such an institutional consolidation of the North American regime would not have had to achieve full political integration just as the EU does not need to have become a United States of Europe to contemplate EMU. Many assume that making currency union acceptable in the USA would require a monetary authority that was still politically accountable to Congress. Others believe the policy rigidity created by NAMU would require labour mobility across national boundaries as well as mechanisms of redistribution so that losing areas could be compensated by winners. Whether labour mobility and regional economic equalization need to be part of a currency union, can, of course, be contested. The EU has only very minor degrees of both since cultural differences restrict labour migration and the EU budget for regional development is modest. NAMU would probably have to be brought into being without either.

At this point we can ask whether NAMU would ever be necessary. If Europe is the implicit model for this analysis, it can be argued that North America is already demonstrating some of the characteristics that the project of monetary union in Europe is designed to achieve. It took the Maastricht criteria -- negotiated behind closed doors and imposed on the EU's reluctant member states over massive protests in the streets of Paris and angry obstruction in the council chambers of Rome -- to push member-state governments in the direction of a neo-liberal orthodoxy which has already been achieved in Ottawa and Mexico City by other, less institutionalized means. A change of generation within the Institutional Revolutionary Party's technocratic elite has brought fervent neo-liberalism to the commanding heights of the government and the Banco de Mexico.(Teichman 1997b: 14-22) The Bank of Canada shifted to monetarism in 1974 well ahead of Paul Volcker's conversion of the Fed. Ottawa's Department of Finance -- chastened by Moody's unfavourable credit ratings -- pushed the national deficit relentlessly down to zero, whatever the cost to the country's social and cultural fabric. In effect, bank, treasury, and finance officials in the three countries already form a continental chapter of the global epistemic community of financial officials -- reading the same books, thinking the same thoughts, convening in the same conferences, and persuading their respective publics that low inflation has priority over low unemployment as the number-one policy priority.


III Implications for EMU

To extract the lessons for Europe of the divergent North American currency experience, let us rephrase our opening paradox. Although the world currency market -- with its high-tech, 24-hour-a-day, instant transmission of billions of funds -- is the most advanced aspect of globalization, exchange-rate autonomy is touted as a prime expression of national identity not only by the continental hegemon but by its neighbours to the north and to the south. Bankers north of the 49th parallel and south of the Rio Grande concede that, as economic integration among the three countries continues to deepen -- with pressure on the two peripheral countries to harmonize their industrial standards and even their tariffs up or down to US levels, exchange rates can be expected to fluctuate less and long-term interest rates converge more. They concur that policies straying from orthodoxy will in any case be rapidly punished by globalized capital markets. Nevertheless, contrary to Ohmae's prognostication that globalization has made obsolete the traditional instruments of central banks,(25) North American banking officials cling to their currency sovereignty.

It would appear that we hold in our hand the key to explaining some of the most intriguing differences between the process of integration on the two continents. If we translate our paradox into global finance's "unholy trinity" -- capital mobility, exchange-rate stability, and monetary-policy autonomy -- we can put our contrast of the two continental systems into a more analytically fruitful light.(Cohen 1996: 280) All members of NAFTA and the EU have opted for capital mobility, but North American states are willing to sacrifice exchange-rate stability in order to retain what for them is the greater good of monetary-policy autonomy. In contrast, those states joining EMU are willing to abdicate monetary-policy autonomy in order to achieve what for them is the higher value of exchange-rate stability.

Thus dogma reigns in its distinctive fashion on both shores of the Atlantic Ocean. On its eastern beaches open economies are believed to be too vulnerable to tolerate the disruptive threat of the very currency volatility which, on its western shore is held to be a stabilizer vital for the survival of separate socio-political regimes. In North America so much trade is carried on within the continental corporation that exchange-rate stabilization is low on the TNCs' political agenda. In Europe it is maintained that the TNCs are a driving force urging EMU, even if they too are shielded against uncertainty by their intra-firm accounting practices.

The elites driving EMU to fruition seem to want a common currency less for economic reasons than to pursue a multiple -- though not necessarily coherent -- political agenda: neo-liberal pressure to restrain the welfare state, the Fortress Europe drive to consolidate continental power in its global context, the Franco-German effort to remain hegemonic within the EU, the "Club Med" countries' striving not to be left behind, and neo-functionalist hopes to achieve a supranational Europe with a common identity for its citizens. Because currency notes and coins are not just one of the most widely produced consumer goods but as a consequence among the most powerful vehicles producing national identities,(Helleiner 1998: 6) one can hypothesize that North America is likely to remain a mirror image of the European Union. Whereas the Euro is expected to strengthen the community-wide self-consciousness of European citizens, North American elites prefer to leave national identities intact while unobtrusively acting as coordinated managers of a continental dollar zone in which Canada and Mexico follow the US lead in most important monetary policy shifts, unless they want to be even more neo-conservative than the Fed.


An enormous territory encompassing widely different geographic characteristics, the Canadian federation itself falls far short of qualifying as an optimal currency zone. Inter-provincial currency rigidity has only been tolerable for the past fifty years because a relative powerful central government was able to compensate regional losers through massive equalization transfers, whether by investing in economic development projects in poor provinces or by guaranteeing a high nation-wide level for social support policies.(26)

The implication of Canada's national experience for Europe is that establishing a single currency for a continental economy whose member-states demonstrate widely differing characteristics and levels of welfare will necessitate the capacity, both institutional and fiscal, to make very significant transfers to compensate losing regions for their economic misfortunes. Otherwise the burden of bearing the impact of adverse shocks will fall on workers in Europe's still quite immobile labour markets.

In North America, with high market autonomy and capital mobility but low institutionalization of political functions, currency autonomy remains a useful vestige of nation-state sovereignty. Held up in the light of North American integration, EMU appears dangerously homogenizing -- an ambitious and highly risky project being driven over uncongenial economic ground. The implication for EMU is that it may become impossibly difficult to sustain relatively generous social policies and labour market structures when the member states are subjected to the policies of a democratically unaccountable continental central bank inspired by a neo-liberal philosophy. If this prophecy comes true, countries with a rich acquis social may come under strong pressure to recapture their currency autonomy or to break the Maastricht rules prescribing fiscal policy conformity in order to protect their unique policy traditions.

Canada participates actively in such multilateral global institutions as the WTO and the OECD. Of greater relevance for its currency concerns are the secretive monthly sessions of the Basle Committee on Banking Supervision within the Bank for International Settlement, the surveillance work done in the International Monetary Fund, and the highly visible annual powwows of the G7.(Coleman and Porter 1993) It may be that a middle-to-large sized power (Canada currently boasts the seventh largest GDP) enjoys more influence on global currency matters through its participation in these many-membered global institutions than it would in a three-member continental currency union in which its GDP represented but 8 per cent of the total continental product. The implication is that the United Kingdom may be right not just in its fear that monetary union will deprive it of a policy lever it needs to adjust to economic disturbances.(Tahani 1997) Its voice on currency matters may be heard more effectively in the global fora as a nation-state than as one of fifteen in the councils of the European Central Bank, particularly if participation in the latter precludes direct participation in the former.

Whether the cure of integration via monetary union imposed from above is worse than the disease remains to be seen. But the prevailing orthodoxy concerning EMU has such momentum that North America's market integration generated without currency union is unlikely to be of much interest in Europe unless or until disaster strikes. At that unhappy point, when other formulae for continental cohabitation would again be considered, the North American experience in abstaining from monetary unification might become pressingly relevant. Meanwhile, continental integration driven from below by market forces proceeds apace in North America in telling contrast with the European model driven by the brave faith that efforts exerted from above can transcend its historic national divisions.


Bayoumi, Tamin, and Barry Eichengreen. (March, 1993a), 'Monetary and Exchange Rate Arrangements for NAFTA', (Washington) International Monetary Fund, Working Paper.

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Figure 1. Real Bilateral Exchange Rate: Canadian dollar, 1950-1997

Figure 2. Consumer Price Index (inflation): Canada and US, 1950-1997

Figure 3. Short-term Interest Rates: Canada and US, 1950-1997

Figure 4. Long-term Interest Rates: Canada and US, 1950-1997

Figure 5. Canadian Terms of Trade, 1950-1997

Figure 6. Exchange Rates: Mexican peso, 1950-1997

Unused material

For all the homogenizing forces that globalization is said to be engendering, the lack of institutional convergence among the world's main systems continues to remain impressive. Divergence is not just the result of a greater-than-expected process of resistance by hold-out national structures against hermonization. New government initiatives may actually be increasing differences between regimes. Until recent years convergence scholarship consisted mainly of comparisons among various national systems. A subset of this literature contrasted the federal United States of America with the European Community as a would-be confederal state.

With the neo-conservative revolution, the American economy has taken on the role of anti-model in the ongoing, even agonizing, debate among scholars of European integration about the survival prospects of a "social Europe." This counter paradigm to the European way consists of a more "flexible" labour market, a less generous welfare state, and a state-market relationship in which the private sector drives the political process rather than the reverse. Whatever differentiates American from European capitalism, the European Monetary Union (EMU) is about to create two further and very significant elements of difference with major implications for governance on both sides of the Atlantic.

In the first place, the institutionalized autonomy of the European Central Bank (ECB) is about to shift monetary policy-making from national central banks (NCBs) -- most of which were susceptible to direct influence by their governments -- into a supra-national institution carefully designed to be as autonomous as possible from political control.(27) This institutionalization in Frankfurt of anti-political monetarism creates a stark contrast with the Federal Reserve Board (the Fed) whose leadership is appointed by the US president and whose policies are kept under careful scrutiny by the US Congress before which the Fed's governor frequently testifies.

A more interesting element of institutional diversity has been introduced on the other side of the Atlantic by the creation in 1994 of a continental trade and investment regime whose monetary policy features contrast sharply (by their absence) with those of the European Union.

Accounting in Europe's common agricultural policy (CAP) would be made less complicated by a common currency. This embryonic inter-regional fiscal balancing parallels the fiscal equalization among sub-national jurisdictions made possible by the fixed exchange rate within each of NAFTA's constituent federal systems.

Democracy In the European Union, where power shifted to the supranational and intergovernmental levels, the democratic deficit has largely focussed on the lack of popular access to and absence of transparency in the inter-governmental, infranational policy processes at the continental level. The problem is not that power has escaped the system but that the public has lost more of its direct control. The democratic deficit is a question of demos more than of kratia.

In North America the absence of supranational institutions leaves not just the hegemon but its two smaller states enjoying apparently full sovereignty. This gives their publics the impression that they are directly connected with the politicians they elect. But, because Canada and Mexico have lost power by self-abnegation in signing NAFTA, by the market gaining greater freedom, by dispute settlement processes operating in a semi-autonomous domain, the democratic deficit is a question more of kratia than of demos.

European Forum

European University Institute

San Domenico di Fiesole


May 30-31, 1997


"The Political and Institutional Deficits

of the European Integration Process"

Draft: April 30, 1998

Stephen Clarkson

The Joy of Flux:

What the European Monetary Union Can Learn from North America's Experience with National Currency Autonomy

University College

Toronto, M5S 3H7

Fax: (416) 971-2027

1. 1

My research was generously supported by interviews with Mostafa Askari (International Monetary Fund), Tom Bernes (International Monetary Fund), Bernard Bonin (Bank of Canada), Javier Guzman-Calafell (International Monetary Fund), John Murray (Bank of Canada), Charles Siegman (Federal Reserve Board), Robert Solomon (The Brookings Institution), and Ted Truman (Federal Reserve Board). Aimée Downey assisted in the research. The text has profited enormously from detailed comments by Eric Helleiner (Trent University) and Jim Stanford (Canadian Auto Workers) and from a critical reading by Tim Lewis and E.A. Safarian.

2. 2Given Canada and Mexico's overwhelming dependence on the US in terms of both trade and foreign direct investment, North America can be considered to be more economically integrated than the European Union.

Intraregional trade in North America, 1990:

For Canada: exports to the US as a percentage of total exports: 72.66; exports to Mexico as a percentage of total exports: 0.37; imports from the US as a percentage of total imports: 62.88; imports from Mexico as a percentage of total imports: 1.24.

For Mexico: exports to the US as a percentage of total exports: 73.12; exports to Canada as a percentage of total exports: 2.42; imports from the US as a percentage of total imports: 70.80; imports from Canada as a percentage of total imports: 1.27.

For the US: exports to Canada as a percentage of total exports: 21.10; exports to Mexico as a percentage of total exports: 7.22; imports from Canada as a percentage of total imports: 18.14; imports from Mexico as a percentage of total imports: 5.96.

Source:p. 15.

Intraregional FDI in North America, 1990:

For Canada: FDI in the US as a percentage of total outward FDI: 62.7; FDI in Mexico as a percentage of total outward FDI: 0.2; FDI from the US as a percentage of total inward FDI: 62.5.

For Mexico: FDI from the US as a percentage of total inward FDI: 63.1; FDI from Canada as a percentage of total inward FDI: 1.4.

For the US: FDI in Canada as a percentage of total outward FDI: 20.9; FDI in Mexico as a percentage of total outward FDI: 1.9; FDI from Canada as a percentage of total inward FDI: 7.9. (DeBlock and Rioux 1993: 22)

3. 3

While Québec's use of French and Mexico's use of Spanish preserves some degree of linguistic heterogeneity on the continent, the homogenization of cultural values broadly defined to include consumer products, professional athletics, and movie or television consumption is far greater than in Europe where diversity is entrenched by the distinct national history and language of each member state. In one crucial dimension, labour mobility, North America is markedly less integrated than Europe.

4. 4

Canada managed to escape the discipline of the Bretton Woods agreement's fixed exchange rate stipulations, allowing its dollar to float from 1950 to 1962 and, following a period of pegging to the American dollar, from 1970 onwards.

5. 5

The European Monetary Commission estimated in 1990 that the elimination of transaction costs under EMU would amount to a savings equal to approximately 0.4% of EU GDP. (Bayoumi and Eichengreen 1993a: 2)


6Lafrance and van Norden (1994: 54) cite earlier studies by Farrell et al. (1983) and Belanger and Gutierrez (1990). Coté (1994) concludes that the effects of increased volatility on trade are ambiguous. The reductions in trade as a result of exchange rate variability are minimal and hedging allows avoidance of these at little cost. As well, such variability can have a positive effect by creating profitable trading and investment opportunities for business.


7Canadian inflation has been lower than the American level for the 1990s as a whole. The increase in consumer prices between 1994 and 1995 stood at 2.8% in the US compared to 2.2% in Canada. International Financial Statistics Yearbook (IFSY), 1996.


8Although central bank lending rates have been historically higher for Canada than for the US, they have fallen below US rates in the last two years. IFSY, 1996.

9. 9

Murray et al. 1996: 35 conclude that there is little support for the excess volatility argument. Most of the broad movements in the Canadian dollar can be explained by changes in market fundamentals and not aberrant speculative activity.

10. 10Historically, Canada's terms of trade variability relative to other G-10 countries has been moderately large, averaging 22.3% between 1979 and 1989, and suggesting a comparatively high degree of volatility. (Fenton and Murray 1993: 508.


11. 11

See Lafrance and van Norden (1995) and Bayoumi and Eichengreen (1993b). Both studies conclude that Canadian supply shocks are negatively correlated to those affecting the US economy, which is not an optimal currency zone either: the 1990-91 recession affected the east and west coasts but not the interior states.

12. 12

The absence of a significant correlation between supply shocks to Western and Eastern Canada suggests the ineffectiveness of currency flexibility for Canada. Mundell (1961).

13. Newfoundland, as the weakest economy in the Canadian federation, is the one province to have experienced an outflow of population in the last five years: its population declined 2.9% between the censuses of 1991 and 1996. (Mitchell 1997) But this argument is double-edged: it can be used against rather than for currency union. With its own currency, Floaters could argue, Newfoundland would have been able to adjust to its economically depressed condition by devaluation and so created jobs through the resulting growth of exports.

14. Within each country, of course, there are conflicting interests with producers, exporters, and the tourist sector favouring a low exchange rate while the financial sector, importers, and tour operators tend to prefer higher levels.

15. Letter from Jim Stanford, 9 June 1997.

16. Canada's tariffs being twice the American level, it stood to lose more market share at home from free trade than it stood to gain market share in the US.

17. 17

Mexico's per capita GNP in 1994 before the last crisis, was $7,019 compared to $20,257 for Canada and $25,572 for the USA. (L'État du monde Paris, La Découverte 1995) Mexican statistics are so notoriously unreliable that other observers' estimates setting Mexican GNP per capita at one tenth US levels are equally credible.

18. 18

Since 1990 consumer price level changes have varied between 26.7 and 35 per cent in Mexico compared with 5.4 to 2.8 per cent in the US. (IFSY 1996: 111-112)

19. 19

For example, disruptions in the international petroleum market would affect Mexico, Western Canada and the US Northwest, all energy-producing regions in North America. (Bayoumi and Eichengreen 1993a: 23)

20. 20

A real demand disturbance for Mexico could be a response to a shift in the government's fiscal policy or a change in the level of world demand for petroleum. Monetary shocks could be changes in net foreign capital unflows or an increase in the domestic money supply in response to the public's desire to increase cash holdings. (Lalonde and St. Amant 1995: 108)

21. 21

The greater severity of demand and monetary shocks in Mexico leads to increased swings in unemployment and national income.

22. 22

Mexico spent over $20 billion during 1994 to prop up the peso. The Washington Post, Jan. 1, 1995. (Teichman 1997b: 21)

23. There is no evidence that Americans would respond to Canada's and Mexico's closer integration in the US economy in a way analogous to West Germany's sacrifice to ease the absorption of the former German Democratic Republic. Public transfer payments from the Federal Republic to East Germany in 1991 amounted to DM 10 billion, approximately two thirds of East German GNP. (Friedman 1992: 144)

24. 24

"The lure of lower financing costs for private businesses, caught up in the dynamics of NAFTA-inspired economic integration and the disruptive effects of real exchange rate swings on competitiveness, will cause monetary union to be given a second look in the Americas." (von Furstenberg 1996: 40)

25. 25

"[A]s the workings of genuinely global capital markets dwarf their ability to control exchange rates or protect their currency, nation states have become inescapably vulnerable to the discipline imposed by economic choices made elsewhere by people and institutions over which they have no practical control." (Ohmae 1995: 12)

26. 26 The irony of this phenomenon can be seen in Quebec's nationalist movement which declares that an independent Quebec would still use a Canadian dollar even though economists believe that, for its economy to survive the shocks it could expect post independence, Quebec would need to manage its own currency. Both Rousseau (1978) and Fortin (1978) conclude that the benefits of an autonomous monetary policy under a separate currency regime are fewer for small, open regional economies which are highly integrated with the national economy. Fortin (1978: 63) maintains that monetary isolation would adversely affect Quebec sovereignty by destabilizing the value of the new currency relative to the Canadian dollar.


27. The fact that the ECB's board of directors is made up of member states' bank governors is unlikely to nullify this autonomy since these NCBs have themselves been made autonomous of their governments in the run up to integration.