Factiva

To fix the loonie -- meaning to stabilize it and/or cause it to rise over the medium term -- we have to understand what ails the currency. A number of ailments have been identified in these pages by academic and professional economists, ranging from poor productivity growth to higher tax rates in Canada -- and everything in between. Most all of these identified ailments are accurate but they all lack the critical essence of what truly ails the currency: bad government spending and investment decisions. Bad investment decisions beget higher taxes and lower productivity. They lie at the root of the loonie problem.

Governments constantly feel the need to spend and invest. Because they can't stop spending they are forced to tax. (President Ronald Reagan had the idea that he would lower taxes and that Congress would accordingly -- for lack of revenue -- reduce spending. Congress didn't, and Mr. Reagan is to this day blamed for gargantuan budget deficits not of his making.)

Not all government spending/investment need be "bad." For example, had the Trudeau government, with its estimated $10-billion investment in the Beaufort Sea, found oil at $2 a barrel, it would have been a fantastic investment. Taxes could have been lowered, productivity would have risen, and the loonie would undoubtedly have gone up in value. But the Trudeau government didn't, and it bankrupted the instrument of its policy, Dome Petroleum, in the process. In contrast, the Netherlands' gas fields in Groningen were a stroke of luck for the Dutch government; without this discovery, the Netherlands and the guilder would not have fared so well.

Canadian governments seem to make particularly bad spending and investing decisions. The Ontario government invested some $30-billion to $40-billion in Ontario Hydro. Today that investment is on the block for $5.5-billion. This is a phenomenal destruction of wealth! A few more such investments, and the loonie will be pushing 40 cents. The B.C. government invested in "fast" ferries. The investment was "small," only $500-million. The fast ferries might not even fetch $10-million on the open market. B.C. can afford it, you say? It could indeed if the B.C. government had encouraged more resource development -- the tax base would have risen. But the B.C. government didn't.

The list goes on; indeed, readers can make up their own list -- this isn't rocket science. Borrow a billion, turn it into a million, and taxes will go up and productivity will go down -- and the loonie will sink, guaranteed. Canadian governments have excelled at destroying wealth -- and the loonie has taken it on the chin.

What about the government's "investment" in people? What about the estimated $7-billion a year spent on aboriginal development? Or the $37-billion of "transfers to persons"? What about the monies spent by the Human Resource and Development Corporation? Will these investments have a payoff? Hey, if we had that oil at $2 a barrel, we wouldn't care. But we don't!

On paper it is easy to fix the loonie. Start with a flat tax, retain a consumption tax such as the GST, cut all lobby-induced spending to zero, invest more in the legal system, including law enforcement, and in the military, and the loonie will be rising in short order.

Or we could abandon the loonie and go for some form of dollarization. This is the choice favoured by more economists as of late, excepting Bank of Canada and several academic economists.

Let's first assume Canada gets everything from the U.S. it might possibly want after dollarization -- Canada becomes the 13th Federal Reserve District, the former governor of the Bank of Canada gets a seat on the Federal Reserve Board in Washington, which makes monetary policy, and some small percentage of seigniorage (the profit in minting money) is paid to the Government of Canada. (It can't get any better than this!) Now what?

Canada will become like a province; the Canadian government won't be able to issue money and will have no means other than through the Federal Reserve to influence monetary policy in favour of some particular Canadian problem. Canadians will then have to take "shocks" such as the Asian crisis on the chin; there won't be a declining dollar to soften the blow.

But the Asian crisis isn't the loonie's fundamental problem; bad government investments (which beget high taxes) are. If the federal government persists with money-losing investments after dollarization, it will have to finance these by borrowing on the open market. Taxes will automatically rise when the investments do not pay off, because there won't be a currency devaluation to spread the load. In short order, bond-rating agencies will downgrade Canada (as debt rises relative to the tax base) and lenders will shun Canada. (Remember how close Newfoundland came to defaulting before Hibernia?) Ergo, the stupidity will have to stop. And because Canada would now be in a monetary union with the U.S., meaning Canadian financial problems may have risks for the overall system, the U.S. -- not the IMF -- will be telling Ottawa to stop the nonsense.

Maybe that is what those who choose this option have in mind: Canadian government stupidity arrested through dollarization. But surely this stupidity can also be arrested without abandoning the Loonie. Once the Canadian government decides to leave most spending and investment decisions to the private sector the loonie will rise and Canadians will become richer as a result. And that would be a pleasant change indeed!

Martin Murenbeeld is a currency and gold economist with M. Murenbeeld & Associates Inc. www.murenbeeld.com

Graphic/Diagram: Paul Lachine / An illustration of a dollar sign with a star and a maple leaf.

Document finp000020020111dy1b0005b