UPDATE: The government of Canada is backing away from a proposal for Iceland to adopt the Canadian dollar, cancelling a speech by a diplomat that would have announced Ottawa is not opposed to the idea.
“Once we got wind of [the speech] and it went through the approval channels, we decided it was not an appropriate venue,” Joseph Lavoie, press secretary to Foreign Minister John Baird, told the Globe and Mail. “It’s a political event. So that the decision was made that it’s not an appropriate event for him to speak at . . . While he may have thought about delivering those remarks, those remarks won’t be delivered.”
A Canadian official told the Wall Street Journal that Ottawa is "not endorsing" a proposal popular within Iceland’s opposition Progressive Party to have Iceland replace its struggling krona with the loonie.
The party has opposed Iceland’s bid to join the European Union, and proposed switching to the Canadian dollar as a way to stabilize its economy without tying itself to the struggling euro area. Popular support for joining the EU and the euro has dropped sharply in Iceland, in the wake of the Greek debt crisis. However, talks to enter the European Union continue under the ruling Social Democratic Alliance party.
In a blog posting Sunday, Carleton University economist Nicholas Rowe suggested Icelandic adoption of the Canadian dollar could end up costing Canada money, if the Bank of Canada is expected to act as a "lender of last resort" to Iceland should another economic crisis hit the country.
Iceland can use the Canadian dollar if it so wishes, Canada’s ambassador to the country is expected to say Saturday.
According to a report in the Globe and Mail, Alan Bones is expected to give a speech to Iceland’s opposition Progressive Party announcing that Canada won’t object to Iceland unilaterally deciding to use the loonie -- so long as the Nordic country is aware of the risks.
Iceland’s economy suffered a crushing blow in 2008 when its banking sector went bust, causing its currency to collapse. The krona lost about 60 per cent of its value and has not recovered. To stabilize the economy, the government instituted currency controls that prevent anyone from taking more than the equivalent of $3,000 out of the country.
That has made Iceland an unattractive place for foreign investors. The currency controls are slated to come down, but many Icelandic economists worry that will mean a return to economic instability. Some of them have suggested simply replacing the Icelandic krona with another, more stable, currency.
In a recent poll, some 70 per cent of Icelanders said they would favour dropping the krona in favour of a foreign currency, and the Canadian dollar was the most preferred option, the Globe and Mail reports.
Canada’s currency has developed a very positive reputation around the world, thanks to its solid run-up in value in recent years -- largely due to energy exports -- and due to the perception that Canada avoided the financial crisis that hit banks in the U.S., U.K. and elsewhere.
For Canada, having Iceland use the loonie would likely have little effect. Canada’s economy was valued at $1.8 trillion in 2011, while Iceland, with a population of around 315,000, had an economy of around $14 billion. Canadian policymakers would barely have to take into account Iceland’s use of the loonie when setting policy.
The Bank of Canada reflected this reality when it previously said it had no problem with Iceland adopting the Canadian dollar.
But it’s for that same reason that Canada’s ambassador to Iceland is expected to warn Icelanders that adopting the loonie can come with risks.
As the Greek debt crisis has shown, countries can suffer serious economic difficulties when they can’t control their own monetary policy. Many economists argue Greece would have had a much easier time bringing itself out of a debt crisis if it had been able to devalue its own currency, essentially shrinking away its debt. But because Greece uses the euro, whose policies are made at the European Central Bank in Frankfurt, that was not an option.
Iceland may face similar problems if it chooses to adopt the loonie. If Canada sets its interest rate too high or too low for Iceland’s economic conditions, it could cause economic distortions such as recession or excessive inflation.
For Icelanders, however, fear of a return to the instability of 2008 may be a more pressing issue, and there may be another factor -- a romantic view of Canada and its economy.
“The average person looks at it this way: Canada is a younger version of the U.S. Canada has more natural resources than the U.S., it’s less developed, has more land, lots of water,” economist Heidar Gudjonsson of the Research Center for Social and Economic Studies told the Globe. “And Canada thinks about the Arctic.”