To: Steven Theobald, Toronto Star
From: Jude Wanniski
Re: Robert Mundell in Toronto
Your account in the Star business section yesterday of Robert Mundell’s speech to the Canadian Club at its Tuesday lunch was a fair and accurate account. I flew to Toronto to attend the Club’s celebration of Canada’s first Nobel Laureate in economics and heard both his speech and part of your interview that followed. There was, though, something of a disconnect, which I think led to your rather scornful view of his assertion that the Canadian dollar, now worth only 66 cents in U.S. coins, is on a path toward 50 cents and that Canada would do well to think of fixing the “loonie,” as you term your dollar with its picture of a Canadian loon, to the U.S. greenback. “Canadian Dollar’s Future Grim, Economist Warns,” the headline read, with Mundell stating “In the long run, the path of the Canadian dollar is down.” You noted that “Mundell said he could see the loonie eventually hitting the 50-cent mark but didn’t explain why. He did predict that the next economic downturn ‘will be hurtful’ to the loonie.” And you added: “Most economists disagree with the idea of pegging the loonie to the dollar. The strongest argument against it would be that Canada would give up the ability to manage its economy, including setting interest rates. It’s better to let the dollar float, said John McCallum, chief economist of the Royal Bank of Canada. ‘A pegged exchange rate is a sitting duck for speculative attacks,’ he said. ‘The vulnerability is huge.’”
As I tried to explain to you after seeing you frustrated in your interview, Mundell’s reasoning was not as clear as it could have been, but to those who have known him for 25 years, the logic is flawless. You are right that “most economists” believe a fixed rate would prevent Canada from “managing its economy,” but Mundell got his Nobel Prize for his work 40 years ago on optimal currency areas. This would argue that a small economy’s like Canada’s, less than a tenth the size of the U.S. economy, would have more to gain than to lose by fixing the loonie to the greenback. It would lose the ability to “manage its economy” by manipulating interest rates, but as Mundell noted in his speech, monetary policy should be devoted to stabilizing the value of the currency and that if the Canadian economy becomes sluggish, it should use fiscal policy to revitalize it, by lowering tax rates where they are too high. Most of the economic sluggishness in the world, including the seemingly perpetual weakness of Canada’s economy, is the result of the neo-Keynesian insistence on assigning fiscal policy to fight inflation and monetary policy to energize economic activity. For 40 years, Mundell has disagreed with the idea that you raise taxes to fight inflation and devalue the currency to boost the economy, as John McCallum of the Royal Bank of Canada apparently would prescribe. Keep monetary policy tight to prevent inflation and cut tax rates to expand the economy, especially where they are higher than they need to be.
If the Canadian political establishment is committed to the wrong policy mix, every time there is an economic downturn, it will turn to easier monetary policy to lift activity and the automatic result is a devaluation of the currency. Unless the consensus of your political leadership abandons the paradigm that now has it in its grip and adopts the Mundell policy mix, I think you can now see by my step-by-step explanation that the loonie will eventually get to half a buck. And if it does not change its ways at that point, there is no reason why the loonie should not eventually make its way to a penny. Instead of writing this as a letter to the editor of the Toronto Star, I suggest you think this through and write an essay for the editorial page on why you think Mundell may be right, and most economists wrong. To this point of his life as a prophet, Mundell has had almost no recognition in his home land. (How can you be any good if you are a local boy?) What he needs is an intelligent young journalist to take the trouble to recognize his genius as a theoretician and translate those ideas into words the leading people of Toronto and Montreal and Vancouver can understand. It would be a shame that Canada went to all that trouble to give birth to little Bobby Mundell almost 70 years ago, a man who has already changed the history of the world for the better, and not take advantage of his ideas at home.