I learn from a sister publication that a handful of economists in Iceland is recommending that the volcanic statelet adopt the Canadian dollar. News from Iceland is always of special interest in Canada, where the Icelandic diaspora has given us legitimate world-historical notables like William Stephenson and, er, the other William Stephenson. The inherent vulnerability of Iceland’s own currency, the króna, has had Icelanders looking at the euro as a refuge, but that option has been yanked off the table for the time being, and may be permanently unavailable within weeks.
One of Canada’s contributions to humanity, as it happens, is the theory of optimum currency areas. The loonie-ization advocates argue that the Canadian dollar is a good choice because Iceland is dependent upon commodity exports and thus has a business cycle more or less in sync with Canada’s. Iceland is also part of the EFTA, with which Canada has a rudimentary free-trade agreement. But that agreement doesn’t cover services and credentials. Mundell’s test for optimality would require free movement of labour between the countries, a common language, and, ideally, some fiscal-transfer mechanism to smooth out the differential effects of the single exchange rate. There is a strong presumption that a currency area should actually be a contiguous area, or very nearly one.
From the Icelandic point of view, however, this raises a tricky question: what the hell is a small sovereign state to do when it’s not part of any optimum currency area? Iceland has appeared on the world stage lately as a tiny, obstreperous gang that banded together to shed financial obligations and swindle British lenders. But when you contemplate its situation, it is hard to see how else Iceland could act in a crisis; we’re talking about 318,000 people, almost all of them each other’s cousins, huddled together on a godforsaken cluster of pumice. Under pressure, of course they will unify to fleece outsiders rather than each other. From this standpoint, the hypothetical power of Icelandic state fiat is never going to be very attractive to investors.
Iceland doesn’t have the power to make the world use its notes; all it really has control over is the unit Icelanders get paid in and use at the corner shop to buy poetry books and kegs of herring. The choice is between the króna, which is a glorified poker chip, or some other unit that has a protective floor value—one established either outside Iceland by someone else’s central bank, or by “nature”, like gold. The pound sterling, sometimes suggested in the past, seems less suitable than ever for a fanatically de-financialized Icelandic economy. Perhaps notes backed by the aluminum Iceland produces in enormous quantities might be the answer? (The mind reels at the possibilities. Could this involve claims on large, physical Yap-esque aluminum megacoins? Or stamped sheets of aluminum foil?) It’s an unnatural choice in theory, but what in the name of Eyjafjallajökull is the natural one?
The Bank of Canada refuses to comment on a foreign country’s monetary affairs, but has indicated it will be happy to provide Icelanders with as many coins and notes as they wish to buy. If Iceland loonie-ized, the seigniorage would actually provide a minor ongoing windfall to the Canadian federal treasury. Unfortunately, I saw a comment on one Icelandic blog that raises a significant objection to the idea: anti-British loathing is, and will be for the foreseeable future, so strong in Iceland that the populace would be psychologically reluctant to accept notes bearing the face of the Queen. When you’re designing or adopting a currency, such “animal spirits” considerations do count.