Loonie's flight to Iceland shot down

An early-stages plan for Iceland to look into adopting Canada's currency has been shot down by the Canadian government.

Despite hope in some quarters that Iceland might adopt the loonie, that may not be happening any time soon.

The idea of moving to the Canadian currency began getting attention at the beginning of last summer as Iceland's Progressive Party began floating the concept as the island nation struggled with soaring unemployment, bankruptcies and massive currency volatility.

But on Friday, the Canadian government quickly put the brakes to that notion after Reykjavik media reported the Canadian ambassador to Iceland, Alan Bones, was set to announce the Bank of Canada was ready to begin talks about Iceland replacing the krona with the loonie as the new national currency.

Bones was to deliver his message in a speech on Saturday at an event sponsored by one of the country's leading political parties.

But after his comments were aired in this country, the response from the Canadian government was swift — the ambassador's speech was cancelled.

"Once we got wind of (the speech) and it went through the approval channels, we decided it was not an appropriate venue," Joseph Lavoie, Foreign Minister John Baird's press secretary, 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," he said.

With a population of 320,000, roughly the size of Windsor, Ont., Iceland frequently has fallen victim to sharp fluctuations in the value of the krona, with the currency nearly doubling in value between 2000 and 2008, and then collapsing after the failure of several of the country's leading banks owing to wrong-way bets on toxic assets.

Officially, Iceland is looking to join the European Union but that plan has fallen out of favour among voters in the wake of the region's sovereign debt crisis, which is expected to persist for many years.

Maurice Levi, professor of international finance at the Sauder School of Business at the University of British Columbia, said he sees some key reasons why a move to the loonie is being considered.

The biggest is the commodity-based economies of both countries.

"When you share a common currency you share the same monetary policy of that country," said Levi. "When interest rates go up in one country they go up in the other country. It's only going to work if the two parts sharing the currency are very highly correlated and move up and down together because otherwise you'd be in conflict."

Added to this is the fact that Iceland is a very small, undiversified economy. Canada, however, is extremely diversified and that makes the Canadian currency much better able to mange rough economic times.

"It is not just by chance that they happen to be talking about Canada when the Canadian dollar has gained 60 per cent of value and that raises the standard of living of Canadians substantially."

Linking up to a stronger currency would bring much-needed investment back to the economically haggard nation.

"A futures market in an Icelandic currency is a non-starter," said Levi. "There would be no liquidity, but there is a very viable market in the case of the Canadian dollar. You can buy Canadian dollar futures anywhere, so again it would be beneficial for Iceland to join."

According to the federal government, bilateral trade between the two countries amounted to just $146 million in 2005, consisting of about $90 million of Canadian exported vehicles and machinery and $56 million of Icelandic fish products, ships and machinery sold to Canada.

While Iceland was the first victim of the financial crisis, it has made huge strides in restructuring its financial system and repairing the damage to its economy.

Unlike many countries, it allowed its ailing banks to fail rather than bailing them out, and it jailed a number of top executives.

Conditions have improved so much that the rating agency Fitch recently upgraded Iceland's debt to investment grade status. Unemployment is down to around 7 per cent and the International Monetary Fund is forecasting economic growth in 2012 of 2.5 per cent.

If Iceland goes ahead with the loonie, it wouldn't be the first time a country has unilaterally adopted another's currency. The U.S. dollar is the de facto currency in parts of South America and internationally it remains the most widely used currency in the world.

For a time in the late 1990s and early 2000s there was a debate over whether Canada should abandon its loonie, which was trading at a significant discount to its current value, in favour of the greenback.

Iceland would have a lot to gain by going to the Canadian dollar, said Finn Poschmann, vice-president of research at the C.D. Howe Institute.

"It would lose control over its currency which is an important buffer against economic shocks, however it would gain a stable currency that it could use freely in international transactions," he said.