The New Year is opening with a high degree of optimism around the US economy. Proposed changes to the US tax code, deregulation and infrastructure investment certainly have the equity markets convinced that better days for growth are just ahead. Unfortunately the optimism seems to stop at the border. The latest GDP and inflation data out of Canada came in well under expectations, increasing the possibility, in the minds of some, that the next move we will see from the Bank of Canada is a cut. Another January surprise, like we had last year?
I just saw in a piece in the Globe and Mail, that stated that out of 149 currencies, only 14 outperformed the Canadian dollar in 2016. For a country competing to export to the world, the fact that we became more expensive certainly does not help the near term growth outlook. We appreciated over 19% relative to the Mexican peso last year, making their goods much cheaper in the US than ours. For many analysts, the solution is easy. Canada needs a lower exchange rate versus the US dollar.
There is no doubt that Canada is at a competitive disadvantage to many countries that export to the US. The problem is that a weaker currency is only helping offset the disadvantages Canadian firms have to deal with relative to the rest of the world. As the Bank themselves points out, energy cost differentials (hello Kathleen), rising non-tariff trade barriers, uncertainty around existing trade agreements and a slow and complex approval process around large projects, all play a part in making our exports more expensive. In a recent article in the Financial Post, $129 billion of infrastructure projects have been stalled or stopped in the last couple of years from opposition of environmental, aboriginal or community groups. Surprisingly, a number of the initiatives revolved around green-friendly projects, like wind turbines. Apparently they were canceled to accommodate the migratory movements of birds. I suspect there were no chicken sandwiches served at the community meetings when the topic was discussed.
Canada is blessed with natural resources. It is our competitive advantage. If we cannot find a way to responsibly utilize these resources for the betterment of our people, then we will find ourselves in a sub optimal growth position. We will find ourselves competing globally, but we are not allowing ourselves to play our starting line-up.
The people who demand a weaker currency have to ask themselves how great the depreciation would need to be to offset these large disadvantages. They should remember that Canada has taken this road before. On a couple of occasions in the last decades, the Canadian dollar has had brushes in the low 60 cent level versus its US counterpart. One could argue that these moves temporarily gave relief from shocks to our economy, either through commodity price swings or as a result of global stress, but the one thing it did not do was build a sustainable and robust export sector. In fact, one could argue that it built a “false” export sector that relied too much on the where the currency was trading and these firms vanished very quickly when the exchange rate moved.
There is a cost, or a tax imposed, on everyone when the Canadian dollar weakens. For our country, this usually means more expensive essentials, like food and energy. It means it costs more for companies to make capital investments to remain competitive in the world, as many of these capital goods are imported. Finally, in these days of financial stability concerns, it pushes home prices in our larger cities ever higher as it makes it cheaper for foreigners to buy. A weaker Canadian dollar is not a panacea.
Will the Bank of Canada openly encourage a weaker currency? It is an easy fix for them that will help them achieve their inflation target as it will push our below-target inflation temporarily upwards. But, in the analogy of interest rates, are we pushing on a string? Given the constraints that we are putting on our nation’s competitive advantage, does the increased value of exports that will respond to a weaker currency outweigh the medium to longer term costs to all Canadians? I would argue that it does not. At some point, we should stop masking the source of our competitive problems with an ever cheaper currency.
And finally to address the likelihood of a January surprise, I would put the odds as very low. With the US expected to do better, oil prices moving higher, domestic infrastructure (if allowed by our eco friends) spending ahead, and with trade deals with the US uncertain, I don’t believe the Bank needs to “panic”. Yet.
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