Transcript THE SURGE IN THE LOONIE:

THE SURGE IN THE LOONIE:
Canadian Dollar Strength or
U.S. Dollar Weakness?
Dr. Kenneth Matziorinis
Department of History, Economics & Political Science
THE VALUE OF THE CANADIAN LOONIE AGAINST
THE GREENBACK: 1971 - 2007
Canadian Dollar Floats in May 1970 (May 1962 - May 1970 = Parity)
1.2
CAD/USD Exchange Rate
1.1
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8
CAD/USD
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Euro
South Korea
Taiwan
Mexico
China
Malaysia
Japan
United Kingdom
Singapore
Switzerland
South Africa
Russia
T-W Broad Index
Sweden
New Zealand
Denmark
T-W Major Currency Index
Thailand
India
Australia
Norway
Brazil
CANADA
CURRENCIES THAT HAVE GAINED THE MOST THIS YEAR:
Year-To-Date: 2007
Appreciation Against the U.S. Dollar
20
15
10
5
0
-5
-10
Why Has the Loonie Appreciated?
Improvements in Underlying Fundamentals
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The introduction of inflation control targeting framework in Canada since 1991:
The target for inflation: 2%
Elimination of public sector deficits and their transformation to sustainable
surpluses: from a deficit of 9% of GDP in 1992 to surpluses of 1% of GDP
Increase in the national saving rate: from 13% of GDP in 1992 to 24% in 2006
Decrease in the country’s external debt: from 44.5% of GDP in 1993 to under 7%
Decrease in interest rates and the cost of capital: from 9% in 1992 to 4.2%
Increase in the rate of gross fixed capital formation: from 18% in 1993 to 22%
Up-turn in commodity cycle: rising commodity and energy prices including oil
Improvement in Canada’s terms of trade: higher export prices; lower import prices
Gains from free-trade with the United States and Mexico: NAFTA
Reduction in political uncertainty over Quebec separation
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The ONLY NEGATIVE: Canada’s lagging productivity growth
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CANADA - U.S. CONSUMER PRICE DIVERGENCE
Since 1991, Canadian prices have risen by 10.8% less than U.S. prices on a
cummulative basis. This adds 10.8% to the value of the loonie relative to the
greenback. Average Inflation: Canada 1.9% vs. U.S.A. 2.6%
160
7
140
6
120
5
100
4
80
3
60
2
40
1
20
0
1991
1992
1993
1994
1995
CANADIAN CPI
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1996
1997
1998
CAN Inflation
1999
2000
2001
U.S. CPI
2002
2003
USA Inflation
2004
2005
2006
CANADA’S GOVERNMENT BUDGET BALANCE, 1992 - 2007
Canada’s public sector has shifted away from the largest deficits to the
largest budget surplus in G-7
4
Surplus (Deficit) % of GDP
2
0
-2
-4
-6
-8
-10
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
All Levels of Government, % of GDP
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2003
2004
2005
2006
2007
NATIONAL SAVINGS RATES, CANADA AND THE U.S.A:
1961-2006
The saving gap widens between the two NAFTA neighbors
30
Percent of GDP
30
25
25
20
20
15
15
10
10
5
5
0
0
62
64
66
68
70
72
74
76
78
80
82
CANADA
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84
86
88
90
U.S.A
92
94
96
98
00
02
04
06
CANADA’S CURRENT ACCOUNT BALANCE, 1992 - 2007
As Canada’s national saving rate recovered, Canada’s international trade
balance has risen in recent years
3
Percent of GDP
2
1
0
-1
-2
-3
-4
-5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Current Account Balance
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NET INTERNATIONAL INVESTMENT POSITIONS OF CANADA
AND THE U.S.A.: 1976 - 2006
A Tale of Two Countries: Canada’s foreign debt is falling while America’s is rising
20
Percent of GDP
10
0
-10
-20
-30
-40
-50
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
U.S.A.
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CANADA
LONG AND SHORT-TERM INTEREST RATES IN CANADA:
1992-2007
The cost of capital in Canada has declined benefiting producers and consumers
10
9
8
7
6
5
4
3
2
1
0
1992
1992
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1992
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2006
2007
2007
2007
2007
2007
2007
3-M Treasury Bills
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Long-Term Gov. Bonds
CANADA’S TERMS OF TRADE, 1987 - 2007
Since 2002 our export prices have risen faster than our import prices,
improving our terms of trade
120
Export & Import Price Indexes (2002 = 100 )
110
100
90
80
70
60
50
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Export Prices
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Import Prices
COMMODITY PRICE INDEX, 1982-90 = 100,
U.S. DOLLAR TERMS
Commodity prices have surged led by the price of energy
300
250
200
150
100
50
0
1996
1997
Total
1998
1999
2000
Total Excl Energy
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2001
2002
Energy
2003
Food
2004
2005
2006
Industrial Materials
2007
U.S.DOLLAR PERCENT DEPRECIATION AGAINST MAJOR
BENCHMARKS
The Loonie is not the only currency being lifted
Year-to-Date
January 2002 November 2007
Trade-Weighted Broad
Index
-7.5%
-23.0%
Trade-Weighted Major
Currency
-10.4%
-35.4%
Gold
-21.1%
-64.8%
Canadian Dollar
-17.1%
-38.9%
E.U. Euro
-8.7%
-38.8%
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THE VALUE OF THE U.S. GREENBACK AGAINST
THE LOONIE: 1971 - 2007
In August 1971 President Nixon Suspends Convertibility of Gold to the U.S. Dollar,
Beginning of the End for Gold Exchange Standard Set Up at Bretton Woods
1.8
USD/CAD Exchange Rate
1.6
1.4
1.2
1
0.8
0.6
0.4
71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8
USD/CAD
U.S.TRADE WEIGHTED EXCHANGE INDEX:
Broad Basket of Currencies
Source: Board of Governors of the Federal Reserve System (1973 = 100.0)
140
130
120
110
100
90
80
70
60
50
40
30
20
10
0
73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8
Trade Weighted Exchange Index - Broad
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U.S.TRADE WEIGHTED EXCHANGE INDEX:
Major Currencies
Source: Board of Governors of the Federal Reserve System (1973 = 100.0)
160
150
140
130
120
110
100
90
80
70
60
73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8
Trade Weighted Major Currency Index
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New Zealand
Australia
South Africa
Norway
CANADA
Sweden
Euro
Denmark
T- W Major Currency
Switzerland
South Korea
United Kingdom
Thailand
Brazil
T- W Broad Index
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Singapore
Russia
India
Japan
Malaysia
China
Taiwan
Mexico
U.S DOLLAR DEPRECIATION SINCE FEBRUARY 2002
Percent (%) Decline in the Value of the US Dollar Since Recent Peak
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
-45
-50
GOLD PRICE, U.S. DOLLAR PER OUNCE
(LONDON PRN FIX)
The U.S. Dollar price of gold has broken through its previous high
of January, 1980, not a positive sign!
1000
U.S. Dollar Price per Ounce
900
800
700
600
500
400
300
200
100
0
71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 0
U.S.Dollar
Source: World Gold Council
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1
2
3
4
5
6
7
U.S. CURRENT ACCOUNT DEFICIT
1960 - 2007
200
Current A/C Balance, Bil of USD
Current A/C Balance as % of GDP
100
2
1
0
0
-100
-1
-200
-2
-300
-3
-400
-4
-500
-5
-600
-6
-700
-7
-800
-8
-900
-9
-1000
-10
60616263646566676869707172737475767778798081828384858687888990919293949596979899 0 1 2 3 4 5 6 7
Current Account Balance
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Current Account Bal as % of GDP
U.S NET INTERMATIONAL INVESTMENT POSITION
1976 - 2006
Source: BEA, US Department of Commerce
1500
Trillions of U.S. dollars
Percent of GDP
1000
15
10
500
5
0
0
-500
-5
-1000
-10
-1500
-15
-2000
-20
-2500
-25
-3000
-30
76
78
80
82
84
86
88
90
Net Foreign Borrowing
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92
94
96
98
0
Percent of GDP
2
4
6
8
U.S NATIONAL SAVING - INVESTMENT IMBALANCE:
1960 - 2006
Investment Needs Exceed Available Savings: Must Rely on Foreign Savings
25
Percent (%) of GDP
20
15
10
5
0
-5
-10
60
62
64
66
68
70
72
Saving Rate
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74
76
78
80
82
84
Investment Rate
86
88
90
92
94
96
98
Foreign Borrowing
00
02
04
06
U.S CONSUMPTION AND PERSONAL SAVING RATES:
1960 - 2006
Spend More and Save Less: Hakuna Matata!
80
Percent of GDP Consumption Left Scale
Percent of GDP Saving Right Scale
12
75
11
70
10
65
9
60
8
55
7
50
6
45
5
40
4
35
3
30
2
25
1
20
0
60
62
64
66
68
70
72
74
76
78
Consuption as Percent of GDP
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80
82
84
86
88
90
92
94
96
98
Personal Saving Rate
00
02
04
06
U.S TRADE BALANCE AND PERSONAL SAVING RATE:
1960 - 2006
Coincidence? Correlation? or Causation?
12
LS: Personal Saving Rate
Current Account Balance :RS
4
10
2
8
0
6
-2
4
-4
2
-6
0
60
62
64
66
68
70
72
74
76
Personal Saving Rate
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78
80
82
84
86
88
90
92
94
96
Trade Deficit as Percent of GDP
98
00
02
04
06
PRICE OF CRUDE OIL BRENT $/BBL
Oil prices have risen again and they are transferring wealth from oil consuming to oil
producing nations. This time, however, the energy intensity of the world economy is
about half what it was in the 1970s
100
Average Annual Price in USD/BBL
90
80
70
60
50
40
30
20
10
0
61
63
65
67
69
71
73
75
77
79
Current Dollars
Source: BP, Historical Data
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81
83
85
87
89
91
93
2006 Constant Dollars
95
97
99
01
03
05
07
CENTRAL BANK KEY POLICY INTEREST RATES: 2001-2007
As the world’s major central banks raise rates, US is forced to cut, narrowing spreads
and reducing the attractiveness of USD-denominated assets
7
Percent Rates (%)
6
5
4
3
2
1
0
2001
2001
2001
2001
2001
2001
2001
2001
2001
2001
2001
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2002
2002
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2007
2007
CANADA
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USA
EURO
JAPAN
GROWTH IN CENTRAL BANK RESERVES: 1999 - 2007
Developing countries are accummulating unspent balances
from export surpluses Source: IMF COFER
6000
Billions
5500
5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0
1999199919991999200020002000200020012001200120012002200220022002200320032003200320042004200420042005200520052005200620062006200620072007
Total Reserves
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Industrial Countries
Developing Countries
COMPOSITION OF GLOBAL ALLOCATED CENTRAL BANK
RESERVES: 1999 & 2007
Not all central banks report the currency composition of their reserves: 64% are
allocated Although the share of U.S. Dollars is falling, the growth in developing country
central bank reserves is sufficient to finance U.S. trade deficit -for now Source: IMF
COFER
U.S. Dollars
64.8%
U.S. Dollars
71.1%
Other
4.9%
Other
8.0%
GBP Sterling
4.7%
GBP Sterling
2.7%
E.U. Euros
18.1%
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E.U. Euros
25.6%
COMPOSITION OF CANADA’S FOREIGN EXCHANGE RESERVES:
October, 2007
Does Canada’s composition of F/X reserves indicative of the direction that other
central banks in the world are going to follow?
EURO 49.3%
YEN 1.5%
US DOLLARS 49.2%
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Why is the U.S.Dollar Depreciating?
Too many negative factors and mounting loss of confidence
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Huge and unsustainable trade deficit, near 6% of GDP
Huge borrowing from the rest of the world amounting to $2 Billion per day
Deterioration in the U.S. net international investment position with the rest of the world:
US net external indebtedness now over 20% of GDP
Loss of confidence in U.S. financial markets: From Enron & WorldCom to the Fiasco in
the sub-prime mortgage and asset-backed securities market involving securities
totalling $1 trillion dollars
Distressed housing market, rising foreclosures, falling housing prices and recession in
housing construction and automobile industries
Cuts in policy interest rates: The fed funds rate cut by 75 basis points to 4.5%, while
every other central bank in the world is raising policy rates
Deteriorating inflation-adjusted interest differentials with the rest of the world
The growing cost and burden on the U.S. A. of the war on terror and the Iraq War:
estimated by CBO to exceed $1.7 trillion by 2017
Large dependence on increasingly unstable foreign oil: 66% of oil consumed in the U.S.
is imported, most of it from the Middle East at a cost of over $30 billion a year
In August, foreigners sold more U.S. securities than they purchased, the sharpest drop
in many years signaling a loss of appetite in U.S. securities by private foreign investors
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Implications for Current & Future Policy
It is not the end of the world, but the world will change
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Depreciating U.S. dollar will help restore international
competitiveness of U.S exports and help reduce trade deficit,
but it will take time
Will intensify global competition and increase the strain on the
rest of the world's economies, including Canada’s
Will undermine confidence in the U.S. dollar as an international
reserve currency and accelerate the movement away from the
U.S. dollar and toward the Euro
Countries with their currencies pegged to the U.S. dollar will
consider de-pegging and increase the probability that oilexporting countries will start pricing their oil in non-U.S.
currencies, further undermining the role of the U.S. dollar as the
world’s currency
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Implications for Current & Future Policy
Tough choices: Between a Rock and a Hard Place!
 U.S. policy makers will be forced to choose between:
A) a strong dollar which implies higher interest rates and weaker
growth for the economy and
B) a weaker dollar which implies lower interest rates and avoidance
of recession.
 - Raising interest rates to shore the currency may push the U.S.
economy to recession and place downward pressure on equity
prices in the short-run, but will address the problem and set the U.S.
on a course of lower interest rates and faster growth in the long-run.
 - Lowering interest rates to shore up the economy will lead to further
currency depreciation, international monetary instability and errosion
of U.S. economic hegemony in the world and by postponing the
problem, reduce future growth and risk higher inflation and higher
interest rates down the road
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Implications for Current & Future Policy
Short-term Pain for Long-term Gain
A tighter monetary stance to defend the integrity of the
U.S. dollar will facilitate the necessary domestic
adjustment the U.S. needs to undergo in order to restore
the saving rate, reduce senseless consumption, clean up
the financial excesses, reward thrift and industry and
punish excess and speculation. In short restore value and
integrity in the U.S. financial system and the U.S. dollar
Recession is probably the better though not the most
popular option for the U.S. now - The Federal Reserve has
to make a stand: what is its main goal? price stability or
economic growth?
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Implications for Current & Future Policy
Solutions are Available, Is there a Political Will to Act?
One credible and sound means to restore confidence
to the U.S. dollar is to adopt an explicit inflation control
target similar to the one adopted by Canada in 1991
and which the current Chairman of the Federal
Reserve Ben Bernanke has already recommended
that the U.S. central bank adopt
A second measure is the introduction of a gasoline
tax. Such a tax can increase domestic saving, reduce
imported oil, reduce oil dependence and reduce
carbon emissions thus achieving three desirable goals
in one strike: reduce trade deficit, enhance national
security and reduce carbon emissions
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Implications for Canada
Payback Time !!!
In the 1990s while going through its massive
corporate and public finance restructuring
Canada relied on a low dollar policy to keep
its head above water
Now our American neighbours to our South
are counting on us to do the same for them!
Currency re-allignments are exchange of
favours. Now we are being called upon to
repay.
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Implications for Canada
Good for consumers, bad for manufacturers a test for EastWest federal-provincial relations
 Stronger loonie will dampen exports and boost imports, reducing
Canada’s trade surplus
 Intense competition from U.S. imports will compress retail
margins and the tourist industry
 Canadian consumers will benefit from lower prices of tradeable
goods
 Consumer inflation will fall and will help keep interest rates lower
than otherwise
 Stronger loonie will accentuate the divide between resource-rich
Western Canada and manufacturing-intensive Central Canada
 Will complicate the application of national policies as two regions
require different treatment
 Possibility that Central Canada will go into recession as Western
Canada continues to grow
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Implications for Canada
Moderating Factors: Strong Domestic Fundamentals
Moderating the negative effects of a stronger
loonie are:
Strong fiscal balances at the federal and
many provincial levels of government
Strong trade balance and concentration in
resources and energy
Strong corporate balance sheets and high
profit margins
High saving and investment rates
Favourable terms of trade
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Implications for Canada
Will a U.S. Slowdown spread into the global economy or will
Emerging economies (BRIC) pick up the slack?
 The extent of the negative impacts will depend on two factors:
 1. On whether the U.S. economy goes into recession, or not, and
 2. On how the rest of the world economy responds to a recession in
the U.S.
 The U.S. accounts for 25% of GWP and in the past has always
served as the world’s growth engine
 This time it may be different: for the first time in almost 100 years
the rest of the world economy may be resilient enough to weather a
U.S. downturn without provoking a global recession
 In its October WEO forecast the IMF has said that China, India,
Russia and Brazil (BRIC) account for more than 50% of growth in
the planet’s economy
 If the BRIC economies prove resilient enough to withstand a U.S.
downtun, it will be the best-case scenario: it will help buttress the
U.S. economy and help prevent Canada from going into recession
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Implications for Canada and the World
Economy
Global Recession or Global Re-ordering?
 Worst Case Scenario:
 The U.S. economy slides into recession and brings down
the rest of the world’s economy: resource prices fall,
Canada’s terms of trade tumble and expose Canada’s two
vulnerabilities: high concentration in resources and low
productivity growth
 Best Case Scenario:
 Emerging economies take on the lead from the U.S. and
maintain global growth albeit at slower rates, commodity
and energy prices do not collapse, Canada’s terms of trade
do not deteriorate materially enough to expose our
weaknesses and allow the U.S. and Canada’s economy to
make an orderly transition
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The Surge in the Loonie!
U.S. Dollar Weakness
The U.S. Sneezes, the World Falls Sick
It May beTheir Currency,
but it is Our Problem Now!
Portends Further Problems for the U.S. Ahead and Major
Challenges for Canada and the World Economy
We All Have a Stake in a Strong U.S. Economy
Thank You For Your Presence!
The End