Loonie Out of Control

The loonie’s spectacular flight toward parity with the greenback (and likely beyond) seems to know no bounds.  It’s climbed by over 25 percent in 7 months; its flight began the same day global stock markets turned the corner back in March.  There’s no reason why this appreciation, the steepest in our history, should stop at mere parity.  Exporters, beware.

Economists agree now that exchange rates are a financial variable, not a real variable.  In other words, they are determined by shifts in a stock equilibrium in an asset market, rather than by a flow equilbrium in real markets (for tradeable products, direct investment, or whatever).

Thus the key problem we face is that hot-money financial traders have too much money to place fleeting bets on different denominations of assets.  The real economy where we must work, produce, and — yes — export, is second fiddle.  I am not in favour of pegging our dollar to the greenback, nor of a common currency.  The real solution starts with questioning why we’ve given financial traders so much leeway to play with so much money.  Reigning in those paper markets, limiting how much money sloshes around and where it is allowed to slosh, would open the door to having exchange rates determined on more sensible, real factors.

In the interim, however, in order to reduce the global demand among financiers for Canadian-dolar-denomianted assets, we need to “shock” their positive view of Canada.  (In that regard, my tongue-in-cheek suggestion to appoint yours truly as the next Bank of Canada governor is only half in jest.  A sudden renewal of Quebec separatism, or a massive accumulation of public debt, would do the trick just as well!)  Our low corporate taxes, our capital-friendly political environment, and above all our uniquely hands-off approach to managing our vast mineral resources (especially oil), are key structural factors behind the appeal of Canadian assets.  Merely announcing that we were changing tack on those fronts, would send enough financiers heading for the exits to accomplish the desired depreciation.

In general, I think the role of monetary policy in explaining the current appreication and/or arranging for its reversal is overemphasized.  I think the deeper structural remaking of Canada’s economy (more business-friendly in general, and more resource-oriented in specific) is the bigger culprit.  We made this point first in the CAW’s submission to the 2007 Competition Policy Review Panel (the “Red Wilson” panel), and I think it’s still valid.  Here’s the link to the full submission:

http://www.caw.ca/en/a-productive-economy-submission-to-competition-policy-review-panel.htm

And here’s my current Globe and Mail column on the loonie’s flight, where I humbly offer my services as leader of the most important economic institution in the land (check out the stunning factoids about the de-globalization of Canada’s GDP):

How to Rein in the Loonie?  Appoint Me!

by Jim Stanford

            March 10 was the day the CEO of Citibank announced his bank was profitable again, igniting a global rally that’s boosted stock markets by 50 percent or more.  Unfortunately, March 10 was also the day the loonie began what has become the fastest, biggest upswing in its history.

            From 77 cents (U.S.) in March, the loonie has rocketed up 25 percent, blasting through 96 cents by Thanksgiving Monday.  It won’t be long before our loonie’s worth more than the U.S. greenback.  That may cause a certain nostalgic smugness among some old-timers (who remember when “a dollar was a dollar”).  But it’s unequivocally bad news for our economy.

            Fair value for our currency, based on purchasing power, is in the low-80s (U.S.).  So Canadian-made products are already artificially overpriced by 20 percent; that will get worse in the months ahead.  No wonder Canadian exports, stagnant for years, have plunged another 10 percent this year.  Statistics Canada announced Friday that our monthly trade deficit reached $2 billion in August – the worst on record.  On this basis, the loonie should be sinking, not flying.

            Here’s a stunning little factoid showing how Canada’s once-vaunted trade position has utterly collapsed amidst both the global financial crisis and the ongoing gritty extension of no-holds-barred globalization.  Exports of goods and services accounted for just 27.7 percent of our GDP in the second quarter of this year.  That’s down 3 percentage points in the quarter, and over 8 percentage points in the last year.  This (admittedly crude) measure of export intensity has fallen almost 20 points since its pre-9-11 peak (of 47 percent in 2000).  Exports now account for the lowest share of Canada’s GDP since 1992 (when the country’s industries were still painfully adjusting to free trade), and we are less export-dependent than we were in 1980.  This is an astounding shift in the composition of our economic activity, that has gone virtually unnoticed.  Unless this traditional reliance on exports is replaced, quickly and permanently, by other economic drivers (like long-run increases, secular not cyclical, in public spending???), we will be driving an economic car without an engine.

            How do we explain the take-off of the loonie, despite these grim trade realities?  It certainly has nothing to do with fundamentals, the real factors economists used to think determined exchange rates (like competitiveness, trade performance, productivity).  Our international trade performance has never been worse.  All our exports (other than oil and minerals) are losing customers.  And our productivity growth is negative.  No, it’s a massive financial mood swing, not economic reality, that explains the loonie’s rocketing ascent.

            It’s cold comfort to note that part of the problem is U.S. dollar weakness (not just the loonie’s strength).  Yes, other currencies are also rising against the greenback – but ours is rising faster.  Since March the loonie has soared twice as much as the yen, and half-again as much as the euro.  Yet we are far more dependent on exports to the U.S. than Asia or Europe.  Mexico is the other economy integrally tied to the U.S., yet its peso has gone nowhere this year.  So Canada is being priced out of all markets, global and North American.

            Bank of Canada Governor Mark Carney agrees the loonie is seriously threatening our recovery.  We’ve got to bring it back to earth.  The question is, how?  Mr. Carney tried jawboning the dollar down, with half-hearted results.  Pledging to keep interest rates near-zero, and finding other ways to boost money supply and prices, would help.  But that ignores the true source of the problem: financial speculators using our currency as a way to bet on the future escalation of oil prices.

            That’s why we’ve got to rethink the fundamental direction of our economic and energy strategies.  Canada has as much oil as Saudi Arabia.  Yet we’re the only major oil exporter in the world with a completely hands-off approach to managing the ownership, development, and export of this resource.  That’s what’s sparked such obsession among global financiers in our mineral resources – which, after all, only account for a couple of percentage points of our GDP.

            So to rein in the loonie, we must rein in the oil export juggernaut that is squeezing out all other exports.  Use environmental and planning approvals to slow down new development.  Tax petroleum profits.  Above all, reimpose sensible limits on foreign takeovers of resource assets.  All that would cool off the loonie in no time.

            Even deeper, we’ll want to rethink all that power we’ve given hot-money traders over this most important price.  They have too much money to play with, making unproductive bets on asset prices – and meanwhile our whole economy gets dragged along for the ride.  Regulating hedge funds and other speculators (constraining their funds, and regulating what they’re allowed to do with them) would restore some stability and rationality to foreign exchange markets.

            Finally, here’s how to seal the deal.  Appoint me as the next Bank of Canada governor.  That’d knock 25 cents off the loonie overnight.