the surge in the loonie: canadian dollar strength or u.s. dollar weakness? dr. kenneth matziorinis...
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THE SURGE IN THE LOONIE:
Canadian Dollar Strength or
U.S. Dollar Weakness?
Dr. Kenneth MatziorinisDepartment 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)
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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
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2CAD/USD Exchange Rate
CAD/USD
CURRENCIES THAT HAVE GAINED THE MOST THIS YEAR: Year-To-Date: 2007
Appreciation Against the U.S. Dollar
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CA
NA
DA
Bra
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No
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Au
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Ind
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Th
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T-W
Ma
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Cu
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Eu
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De
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Sw
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Bro
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In
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Ru
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So
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Afr
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Ma
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Ch
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Me
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Ta
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So
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Ko
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0
5
10
15
20
-5
-10
Why Has the Loonie Appreciated?
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
The ONLY NEGATIVE: Canada’s lagging productivity growth
Improvements in Underlying Fundamentals
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CANADA - U.S. CONSUMER PRICE DIVERGENCESince 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%
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1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
20
40
60
80
100
120
140
160
0
1
2
3
4
5
6
7
CANADIAN CPI CAN Inflation U.S. CPI USA Inflation
CANADA’S GOVERNMENT BUDGET BALANCE, 1992 - 2007Canada’s public sector has shifted away from the largest deficits to the
largest budget surplus in G-7
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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
2
4
-2
-4
-6
-8
-10
Surplus (Deficit) % of GDP
All Levels of Government, % of GDP
NATIONAL SAVINGS RATES, CANADA AND THE U.S.A: 1961-2006
The saving gap widens between the two NAFTA neighbors
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62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
0
5
10
15
20
25
30Percent of GDP
0
5
10
15
20
25
30
CANADA U.S.A
CANADA’S CURRENT ACCOUNT BALANCE, 1992 - 2007
As Canada’s national saving rate recovered, Canada’s international trade balance has risen in recent years
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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
1
2
3
-1
-2
-3
-4
-5
Percent of GDP
Current Account Balance
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
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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
0
10
20
-10
-20
-30
-40
-50
Percent of GDP
U.S.A. CANADA
LONG AND SHORT-TERM INTEREST RATES IN CANADA: 1992-2007
The cost of capital in Canada has declined benefiting producers and consumers
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199219921992199219921992199319931993199319931993199419941994199419941994199519951995199519951995199619961996199619961996199719971997199719971997199819981998199819981998199919991999199919991999200020002000200020002000200120012001200120012001200220022002200220022002200320032003200320032003200420042004200420042004200520052005200520052005200620062006200620062006200720072007200720072007
0
1
2
3
4
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6
7
8
9
10
3-M Treasury Bills Long-Term Gov. Bonds
CANADA’S TERMS OF TRADE, 1987 - 2007Since 2002 our export prices have risen faster than our import prices,
improving our terms of trade
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1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
50
60
70
80
90
100
110
120Export & Import Price Indexes (2002 = 100 )
Export Prices Import Prices
COMMODITY PRICE INDEX, 1982-90 = 100, U.S. DOLLAR TERMS
Commodity prices have surged led by the price of energy
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1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
50
100
150
200
250
300
Total Total Excl Energy Energy Food Industrial Materials
U.S.DOLLAR PERCENT DEPRECIATION AGAINST MAJOR BENCHMARKS
The Loonie is not the only currency being lifted
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Year-to-DateJanuary 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%
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
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
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8USD/CAD Exchange Rate
USD/CAD
U.S.TRADE WEIGHTED EXCHANGE INDEX: Broad Basket of Currencies
Source: Board of Governors of the Federal Reserve System (1973 = 100.0)
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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
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
Trade Weighted Exchange Index - Broad
U.S.TRADE WEIGHTED EXCHANGE INDEX: Major Currencies
Source: Board of Governors of the Federal Reserve System (1973 = 100.0)
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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
60
70
80
90
100
110
120
130
140
150
160
Trade Weighted Major Currency Index
U.S DOLLAR DEPRECIATION SINCE FEBRUARY 2002
Percent (%) Decline in the Value of the US Dollar Since Recent Peak
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Eu
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CA
NA
DA
No
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So
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Afr
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Au
str
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a
Ne
w Z
ea
lan
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0
5
10
15
20
-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!
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
0
100
200
300
400
500
600
700
800
900
1000U.S. Dollar Price per Ounce
Source: World Gold Council Canbek Economic Consultants Inc.
U.S.Dollar
U.S. CURRENT ACCOUNT DEFICIT1960 - 2007
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60616263646566676869707172737475767778798081828384858687888990919293949596979899 0 1 2 3 4 5 6 7
0
100
200
-100
-200
-300
-400
-500
-600
-700
-800
-900
-1000
Current A/C Balance, Bil of USD
0
1
2
-1
-2
-3
-4
-5
-6
-7
-8
-9
-10
Current A/C Balance as % of GDP
Current Account Balance Current Account Bal as % of GDP
U.S NET INTERMATIONAL INVESTMENT POSITION1976 - 2006
Source: BEA, US Department of Commerce
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76 78 80 82 84 86 88 90 92 94 96 98 0 2 4 6 8
0
500
1000
1500
-500
-1000
-1500
-2000
-2500
-3000
Trillions of U.S. dollars
0
5
10
15
-5
-10
-15
-20
-25
-30
Percent of GDP
Net Foreign Borrowing Percent of GDP
U.S NATIONAL SAVING - INVESTMENT IMBALANCE: 1960 - 2006
Investment Needs Exceed Available Savings: Must Rely on Foreign Savings
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60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
0
5
10
15
20
25
-5
-10
Percent (%) of GDP
Saving Rate Investment Rate Foreign Borrowing
U.S CONSUMPTION AND PERSONAL SAVING RATES: 1960 - 2006
Spend More and Save Less: Hakuna Matata!
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60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
20
25
30
35
40
45
50
55
60
65
70
75
80Percent of GDP Consumption Left Scale
0
1
2
3
4
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6
7
8
9
10
11
12Percent of GDP Saving Right Scale
Consuption as Percent of GDP Personal Saving Rate
U.S TRADE BALANCE AND PERSONAL SAVING RATE: 1960 - 2006
Coincidence? Correlation? or Causation?
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60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
0
2
4
6
8
10
12LS: Personal Saving Rate
0
2
4
-2
-4
-6
Current Account Balance :RS
Personal Saving Rate Trade Deficit as Percent of GDP
PRICE OF CRUDE OIL BRENT $/BBLOil 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
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
0
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20
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40
50
60
70
80
90
100Average Annual Price in USD/BBL
Source: BP, Historical Data Canbek Economic Consultants Inc.
Current Dollars 2006 Constant Dollars
CENTRAL BANK KEY POLICY INTEREST RATES: 2001-2007As the world’s major central banks raise rates, US is forced to cut, narrowing spreads
and reducing the attractiveness of USD-denominated assets
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200120012001200120012001200120012001200120012001200220022002200220022002200220022002200220022002200320032003200320032003200320032003200320032003200420042004200420042004200420042004200420042004200520052005200520052005200520052005200520052005200620062006200620062006200620062006200620062006200720072007200720072007200720072007200720072007
0
1
2
3
4
5
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7Percent Rates (%)
CANADA USA EURO JAPAN
GROWTH IN CENTRAL BANK RESERVES: 1999 - 2007Developing countries are accummulating unspent balances
from export surpluses Source: IMF COFER
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1999199919991999200020002000200020012001200120012002200220022002200320032003200320042004200420042005200520052005200620062006200620072007
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
5500
6000Billions
Total Reserves 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
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U.S. Dollars71.1%
E.U. Euros18.1%
GBP Sterling2.7%
Other8.0%
U.S. Dollars64.8%
E.U. Euros25.6%
GBP Sterling4.7%
Other4.9%
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?
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EURO 49.3%
US DOLLARS 49.2%
YEN 1.5%
Why is the U.S.Dollar Depreciating?
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
Too many negative factors and mounting loss of confidence
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Implications for Current & Future Policy
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 oil-exporting 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
It is not the end of the world, but the world will change
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Implications for Current & Future Policy
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
Tough choices: Between a Rock and a Hard Place!
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Implications for Current & Future Policy
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?
Short-term Pain for Long-term Gain
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Implications for Current & Future Policy
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
Solutions are Available, Is there a Political Will to Act?
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Implications for Canada
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.
Payback Time !!!
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Implications for Canada
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
Good for consumers, bad for manufacturers a test for East-West federal-provincial relations
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Implications for Canada
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
Moderating Factors: Strong Domestic Fundamentals
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Implications for Canada
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
Will a U.S. Slowdown spread into the global economy or will Emerging economies (BRIC) pick up the slack?
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Implications for Canada and the World Economy
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
Global Recession or Global Re-ordering?
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The Surge in the Loonie!U.S. Dollar Weakness
The U.S. Sneezes, the World Falls SickIt 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
The End
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