the surge in the loonie: canadian dollar strength or u.s. dollar weakness? dr. kenneth matziorinis...

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)

Canbek Economic Consultants Inc.

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


CA

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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


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%


1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

20

40

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160

0

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6

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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


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


62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

0

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30Percent of GDP

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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

Canbek Economics Consultants Inc.

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


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

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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


199219921992199219921992199319931993199319931993199419941994199419941994199519951995199519951995199619961996199619961996199719971997199719971997199819981998199819981998199919991999199919991999200020002000200020002000200120012001200120012001200220022002200220022002200320032003200320032003200420042004200420042004200520052005200520052005200620062006200620062006200720072007200720072007

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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


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


1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

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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


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)


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

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20

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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)


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

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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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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

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600

700

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1000U.S. Dollar Price per Ounce

Source: World Gold Council Canbek Economic Consultants Inc.

U.S.Dollar

U.S. CURRENT ACCOUNT DEFICIT1960 - 2007


60616263646566676869707172737475767778798081828384858687888990919293949596979899 0 1 2 3 4 5 6 7

0

100

200

-100

-200

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-1000

Current A/C Balance, Bil of USD

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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

Canbek Economic Consultants

76 78 80 82 84 86 88 90 92 94 96 98 0 2 4 6 8

0

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1000

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Trillions of U.S. dollars

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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


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

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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!


60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

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80Percent of GDP Consumption Left Scale

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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?


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

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6

8

10

12LS: Personal Saving Rate

0

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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

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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


200120012001200120012001200120012001200120012001200220022002200220022002200220022002200220022002200320032003200320032003200320032003200320032003200420042004200420042004200420042004200420042004200520052005200520052005200520052005200520052005200620062006200620062006200620062006200620062006200720072007200720072007200720072007200720072007

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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

Canbek Economics Consultants

1999199919991999200020002000200020012001200120012002200220022002200320032003200320042004200420042005200520052005200620062006200620072007

0

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1000

1500

2000

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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


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?


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


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



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!



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



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?


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 !!!



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



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



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?


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?

Canbek Economics Consultants Inc.

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

Thank You For Your Presence!

the surge in the loonie: canadian dollar strength or u.s. dollar weakness? dr. kenneth matziorinis...

Documents

gdp slide

canadian prices

canadian loonie

gdp increase

canadas national saving

percent of gdp

canadas terms of trade

canadas public sector