Here’s a Suggestion Mr Carney

The governor of the Bank of Canada Mark Carney has again continued to scold and give lessons to Canadians. He does this in his Monetary Policy Report of April 2012 where he reiterates some of the comments this blog criticized in a previous post. Those comments were that Canadian exporters needed to retool and refocus and that Canadian consumers needed to slow their pace of debt accumulation. The focus of the ‘retool, refocus and retrain’ mantra is largely advocated so as to increase Canadian firm’s ability to compete internationally and export. While this blog has already stated its objection to paternalistic economic communication from government institutions towards the private sector, this blog does accept Carney’s view that Canadian prosperity is underpinned by healthy trade numbers and international competitiveness. There is one criticism the Governor could have levelled that balances private sector independence and improved competitiveness, that critic should be less debt supply and it should be levelled at governments.

Talk of trade competitiveness unfortunately always boils down to currencies. In Canada manufacturers and commentators are always complain about the high Canadian dollar and how many jobs it kills. Leaving aside the fact that a high currency has as many benefits for a country as it has costs, a currency artificially above its equilibrium (or below it for that matter) is however  a concern. Let’s assume that the Canadian dollar is artificially overvalue, who might the culprit be for this imbalance? The Loonie isn’t a reserve currency so that can’t be it. Contrarily to McGuinty’s opinion oil isn’t to blame either. As the Central Bank report notes, Canadian oil is sold at a steep discount to certain international oil benchmarks, meaning that eastern Canada imports at high prices while the west exports at cheap prices, so the impact of higher oil prices only marginally affects the Canadian currency. In any case studies have refuted the claim of the Loonie being a petro-dollar. So who exactly is contributing to the Canadian dollar remaining above par with the US dollar?

To answer that question the certain economic facts need to be reviewed. Commentaries on trade and currencies often emphasize a restricted number of causes for currency fluctuations. Currency movements need to be understood in terms of foreign exchange market equilibrium. Every currency trade impacts the prevailing exchange rate but every trade does not just involve a quick speculation or an oil contract purchase. Much purchasing and selling of currencies involves savings diversification by institutional money managers. To give some colour to this point in 2007 before the crisis hit, foreigners shed roughly ~10 Billion of government paper while exporters sold just over 460 Billion dollars of exports. Since the beginning of the crisis over 400 Billion of Canadian government financial papers have been sold to foreigners. What does all this mean? Government budget surplus reduces the supply of government debt available to foreigners for purchase, a government deficit increases the supply. Since foreigners must buy Canadian dollars to purchase both export goods and government debt, Canadian governments’ profligacies are partially to blame for the high Canadian dollar. Part of their issuance of debt has been sold to foreigners increasing the demand for the Loonie and crowding out exports of goods and services.

Some might be tempted to point to Europe to refute these assertions. They would note Europe’s deficits have widened since 08 while the Euro has generally fallen. This is easily explained by sovereign risk. Canadian government debt is perceived to be a safe investment while much of the Euro area’s debts are considered very risky. Investors the World over generally prefer to buy Canadian debts than those from the PIIGS as they could be described as better quality products. Essentially Canada’s two most popular exports have now become oil and debt, small wonder manufacturing in Ontario can’t keep up. So if Mark Carney is so considered with the twin problem of profligacy and competitive weakness why isn’t he calling for Government austerity?