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?

Could Carney Be Wrong

Mark Carney the Bank of Canada’s Governor has been one of the most vocal central bankers Canada has yet seen. He intervenes in the media often and repeatedly about some of his worries concerning the health of the Canadian economy. His chief worries revolve around three subjects broadly vassal to the theme of international competitiveness. The first of his worries is that Canadian manufacturers aren’t using the combination of low interest rates and high Canadian dollar to invest in cheap foreign capital goods. His second ”keep me up at night” issue is that of Canadian businesses’ low exposure to rapidly developing countries and over exposure to stagnant markets. His third problem and dilemma is that of rapidly escalating household debt load. While not explicitly saying so, Carney’s fear is that Canada will increasingly ressemble the pre-crisis US; a debt saddled and internationally uncompetitive economy. Commentators have been doing a fair bit of wall painting by noting that Canadian Households are second in indebtedness in the G7+BRIC category. Economic nationalists regularly plaster business newspapers with doomsday scenarios foreshadowed by Canada’s perennially lagging productivity. Alright, let’s breath… wait a minute and think about this.

It is a little funny that Carney’s most recent musings about Canadian manufacturers and business came less than a week after the latest numbers of the Canadian Survey of Business Investments . The survey’s data reveals that new capital expenditure (read fixed capital formation) is expected to run at the fourth highest clip in over two decades, only failing to surpass the dotcom bubble fueled investment mania at the turn of the millennium. One would have thought that the BoC Governor would have taken note of such a survey. It seems that manufacturers were just waiting for the Goldilocks’s moment of low interest rates, easy lending conditions and better international sales prospects to start investing. A traditional Canadian conservative way of doing business, one that served Canada’s financial sector well during the crisis. In any case with Chairmen Bernanke of the Fed’s pledge to keep interest rates near zero through 2014, Canadian manufacturers probably expect their low rates + high currency combo to persist a while longer, so what’s the big rush to invest? As noted above business investment isn’t our central bankers only preoccupation. Our aversion to developing nations export markets tick’s him off as well.

When it comes to Canadian exporters’ choice of export markets, I propose that bureaucrats who have never managed anything other than a hyped up economic think tank (say a central bank) or sovereign debt investment bank department (say at Goldman Sach’s), stay out of real businessmen’s head. When Mark Carney proposes exporters start doing business with emerging markets, which ones is he talking about? Is he talking about Russia? a country where ex-KGB mafia is indistinguishable from the oligarchical business class and where the contracts you sign are only as good as the prevailing mood of the Kremlin? Is he talking about Brazil? Brazil a country where if your company spills a drop of oil in the ocean your executives risk loosing their passports and being prosecuted by only thinly-veiled xenophobia infected local prosecutors. Maybe, he meant China? That very same country that will toss Rio Tinto executives in jail just to squeeze a better deal out of those executives’ native country and supposed business ally Australia. International business is a tough business in itself, why don’t we let those entrepreneurs that have first hand experience decide when they want to abandon the largest markets of the World (Japan, US and Europe) for some of the riskiest markets on Earth.

We’re left to examine the remaining entry on the Carney sin list. Our profligacy and lack of thriftiness. So Canadian household debt levels have jumped to never before seen heights. With interest rates at a historic low this is to be expected. The number however only gives an incomplete picture of Canadian households’ health. Household average debt says nothing about the distribution of that debt. In the US, the subprime crisis became a crisis because debtors were at or not far away from the bottom of the income distribution. In Canada most of the ongoing issuance of debt is for mortgages, and less than 9% of Canadians have less than 10% equity in their homes. If we add the two together it says that on average wealthy Canadians are the one’s increasing their average debt load, since homeowners that own a decent amount of home equity are generally well off. Something which makes sense as most wealthy Canadians do not need to indebt themselves to live, whether they choose to invest when their financing costs go through the floor is a whole other ball game. Maybe commentators want to come out with more data on the distribution of indebtedness in Canada before alarming national rate strategist.

The accusation that Canada is uncompetitive however is rooted in other numbers than simply those on indebtedness or exposure to this or that foreign market; it is rooted in the fact that on an aggregate level more Canadian workers working longer hours have not been producing as much. The US has seen its per worker productivity increase faster than Canada’s for much of the last few decades. Something that we should all be worried about in normal circumstances. Canada is not living in normal circumstances. Canada is in the midst of reallocating some of its labour and capital resources to a sector where it actually holds a comparative advantage. For the last few years Canada’s workers, corporations, entrepreneurs and capital markets have been investing time and effort in developing its valuable natural resources. There are very long lags between payoff and investment for some of Canada largest most capital intensive projects. The Business Investment Survey forecasts fixed capital formation in the resource extraction industries will beat the record set last year by $13 Billion dollars. For now this money creates little revenue, profits or exports but 3, 5, 10 years down the line expect to see GDP jump. Building Oil Sands steam assisted gravity drainage mines takes years, likewise BHP Billiton’s Jansen potash mine wont be operational for years. The Canadian mining landscape is only now starting to bubble, when it starts to boil those productivity numbers we spend so much time worrying about will become jokes. All in all Canada is shifting. The economic landscape we now see will not be the same. Mr Carney rest easy, Canada’s households and entrepreneurs have got this one under control.