Chartered Banks Go Loonie
Debate is heating up about whether the Bank of Canada should or will intervene in currency markets to lower the Canadian dollar (as I have been proposing for three months). Todayâ€™s two-cent drop in theÂ exchange rateÂ may indicate that currency traders are anticipating this possibility.
Over at Worthwhile Canadian Initiative, Stephen Gordon objected to recent comments from RBCâ€™s Patricia Croft on The National. She said that the Bank of Canadaâ€™s reserves are too small to affect global currency markets.
Of course, as professor Gordon points out, the Bank of Canada actually has unlimited reserves of Canadian dollars to sell. Limited reserves of foreign currency would only constrain the central bank from doing the opposite: buying Canadian dollars to raise the loonieâ€™s value.
Gordon characterizes Croftâ€™s comments as a striking gaffe. But what strikes me is that her comments were entirely consistent with those of other chartered-bank economists.
Indeed, my original post on this subject responded to a Financial Post column by two TD economists claiming, â€œThe Bank of Canada is too small to have the desired effect on the FX market via intervention. Canadaâ€™s currency reserve ranks only 33rd in the world . . .â€
Scotiabankâ€™s Derek Holt went further: â€œIf youâ€™re the Bank of Canada trying to lean against global foreign exchange markets, good luck. Youâ€™re setting yourself up to have your head handed to you.â€
Of course, there is a legitimate argument against lowering the exchange rate. Other things being equal, a higher loonie reduces consumer prices in Canada (although exchange rates are only partially passed-through to consumers). This argument is not especially persuasive given that consumer-price inflation is already negative.
On the other hand, the loonieâ€™s rise squeezes Canadaâ€™s producers, who buy most of their inputs at Canadian-dollar prices but sell much of their output at US-dollar prices. (While Canadian-based producers import many inputs, very few have a greater proportion of inputs than of output priced in foreign currency.)
Rather than debate the desirability of lowering the Canadian dollar, many chartered-bank economists are trying to deny the feasibility of lowering it. They ignore or dismiss the Bank of Canadaâ€™s capacity to expand the supply of Canadian dollars, even though the central bank itself has repeatedly alluded to this capacity.
Why would chartered banks want to rule out the possibility of lowering the loonie?Â Perhaps these well-capitalized institutions see the financial meltdownâ€™s wreckage as an opportunity to expand abroad. As the Canadian dollar rises, acquiring non-Canadian assets becomes cheaper.
More generally, a countryâ€™s financial sector usually prefers its national currency to be stronger. For example, banks would rather have their loans repaid in strong dollars than in devalued dollars.
A major theme in Britainâ€™s economic history is that, while British industry needed lower exchange rates to compete in world markets, its financial sector (â€œThe Cityâ€) pushed the government to keep the pound overvalued. Similarly, the US financial sector historically advanced a â€œstrong dollarâ€ policy, often to the detriment of American industry.
The chartered-bank line on the loonie seems to reflect a similar conflict of interest between Canadian finance and Canadian industry. The key question is which side the Bank of Canada will come down on. We could have an answer as early as Thursdayâ€™s Monetary Policy Report.