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). Today’s two-cent drop in the exchange rate may indicate that currency traders are anticipating this possibility.

Over at Worthwhile Canadian Initiative, Stephen Gordon objected to recent comments from RBC’s Patricia Croft on The National. She said that the Bank of Canada’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 loonie’s value.

Gordon characterizes Croft’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, “The Bank of Canada is too small to have the desired effect on the FX market via intervention. Canada’s currency reserve ranks only 33rd in the world . . .”

Scotiabank’s Derek Holt went further: “If you’re the Bank of Canada trying to lean against global foreign exchange markets, good luck. You’re setting yourself up to have your head handed to you.”

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 loonie’s rise squeezes Canada’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 Canada’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? Perhaps these well-capitalized institutions see the financial meltdown’s wreckage as an opportunity to expand abroad. As the Canadian dollar rises, acquiring non-Canadian assets becomes cheaper.

More generally, a country’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 Britain’s economic history is that, while British industry needed lower exchange rates to compete in world markets, its financial sector (“The City”) pushed the government to keep the pound overvalued. Similarly, the US financial sector historically advanced a “strong dollar” 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 Thursday’s Monetary Policy Report.

13 comments

  • Huh. I hadn’t realised that so many other private sector economists have made the same mistake.

  • Erin ok but why are you just focussing on the BOC? Exchange rates are not really in their mandate in any direct way. And you would have to believe the bank has the stones to weigh into fx markets. This on top of what you argue would be contrary to the interests of commercial banks. If I were a currency trader I would be betting against the likely-hood of the BOC doing any thing more than rattling its sharp stick.

    So why not go the Brazil route and demand that finance slap a 2% tax on inward portfolio investment? I would go one step further and demand and additional 2% tax on all inward bound investment in the oil and gas sector.

    If you were to get an opposition party to demand such a policy it might have the effect of giving the BOC some resolve to move into fx markets given the alternative of what effectively amounts to capital controls–which are way more taboo than fx manoeuvres.

  • Simply amazing that somebody like Croft can climb that high and be that uneducated in such subject matter.

    She is either purposely misleading the public or is just that ahhhh ahhh, upidstay (latin)? Wow, she is dangerous for Canada- somebody should put a WHMIS label on her.

    The funny thing is, the way Carney was talking you could almost see Haprer’s froth on him. He sounded quite desperate to do something about the dollar. I think Harper realizes that this rise in the dollar- if it stays around- will lead the economy off the cliff again.

    As Jim points out and I think it is pretty much in agreement on the blog, that without an engine to drive the economy appearing on the radar, this fledgling respite in the downward trajectory, is quite delicate. Things like a through the roof dollar will be disasterous.

    As we have stated on here and least I did anayway, there is no real fear of a high Cdn$ as long as it appreciates over the long run. Bouncing around at the whim of speculators is about as constructive as collapsing falsework on a bridge being built to somewhere.

    Anybody read Gary Geddes latest poetry collection called Falsework- a poetic account of the collapse of the Second Narrows Bridge in Vancouver circa 1958- such a good piece of literature.

  • Paul wrote:

    “The funny thing is, the way Carney was talking you could almost see Haprer’s froth on him. He sounded quite desperate to do something about the dollar. I think Harper realizes that this rise in the dollar- if it stays around- will lead the economy off the cliff again.”

    I rather read it as smoke and mirrors. What they want to be seen as is concerned when in reality neither man gives a tosh about the manufacturing sector. In their minds it is an overly unionised sector of the economy that got fat on cheap exchange rates and inefficient union contracts. In their minds a couple of years in decline will simply lay the basis for recovery. Both men are deeply committed to the ontological proposition that capitalism most always leads to best outcomes and that the state only should intervene to shore up this ontological vision.

    The tail is and has been wagging the dog for the better part of thirty years.

    I notice the CAD is already up today. Waiting for the close at the end of the week to see what all this jaw jaw has amounted to.

  • Travis, on your first comment, I must disagree with the suggestion that exchange rates are not part of the central bank’s mandate. The Bank of Canada Act preamble begins, “Whereas it is desirable to establish a central bank in Canada . . . to control and protect the external value of the national monetary unit.”

    However, I agree that capturing more resource rents for the Canadian public would also help to stem the inflow of hot money to buy Canadian resource companies. Furthermore, these approaches are not mutually exclusive.

    Intervention in currency markets is something the Bank of Canada could do right now to moderate the exchange rate, at least temporarily. An overhaul of Canadian resource and/or foreign-ownership policies would take longer, but would also have more profound effects.

  • “Whereas it is desirable to establish a central bank in Canada . . . to control and protect the external value of the national monetary unit.”

    Man that is more vague than S1 of the Charter: you could drive a fascist bus through the charter with S1. At least we have the OAKS test to mitigate the vagaries of S1. No such equvalent exists for the preamble to the enabling legislation for the BOC.

    External value???? and your talking to someone who is more than sympathetic to a price value distinction. External value. The Bank could simply argue that staying out of fx markets is the only way to preserve the medium to long term value of the CDN dollar. Value is nebulous here.

    But like I said, sometimes the threat of a bigger stick makes a smaller stick seem more credible and palatable. Imagine the following:

    “The Government of Canada announced today that it is preparing legislation to be introduced into the house in two months time that would levy tax on inward portfolio investment and a surcharge on all inward bound oil and gas investment should the relative value of the dollar not decline to acceptable levels in the next 60 days.”

    Now those bright lads over at the BOC would be forced to interpret their vague preamble in a very definite way and might feel that intervening in fx markets would, given the alternative of capital controls, “protect the external value of the national monetary unit.”

  • Really Travis?

    You could be right. I would have thought that at some point Harper’s political future would come barking at him like a starving mad dog that the manufacturing sector has become. But alas you could be right, as I do realize they are idealogues. I just was thinking Harper might have saw the political lights of a declining manufacturing sector.

    But then again he is so concerned with image rather than substance- to try and make him look good during this recession. Quite smug really- maybe as I stated this will be the nailing of his coffin.

    Gee I was actually thinking he had somekind of emotion in him- and finally saw the light and got the bank going. Him playing a Beatles song, i guess the artists are right- interpretation is in the eye of the beholder, cause being a libertarian and actually understanding the words to the song he sang just is not rational on any level.

    Anyway I will take your brain under consideration Travis and let my libertarian thoughts of Harper become more relentlessly progressive!

    I do also agree that we need a lot more policy outside of the BoC to help curtail the rapid accent.

  • Travis, we can debate Section 1 of the Charter another time.

    The Bank of Canada Act’s preamble obviously does not stipulate what policy, if any, should be applied to exchange rates. However, it does define the central bank’s mandate to include exchange rates.

  • Erin, thankfully we don’t really ever have to debate S1 because of the OAKS test. We could could debate the OAKS test but I take your point.

    As I originally said “in any direct way.” You take the preamble to mean they do in a direct way although admit there is no substantive content to that. Gordon has made the point they have almost infinite means to do so (as far as devaluation is concerned). I am focussing on why I do not think they will and why it would probably be productive to think about an end run around the BOC.

    Ever since its early (failed) monetarist experiments the BOC has made it clear it really sees its only responsibility to price stability. And practice has further shown that it really only means in the face of mild to strong inflation but not mild deflation. I just can”t see them intervening in fx markets in what would largely be read as a policy of competitive devaluation etc. etc.

    Anyway we do not disagree on the policy outcome we want to see just the most practicable way to get there. I suppose we will just have to wait and see.

  • Ok. I think we can agree on the following two facts:

    1. The Act’s preamble clearly identifies exchange rates as part of the mandate.

    2. Canadian central bankers have defined inflation control as their only mandate.

    I fear saying that the first has “no substantive content” or does not apply “in any direct way” legitimizes the second. Instead, we need to reassert that the Bank of Canada has some responsibility for exchange rates, employment, financial stability, etc.

    At the same time, I take your point that we cannot rely on our current central bankers to solve the exchange-rate problem. Therefore, it makes sense to also advance policies that would moderate the loonie without action from the Bank of Canada.

  • Agreed. I have long since dreamed of something like the following being uttered in the house of commons by the leader of one of the opposition parties:

    “The BOC must understand that it too requires a charter to conduct its affairs and that is called the Bank of Canada Act. The Governor of the BOC should be further reminded that the enabling legislation is just that: a simple piece of legislation enacted by the Parliament in furtherance of the public interest. What parliament gives with one hand it always free to take away with the other should it deem the public interest not adequately served.”

    Such heresy will of course never be spoken.

    It is not the churches which rise from the centre of the city scape but rather the banks. There is but one pope and he sits not in Rome.

    We should go looking for a private member with low future political ambitions.

  • There are always winners and losers whenever the exchange rate changes, and there are different causes of the rates to change (meaning that the same observed rise or fall in the loonie has different implications for Canadians under different conditions).

    This is really part of the argument in favor of fixing or pegging the exchange rate or allowing it to fluctuate within a band of acceptable ranges. If this is pursued, however, the Bank foregoes some of its control in other areas – interest rates and inflation.

    Without a deeper understanding about what is wrong with the Canadian economy, and a much needed discussion over where it should be headed, it is difficult to assess which public policy instruments are the best road to get us there. I suspect that part of the problem in this crisis and the generation leading up to it has been the consistent tendency to not have an overall long term vision about having an economy that grows such that most enjoy some of the benefits including the ability to provide better quality government goods and services for a more affluent society.

    While I disagree with Charters Banks statements that we cannot influence the exchange rate due to the size of the markets, we also do not have a limitless ability to simply print more dollars. The Bank does face market limits in what it can do and most ordinary people saving their loonies in the bin do not want to see their savings eroded by a governemnt printing press. The interest rate is already low and this serves to restrict, to some degree, the options available. True, we don’t have to buy huge volumes of foreign currencies to change the exchange rate, we can sell more loonies, but the policy options still face a challenging set of limits in the current setting, all of which of course involves trade offs – I just think they are more difficult than under more robust economic conditions.

  • Unless you see the US FED raise rates themselves in the third quarter of next year which (I dont think they will) and taking into account as Berrie Hebb states “The Bank does face market limits in what it can do and most ordinary people saving their loonies in the bin do not want to see their savings eroded by a governemnt printing press.” and go on to say their would be an unacceptable level that if the CAD hit would be equaling damaging. The US dollar could also keep falling outside that limit then what do we do. it all hinges on the FED raising rates at some point but they can sell us dollars on the market a lot more then we can and have and who knows when that will stop and the US dollar has not hit a bottom yet.

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