Japan Shows Us The Way
A week ago, Paul Krugman wrote that Japanâ€™s stable if sluggish economy and low unemployment could start looking pretty good compared to the Voodoo economics advocated by US Republicans. The counterintuitive case for Japan as an economic model just became more compelling with the Bank of Japanâ€™s intervention to lower the yen. As reported on the front page of todayâ€™s Report on Business:
Critics of the free-market approach to exchange rates welcomed Japanâ€™s apparent abandonment of that orthodoxy. â€œThe Bank of Canada should do the same thing,â€ said Erin Weir, an economist at the United Steelworkers union in Toronto, who has argued that officials in Ottawa should intervene to weaken Canadaâ€™s dollar. â€œJapanâ€™s actions confirm my point that currency devaluation is a viable option.â€
At 97 US cents, the Canadian dollar is significantly overvalued. The OECDâ€™s latest figures indicate that the domestic purchasing power of a loonie equals 85 US cents. So, todayâ€™s exchange rate gives foreign-made products a cost advantage of up to 14% versus Canadian-made products.
The obvious consequence is a big trade deficit. A deteriorating trade balance was the main cause of Canadaâ€™s economic slowdown in the second quarter. Statistics Canadaâ€™s last Labour Force Survey reported job losses in industries sensitive to the exchange rate.
The main objection to currency devaluation is that it increases output and employment in one country at the expense of other countries. Interestingly, no one raises this objection to corporate tax cuts, which explicitly aim to attract investment away from other jurisdictions.
The Bank of Canada intervening to lower the loonie would simply bring it closer to fundamentals. No one could reasonably accuse Canada of creating an unfair competitive advantage through exchange rates.
Of course, every country trying to devalue simultaneously would be futile. A traditional argument was that all G-7 countries, including Canada, had to tow the line of non-intervention in order to dissuade Japan from intervening. But since that ship has sailed, our central bank should now feel freer to clip the loonieâ€™s wings.