The Odd Conversion of Mainstream Economists to the Virtues of Depreciation

The long-overdue depreciation of Canada’s currency is gathering steam. The dollar lost 8 cents against its U.S. counterpart, in fits and starts, over 2013. It’s lost another 2 cents since the start of 2014, and negative sentiment about the currency is accumulating among financial analysts and traders.

Indeed, once the expectation that the loonie will fall becomes entrenched among enough of the red-suspendered trading set, that belief quickly becomes self-fulfilling. Speculators who think the loonie will fall, sell or short the asset to take advantage of that fall, and this only accelerates the decline. So we can expect the dollar to continue weakening – perhaps faster and further than would have seemed possible until very recently.

On last night’s CBC Bottom Line economics panel, I thought I was going out on a limb with my bearish prediction that the dollar would be in the mid-80s by the end of this year. But then I was trumped by Patti Croft, former RBC economist (who once was very bullish on the loonie): she said it could reach 80 cents in “the blink of an eye.”

The present downturn is a welcome, but overdue, reversal to a decade-long, pointless, and destructive financial detour for our currency. From 2002 through 2007, the loonie shot up over 60 percent. For the next five years it bounced around par with its U.S. counterpart. Now, finally, it is heading back down.

At or near par with the U.S. greenback, the loonie was substantially overvalued by any fundamental measure. The most common way to estimate the “fair value” of a currency is according to relative price levels in different countries (what economists call “purchasing power parity”). On this basis, the Organization for Economic Cooperation and Development pegs the loonie’s benchmark at 81 cents (U.S.). [You can see the whole set of OECD PPP estimates here.]

Temporary factors (like investor expectations, big financial flows, or unusual success in export markets) can push the exchange rate away from its fair value – for a while.

But even waterfowl can’t stay aloft forever, and it’s been clear for years that eventually the loonie must come back to earth. At par, the inflated dollar made Canadian-made goods and services artificially expensive to foreign buyers (imposing a cost penalty of around 25 percent). Consequently, anything we sold to foreigners (other than resources, which are usually denominated in U.S. dollars) was priced out of the market. Even resource industries are hurt by overvaluation: while it doesn’t affect their sales volumes as much (given U.S. dollar pricing for most commodities), it does cut into profits and incomes back home – once those revenue streams are translated into Canadian dollars.

In 2004 I published a report for the CAW predicting the loss of 400,000 manufacturing jobs if the dollar stayed above 85 cents (U.S.).  But sadly, it turns out my guess was conservative: almost 500,000 disappeared since the currency took off.

And it’s not just manufacturing that suffered from the loonie’s flight of fancy. Other export-oriented sectors were hammered even worse. Tourist visits to Canada, for example, plunged by almost half since 2000 (from almost 50 million per year to just 25 million), not surprising given Canada’s status as one of the most expensive destinations in the world. That’s a worse decline than was experienced in manufacturing, yet it gets little public attention. Border towns have been devastated; huge flows of southbound cross-border shopping every weekend made matters worse.

Indeed, Canada’s overall trade performance was among the worst in the world throughout the loonie’s manic episode. Exports plunged from 44 percent of GDP in 2000 to just 30 percent last year – making a mockery of the federal government’s supposed “trade agenda.” Combined with surging imports, this has produced an enormous deficit in international payments: over $60 billion last year, the highest in history. Since late 2008, Canada’s debt to the rest of the world grew by $290 billion. (That’s twice as much as the growth in federal government debt over the same period.)

The federal government likes to boast of its “sound fiscal management,” justifying the stealth austerity it has used to achieve a faster-than-expected balanced budget (never mind the macroeconomic side-effects of the cutbacks). But federal government debt is owed mostly to ourselves. And assuming that the debt-financed spending was productively spent, this serves a useful social purpose.

Our growing foreign debt, in contrast, is more unambiguously problematic. Running up debt, twice as quickly, to foreigners in order to sustain an uncompetitive trade balance, isn’t prudent – it’s reckless.

Unfortunately, Canadian policy-makers (including Finance Minister Jim Flaherty, and successive Governors of the Bank of Canada) endorsed, and even perversely celebrated, the dollar’s rise over the past decade. Unlike other countries which intervene to manage exchange rates (such as Norway, Australia, Switzerland, Brazil, China, or Japan), Canadian authorities let the currency float wherever markets took it.

While the loonie was taking off, I made several deputations to Bank of Canada officials warning of the negative consequences for our real economy (sometimes jointly with manufacturing executives). The Bank’s line, and they were sticking to it, went like this: The Bank is in the business of targeting inflation, and inflation only. We take the exchange rate and trade balance into account when we formulate our forecasts of inflation. But we do not take action to move the exchange rate. To do so would be self-defeating, and would undermine the solid economic benefits that come from low and stable inflation.

Most mainstream economists, accepting the Bank’s logic, also tacitly or explicitly endorsed the dollar’s rise during this time. Those of us who worried about the overvalued loonie were even targeted with near-McCarthyist ideological attacks for a couple of years. Our arguments that an oil-fueled loonie was damaging the rest of the export-oriented economy were dismissed as anti-Alberta ravings – on par with the subversive actions of foreign-financed environmentalists. The dollar was not too high. Even if it was, oil was not to blame. And at any rate, a high dollar helps Canadian manufacturers (making it cheaper to import capital, forcing companies to innovate, etc. etc.).

If they really believed that, how do we now understand the sudden near-unanimity among mainstream economists (including everyone on our CBC panel last night) that the current decline in the dollar is good for Canada’s economy? Finance Minister Flaherty (the same guy who not long ago cited the high dollar as proof of Canada’s “strong fundamentals”) seemed to endorse the depreciation last week – although he immediately contradicted himself by saying that he still wants it to be affordable for Canadians to travel abroad. And mainstream analysts across the board (banks, business, and media) are all heralding the dollar’s decline as a harbinger of better economic times ahead.

The Bank, for its part, has been silent. Indeed, some have credited Governor Stephen Poloz, in part, with engineering the depreciation. (I don’t believe that – although the Bank’s newly dovish tone on interest rates, reflecting the obvious and stubborn stagnation of Canada’s macroeconomy over the last two years, has certainly played a role in the current downturn.)

To some extent, this inconsistency in mainstream thinking about the dollar might reflect their laissez faire assumption that if the market decides something (even a market as flighty and speculative as foreign exchange trading), it must be efficient and legitimate. Through that lens, when the dollar was high, that was good – and when the dollar is low, that’s good, too. And to a degree, discussion about the dollar was polluted (as noted above) by the same oil-boosting impulse that has distorted other Canadian policy debates during this era of the “petro-state.” Acknowledging that the high dollar (so obviously linked to the oil boom) was damaging, might directly or indirectly undermine the view that oil is king. That’s not acceptable, so we really shouldn’t go there. Whatever the reasoning, it is very odd to say the least that I have suddenly been joined by most other economists in welcoming the current depreciation – and, indeed, egging it on.

Finally, Canada’s lacklustre employment record and miserable trade performance are sinking into the consciousness of traders. Speculative behaviour will now hasten the loonie’s downturn – possibly even causing the currency to overshoot the PPP benchmark in the other direction.

Unfortunately, much of the damage from this pointless, decade-long to-and-fro will be permanent. Many industrial jobs that exited Canada since 2002 won’t come back, even if the dollar returns to normal. Global companies worry that if currency traders are infected by another bout of loonie-mania (sparked by oil prices or some other cause), our government will once again let it happen – destroying competitiveness in the process.

So while I welcome every downward tick, I am still not popping champagne corks. Canadian policy-makers haven’t learned the lessons of its pointless, destructive escapade – which means it could happen all again.

A shorter version of this commentary previously appeared in the Globe and Mail.


  • Well…. the underlying view here is that exports are good per se, a very debatable point.

    About half our exports are barely processed raw materials. Why is exporting more of them a good thing? The lower Loonie will promote an even greater over-development of the tar sands, greater export of our natural gas, minerals, forests and so forth. True we get jobs but we don’t get the output, people in other countries get the benefit of that. The same applies to higher value-added production, although we might get more employment.

    Wouldn’t we be better off producing all the things we so desperately need such as more and better public transport, infrastructure, public housing, low energy use everything, renewable energy sources, etc? Lots of good manufacturing jobs and high value-added there and we’d get the benefits of the output. Exports could be useful in some industries to help reach levels of output required for high productivity and R&D, but that’s not the same as making exports, supplying the needs of other countries, the goal of economic policy. The purpose of deliberate currency depreciation is to promote export-led growth. Need I point out that export-led growth is typically what the IMF, and others, recommend for third world countries?

    Of course we should also increase spending on all the public services we require – day care, continuing care for seniors, assistance to people with disabilities, etc. Once again Canadians would benefit from BOTH the jobs and output.

    In addition I’m pretty sure that applying environmental laws to bring the tar sands to a more reasonable, reduced, level, and providing more goods and services for ourselves would drive down the value of our dollar in any event.

    Let’s not forget either that depreciation of our currency also has the negative effect of making imports more expensive. Yet Canadians want imported things: electronics, automobiles, fruits and vegetables and travel to warmer countries in the winter. Deliberately lowering the currency means workers in non-exporting industries and retirees are subsidizing workers in export industries through higher prices for the things they want.

    An aside on the Canadian dollar. It is hardly surprising its value increased following the financial crisis. Europe and the US were hit with very high unemployment and collapsing banking systems. Japan was in a 20 year recession. Canada’s recession was less severe than in the US and most of Europe and our banking system was secure. Wouldn’t you increase your portfolio holdings of Canadian dollars somewhat under those circumstances if you were investing in currencies? Now that the economic crisis is past, at least in the view of most main-streamers, it is hardly surprising that our currency is depreciating.

  • Great point, Jim! I too have been struck by how quickly Canada’s economic consensus shifted from defending the high loonie to defending its depreciation.

    I had the same experience on CBC panels I did last week for The Lang & O’Leary Exchange (video clip) and Power & Politics (an hour and 47 minutes into Friday’s episode).

    There was also a consensus for depreciation on TVO’s economic-outlook panel, which will be broadcast on tonight’s The Agenda With Steve Paikin. (In fairness, my fellow panellist, Avery Shenfeld, has been consistently critical of the overvalued exchange rate.)

    By the way, the purchasing-power figures linked above seem to end in 2011. Here are the OECD’s latest annual figures.

  • At some point a market force does indeed produce results. My point- the reason many institutions have given the looney an about face is mainly to do with the lack luster performance of the economy and the wide spread notion that consumer debt and the housing double have reach a risky level in Canada. Risk means many things to financial markets but avoidance or in the speak of finance and forex the swaps will be triggered as the spreads will not be covered and it will bring on some massive movements in the algorithms of decision makers.

    It is amazing to note all the work that is put into 5 or 6 lines of advanced algorithmic code, but ultimately all that quantitative is indeed attached at the hip to the qualitative- and this to me is brought on by the mismanagement of the economy and the numbers that feed those algorithms.

    The fundamentals are not good, and without an engine to drive the economy, it is more of this elongated decline. There is a reason we continue to fall further into debt and its roots cause is the polarization and the decline of demand.

    (yes rising home prices do produce more debt, but it also drives up the net value of those houses- which does indeed produce actually existing exchange value as defined by the legal infrastructure of accounting specifies. But the question is how much of those asset rises were then converted into debt?)

    It is these newly found financially induced exchange values in home prices and easliy gotten credit whether it be home equity or credit cards that have maintained the bare essentials of demand throughout this period. Quite a few studies make note of these facts, and the debt levels have reached points that signal change.

    One could argue that the stealth austerity as imposed by Feds and some provinces actually helped pile on that debt to all time highs for consumers. Sure we could have a balanced public deficit by Harper in 2015, but it undoubtedly created a lot of impetus for the rise in consumer debt levels. So really what did that accomplish? The two are causally linked, so instead of public goods being provided which in many cases leads to increased productivity for now and future, and less income polarization, we have had a consumer debt explosion into private consumption- that ultimately does not produce near the same return for the economy in terms of short and long term productivity. More houses, TVs and cars, will certainly not help maintain and help pay for those houses, TVs and cars.

    My point- at some point the markets as defined will indeed start to react to the over indebted consumers, and the lack luster economy. And indeed it is making its correction towards the goal of long run PPP for our dollar. The question is why so much distortion in the first place? Why did oil peak so high, and why did natural gas stay so low- enough to make it feasible to push the tar sands into that “profitable” space (excluding the real negative externalities like reclaimation, massive CO2 increases which once broken can never be fixed- ask Neil Young he will back me up)

    This which of course drove the expectations on Canada’s economy which partially resulted in such a higher petro dollar.

    I am kind of curious, if we indeed would have had a Harper government that would have spent more and cut less and maintained a bit of a deficit, which would have potentially lead to a decrease in consumer debt- through say improved EI benefits, better public housing, more students support and training, better transportation, etc- would the international community of money traders have been in so much of a panic over consumer debt levels- would the housing bubble be as advanced as it is and would the government had to keep relying on propping up the housing market and credit to keep consumer liquidity enough to maintain demand and ultimately its chance at re-election.

    So the question must be asked- is this dollar decline really just the notions of market traders and money speculators- or is it a direct result of mismanagement in the first place by Harper? Over expanding the tar sands when the first chance that seemed “profitable” the markets as regulated by Harper unleashed an army of trucks, excavators, water pumps and upgraders onto the land scape- at a pace never seen before on the planet.

    Was it the root cause of the dollars rise and fall- I have to say it sure seems so to me.
    I am all for giving Canadian companies a chance to compete, so I say bring the dollar to PPP and lets have a level playing field. Yes short term problems do arise, but the rise in the dollar for 10 years was not short term- it was a side effect of uncontrolled tar sand development- there is not a doubt.

    Sorry about the typos.
    Paul Tulloch

    So finally the shroud of the amazing economics of Canada has burned off and underneath is a weak shivering job market, a pile of anxious pipes, steam cleaning and giant tailing ponds and holes in the ground in Northern Alberta, and plenty of shuttered factories in Ontario and Quebec.

    I still go back to one measure- the size of provincial work forces. Ontario and Quebec 11.7 million workers – Alberta 2.3 million.

  • Paul,
    I’d like to pick up on your point regarding the austerity drive by the federal government, targeting a balanced budget for 2015.

    It is unfortunate indeed the Harper government is hell-bent on applying family budget principles to the our country. Inadequate spending by the feds forces the economy to operate well below its potential more or less permanently. Currently nearly two million people are being deprived of the livelihood they would like to have due to unemployment and underemployment. Yet there are all kinds of services we desperately need that they could provide us. How sad this work is not being done. The workers would be there but the feds, the government with the deep, deep pockets, won’t provide the money to pay them, so they remain without jobs or under-employed. And the rest of us are deprived of basic services, daycare, continuing care for seniors, etc.

    As you point out inadequate federal spending also means there is less money in the economy for people to spend so many take on higher debt to maintain their standards of living. Less `debt`for the feds but more debt for families. What’s the logic there?

    Sadly, and I believe this is a deliberate strategy by the Conservatives, an endlessly balanced federal budget will put continuous and increasing fiscal pressure on the provinces eventually resulting in cutbacks to social programs and public sector worker wages and benefits. When the Conservatives use inappropriate, but intuitively appealing family budgeting logic to justify austerity it makes them appear responsible. It also makes the provinces appear irresponsible when they are forced to take on increasing debt to maintain services. The feds do the dirty work but the provinces take the blame.

    If we believe the federal government will never provide adequate spending because we will never be able to force them to by political means then one solution is to rely on foreign demand to bail us out. This is not an efficient way for us to achieve a better life for the reasons I have outlined in my previous comment. In addition it means surrendering control of our economic well-being and becoming dependent on demand conditions in other countries. I prefer we be the masters of our own destiny and not be dependent on the vagaries of trade flows.

  • Hi Keith- glad to hear you voice of reason- and of course I agree with you on most things most of the time. I too do not want to be reliant on those trade flows, however and I think Jimbo tweeted something on this today- a lower dollar is what will help bring in those investment flows. I say help but I have to say- it would also take a focal point by the central bank to help support a lower PPP based dollar. If somehow we could maintain healthy homegrown levels of scarcity in terms of of the needed business investment, technology transfers, innovative forms of organization, etc in both the public and private spheres than I am all in on not relying on external sources. Then again, given our small open economy, we have shown in the past a good ability to incubate and grow global success stories- sadly we have a horrible track record at longevity or potentially changing political will has thrown some of our greats into the twisting nether of destruction- Nortel, Blackberry, ATI, quite a number of Steel companies, pulp and paper, etc.

    So if one could indeed, say like a Finland and Sweden, grow a few success stories where dollar differentials from PPP have limited impact on competitiveness than I am in. However, that political and economic industrial capacity has not been around and I am not sure it ever has been.

    I will say this- given our proximity to the USA, and our business culture closeness- one would think it would be much easier to prevail within such space and create success- and of all the beggar thy neighbour attempts in dollar devaluation- I truly think our case would indeed be much more efficient.

    However- with a majority of the developed economies now embarking on such concurrent devaluation strategies- I am sure it will be less effective then it was during the mid to late 90’s when the liberals were trying to manage the NAFTA integration with a 65 cent dollar devaluation.

    I still hold some theoretical guidance in PPP as the long run level of ones dollar.

    If it is trade in high value added, innovative, sustainable products and services then I am have no problems with trade related dependencies- although I would not want to be dominated by one country in terms of foreign ownership of production.

  • I think you are probably right Jim in that it is just a “market” gets the price right dogma. Add to that the Pandora’s box of policy if you don’t believe that the market gets the price right. To their mind it is a lesser evil to believe something you don’t believe to be true all the time then the truths that would also flow from the belief that the market does not always get the price right.

    The good news is that the consensus view is that the super cycle is over so you can have your manufacturing sector back for a while because the new price is right for that…for a while.

    Hell of way to run industrial policy but enlightenment thinking and almost any brand of humanist pretensions have been long since sacrificed to the abstraction that is the market.

    Now everyone go short the CAD and get a little of the last of the super cycle wine.

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