Writing in the Financial Post, MLI senior fellow Philip Cross explains that while many Canadians celebrated the loonie’s recent plunge to around 90 cents (US), the benefits of a weak dollar tend to be exaggerated, and the costs, which are in fact greater, ignored. “Not only consumers will pay higher prices. Businesses import most of their machinery and equipment. Faced with higher prices, firms will trim their outlays for machinery and equipment, which ultimately will depress productivity and wages in the future”, Cross writes. He was also quoted on the issue by Financial Post columnist Terence Corcoran, and he was interviewed on BNN.
Philip Cross, March 13, 2014
After hovering around parity with the U.S. dollar for three years, Canada’s loonie fell sharply in 2013 to near 90 cents (US), where it still hovers. Initially, the lower dollar was greeted with relief, especially for our manufacturing exporters. However, as the dollar continues to languish, awareness grows that the benefits of a weaker loonie are small compared with its costs.
Our lower exchange rate automatically raises the Canadian price for goods where an integrated North American market sets one price in U.S. dollars — mostly gasoline and home heating fuels. The lower Canadian dollar already has opened up a gap between the price for these goods in the U.S. and in Canada. In January 2014, for example, the price of gasoline in the U.S. edged up 0.1% from January 2013, while in Canada it was up 4.6%. Prices will rise soon for products that consume a significant amount of energy, such as air travel.
Prices for some other products are sensitive to the exchange rate. The cost of fresh fruit and vegetables, mostly imported during our winter months, was up an average of 4.1% in Canada from a year-earlier, compared with a slight decline in the U.S. Of course, cross-border shoppers face large price increases, since they automatically have to pay more to buy U.S. dollars. The same increase will face Internet shoppers buying products priced in U.S. dollars.
Not only consumers will pay higher prices. Businesses import most of their machinery and equipment. Faced with higher prices, firms will trim their outlays for machinery and equipment, which ultimately will depress productivity and wages in the future. Meanwhile, governments will feel an increased burden of their debt that is denominated in U.S. dollars.
The benefits of a lower exchange rate go primarily to exporters. Firms that earn U.S. dollars from exports will profit from a lower exchange rate, as these U.S. dollars buy more Canadian dollars when they are repatriated. Even here, the benefits are likely to be limited to prices, since the volume of exports shows little sensitivity to the exchange rate. The volume of Canada’s exports is largely determined by the trend and composition of demand in our major export markets.
Some may view a lower dollar favourably out of hope it will shift growth from natural resources to manufacturing. They will be disappointed. The most stimulus to exports from a lower dollar is for natural resources, which need it the least, and the least stimulus is for manufacturing, which needs it the most. This reflects how manufacturers adapted to the higher dollar over the past decade. When the dollar was near parity with the U.S. greenback, firms hedged their exposure to the high dollar by reducing their reliance on exports and increasing their use of imported inputs. This “natural hedge” reduced the net exposure of manufacturing firms to exchange rate fluctuations by almost ten percentage points in the past decade. Meanwhile, our natural resource industries have the highest net exposure to a lower dollar, because they export most of their output while importing few inputs. With prices already high for most commodities, this will further tilt our economy towards natural resources.
The other major beneficiary of a lower exchange rate is to Canadians invested abroad, who pocket more Canadian dollars when they repatriate these investment. This is a dubious benefit for our economy. It rewards people for not investing in Canada, at the cost of lowering the value of all assets in Canada. The losses foreigners will feel on these investments will make Canada a less attractive place to invest in the future, while encouraging Canadians to invest more abroad.
The myth that a low exchange rate encourages economic growth took hold in Canada in the 1990s. Canada’s manufacturing growth was led by low-wage industries such as clothing, textiles and furniture, where employment rose 29.7% from 1992 to 2000. The flimsy basis for this allocation of resources was fully-revealed, when a rising dollar and China’s exports devastated these industries. In retrospect, one can only look back with wonder and astonishment thatCanada acted as if our future lay in investing in low-wage industries predicated on a chronically low exchange rate. Even the 1990s boom in autos and high tech was partly a figment of a low exchange rate, which enabled these exporters to reap export earnings in U.S. dollars while paying their Canadian workers the equivalent of 63 cent U.S. dollars. It was a business model doomed to fail when the exchange rate started to appreciate.
Devaluationists should be pleased that the boost to manufacturing indeed seems to be happening. Factory jobs have risen 1.5% since last October, while investment in manufacturing is projected to rise further in 2014. However, there is no sign this is boosting the overall economy, as both total employment and business investment have stalled. Apparently, there is something more to economic growth than just revving up factory output. At least we no longer have to listen to the acrimonious and tiresome debate about Canada’s manufacturing sector suffering from “Dutch Disease.” But what do you call an economy where manufacturing prospers and the rest of the economy languishes? Perhaps “Asian Disease,” where exports flourish but domestic demand retards growth.
Philip Cross is the former Chief Economic Analyst for Statistics Canada and the author of a forthcoming Fraser Institute commentary on the dubious benefits of a lower exchange rate.