Wednesday, May 9, 2012

Thomas Mulcair and Dutch Disease

On the weekend Thomas Mulcair raised the point that Canada might be suffering from Dutch Disease because of all our natural resource exports.   A country is suffering from Dutch Disease when the money flowing into a country quickly drives up the value of the currency enough to make the manufacturing sector uncompetitive.  

Thomas Mulcair is wrong, Canada is not suffering from Dutch Disease, we have a small trade surplus and a moderate sized current account deficit.     There is no large scale inflow of foreign currency into Canada and therefore there is no case for this being a Dutch Disease.  In fact Canada has a net outflow of money from the country, if anything there should be pressure for the dollar to fall.   The Canadian dollar should never have started to fall away from parity with the US dollar in the 1970s.

That said, there has been some broad co-relation between the Canadian dollar and the value of commodity prices in the 1980s and 1990s, but since then the Canadian dollar has lagged behind the rise in commodity prices, though gold and silver and the Canadian dollar stayed steady till about 2005.   We can look at a completely non-commodity currency like the Swiss franc and see the two currencies have been +-10% of each other since 1994 with no link to commodity prices.  The relationship between the Canadian dollar and Norwegian kroner over the same period has been much more erratic, the kroner being the ultimate petro currency.

From 2004 to 2011 Canadian overall exports increased 43%, in Saudi Arabia by 210%, Australia and Russia they increased by 206%, Switzerland by 135%, and Norway by 108%.  Canada is not suffering from a dramatic increase of commodity exports that come with the Dutch Disease.

Manufacturing in Canada is suffering because there has been a long term lack of investment in productivity improvement.   From the 1977 to 2001 Canadian manufacturers managed to avoid investing in improvements because the dollar had a long term downward trajectory.  At the end, the Canadian dollar had lost 40% of its value when compared to the US dollar.   This was a convenient way to stay competitive but it could never continue in the long term because the slide has to stop at some point.

So why do we have a rising Canadian dollar?  

In Canada we have fundamentally good macro-economic government policy.   This means we have:

  • an independent reserve bank free of political influence.   
  • government debt that is under control.  
  • international confidence in our legal and political systems
  • liquid capital markets
  • control of inflation
  • long term low bond rates
  • a stable AAA credit rating which is much rarer now than five years ago.  Canada is one of only  13 countries world wide with this rating
  • increasing exports is not hurting the country

At $0.62 USD over a decade ago, it was clear that the Canadian dollar had to rise given the positive macro-economic policies of the government.

Since 2007, other than a dip  for 10 months in 2008/09 at the start of the global crisis, the Canadian dollar has been hovering around parity with the US dollar.   We are going on close to five years of rough stability in the dollar.  This has been five years for manufacturers to invest in improving their productivity.  

Could be end up suffering from Dutch Disease?   At 3,000,000 barrels a day, or about 1,000,000,000 barrels of oil a year, the net inflow of money into Canada from this is roughly $125 billion, or about 8% of the Canadian GDP or just a bit more than 1/4 of our exports.   For the oil exports to have a Dutch Disease situation we would have to export more like 3,000,000,000 barrels of oil a year or see the price of oil rise to  over $300 a barrel or a combination of the two.  By 2020 Canada is projected to be producing 1.56 billion barrels of oil a year.

Yes there are other commodities that have an impact as well but they are not nearly as big an impact as oil.
Post a Comment