Industry Committee on Jan. 30th, 2008

[The Chair, Conservative, James Rajotte]

You have about 40 seconds.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Can you, in finishing up on this line of discussion, just talk about the impact of commodity prices? Surely that is one of the key factors. You've mentioned it. I guess the concern is that if commodity prices are a key factor in driving up the dollar, what is the relationship between that and other sectors of the economy, like tourism, manufacturing, or other aspects? Could you just say a few words on that?

[Paul Jenkins]

It is a complicated story, and if I try to cut through it and simplify it.... In Canada we have seen this big increase in what we call our terms of trade. This is because the products we're selling internationally are being sold at a high price, and that has generated a lot of income for the Canadian economy. That's why, in part, the domestic side of our economy has been doing so well: because we've actually been generating a lot of income for Canada through the sale of these products in the international market. So you see that income growth through this increase in our terms of trade having an impact across the economy.

The exchange rate movement reflects these increases in prices of the products we sell internationally, just as it was the reverse after the Asian crisis.

I apologize again.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Mr. Eyking.

[Mark Eyking, Liberal, Sydney—Victoria, NS]

Thank you, Mr. Chair, and I thank the guests for coming here today. It's a good time to be talking about the situation we're in right now.

You people alluded to the flow of money around the world and how it flows between countries and institutions more so than ever before. Recently there was an article in The Economist about following the money, about where all this money is coming from. They said that in one minute the money that a peasant farmer is saving in China could be loaned to somebody borrowing to get a Starbucks coffee. It might be that for the first time in the world poor people are lending to rich people. But anyway, when you follow the money and when they talk about over half a trillion dollars being lost in the United States, somebody is losing the money. Whoever had to lend them a dollar loses a dollar. The saver or somebody who lends a dollar is going to lose a dollar.

When you go back to thinking how Canada is going to shake out in this whole scenario when the merry-go-round stops, would you have any projections or rough estimates of how much Canadians--people who save or Canadian taxpayers--might end up footing for this bill by the time it's done?

[Paul Jenkins]

I'm going to ask John to address this, because there is a real global dimension here, but I'll just say by way of introduction that Canada is running a current account surplus again because of the high prices of the products we sell. So globally, we're a net saver from that point of view. I think one of the lessons we learned through the seventies and eighties is the importance of continuing to be very prudent in terms of the amount of debt we take on as a country, regardless of sector.

John, do you want to talk a little bit about the global dimension here in these flows?

[John Murray]

Sure. I'll be brief.

There is a vast amount of money circulating through the world economy, of course, and right now, unfortunately, we happen to be going through a very challenging time. There have been some losses, but you wouldn't want to leave with the sense that everyone's losing money and of necessity the taxpayer or governments are going to wind up picking up the pieces.

Just to put things in context, we start from a very strong position. Our banks have been very well capitalized. Our firms have on average been very profitable, although obviously there are some sectoral differences. And households, especially in Canada, are in good shape. Our housing situation and our housing prices, of course, have been quite different from those in the United States.

Equity prices, while down very recently, are about flat year on year, and if you take a five-year period--these figures just happen to stick in my mind--Canadian equity is up 80%. So there is net wealth to draw on and a fairly strong starting point.

I don't know if this, in part, answers your question.

[Mark Eyking, Liberal, Sydney—Victoria, NS]

Even though we're well off, we're still going to lose. I know we're in a better position, but if you're a household, and you have savings of $50,000, and you have some shares in the Bank of Montreal, or whatever, and you're a Canadian taxpayer, somehow you're losing money if it goes across the border to help bail them out. That's my question. How much is going to go, roughly, out of Canadian hands? Even though we might be more liquid, we might be better off, that's not the point. The point is how much is it going to cost the Canadian public? Is there a rough estimate?

[John Murray]

I'm not sure I follow the question exactly, so I hesitate to give an answer, but one point that might be worth making is that there are difficult as well as very positive periods, and you rely on some diversification to get you through. One of the advantages of all of the foreign investment we've seen is better diversification. There are always some losses and some gains, but on average, we know from experience, you come out ahead.

[Paul Jenkins]

The other point, perhaps, very quickly, is that when you look at balance sheets--

[The Chair, Conservative, James Rajotte]

Sorry. Mr. McTeague wanted to get in a brief question.

[Paul Jenkins]

Yes. Sorry.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I have just a brief question. Banks have been rather exposed to the non-asset-backed commercial paper problem down south of the border. Your bank has intervened in concert with other international banks to rescue or to help and assist and provide liquidity to the market. Obviously, there are impacts beyond consumers here with respect to how much available credit really is out there and whether or not this will affect consumers. But I think the real issue for all of us here is to recognize whether or not the disparity between the U.S. Federal Reserve rate and our current interest rate will enhance the strength of the Canadian dollar and therefore have a damaging impact on manufacturing, among other things.

[Paul Jenkins]

I'm going to repeat what I've already said. First of all, in the context of putting together our updated projection for the Canadian economy, we had built in a fair degree of easing on the part of the Federal Reserve, indeed easing beyond what they had announced the morning of January 22, which was the day we were making our own announcement. In our base-case projection, we had built in a considerable amount of easing on the part of the Federal Reserve, feeling that that was an important ingredient to get the U.S. economy moving forward, which we do have beginning in the second half of the year and into 2009.

As I noted earlier, in our base-case projection, we have assumed a level of 98 cents for the Canadian dollar. Again, the relationships here are not very precise, but were the Canadian dollar to move to a range that we felt was outside what historical relationships would support, and were it to be sustained at these higher levels, clearly we would have to factor that into our thinking in terms of the impact of that on the Canadian economy through output and inflation.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll now go to Mr. Van Kesteren.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Thank you, Mr. Chair.

I'm going to talk really fast, because I don't have a lot of time.

I want you to take me back to Economics 101. It used to be that the British had the sterling, and then we had gold, and then we got rid of gold; I think in the seventies we abandoned gold. I read that in 1991 the monetary policy came into effect. Explain this to me in layman's terms. We say our dollar is worth a buck. The Chinese take that dollar, and they say, by determining what they can buy, how much that money is worth. Is that kind of what's right? Where does that fluctuation come from? And when you change that interest rate--which is money that is passed between banks--is that kind of like introducing new currency?

It used to be that when we had inflation, governments would print money, and then inflation would come about. I understand where inflation comes from, but I just don't understand where the new money comes in, and that leads to my next question.

I'll tell you why I ask that question. This is scary. The more I listen to you, the more confused I get. That's not because you're confusing. I think you guys are brilliant, and you're doing a great job, but it seems to me that this whole policy is so complex, whereas it used to be very simple. Mr. Eyking was talking about the housing industry in the States, which would determine a nation's wealth, which would reflect on the value of the dollar. Suddenly we realize that those houses aren't worth $200,000, they're worth $150,000, and that changes....

Is the same true with a company like Yahoo, which really has no wealth? Do we determine the wealth of a nation from institutions like that, and are they volatile like the mortgage?

[Paul Jenkins]

Again, that's a very good but complicated question to answer.

Fundamentally, in terms of running monetary policy, what we do by raising and lowering interest rates is to influence the level of total demand in the Canadian economy. So if you lower interest rates, you support or stimulate higher demand. If you raise interest rates, you do the opposite.

What we try to do, in very simple terms, is to set interest rates at a level that keeps total demand in the Canadian economy close to what the economy is capable of producing. If demand is above that supply capability, it leads to inflation. If it's below, it leads to disinflation. That is fundamentally what we try to do.

Now, in doing that for the Canadian economy, it is complicated. We do need to add up the factors that are influencing total demand in the Canadian economy. That includes what is happening in the United States, because we have these direct trade links with the United States. It includes a view as to what's happening in China, because we see those links through commodity prices. It includes our view as to what's happening in financial markets, because there are links through financial markets.

Our job is to add all of this up in terms of how we see these factors impacting on the Canadian economy, setting policy to keep supply and demand in balance and, through that, inflation low, stable, and predictable. It's that predictability and low level of inflation that we think is the single-most contribution we can make. We do not want to go back to the 1970s and 1980s.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

Tell me now why it's either a bad idea or a good idea to peg our dollar at 85 cents.

[Paul Jenkins]

Very quickly, let's do two counterfactuals.

Had we pegged the Canadian dollar during that period of the Asian crises, we would have had.... The decline in commodity prices was stimulating the U.S. economy. Had we been on a fixed exchange rate then, we would have had to raise interest rates, leading to higher unemployment and lower wages. You have to regain your competitiveness somehow. Movements in the exchange rate facilitate that.

The other counterfactual is what we're going through right now. Had we been at a peg at 85 cents, with commodity prices moving up, to keep it there we would have had to keep interest rates lower and lower, leading to inflation.

Those would have been the two consequences had we been at an 85-cent peg. I mean, pick your level. It would have led to either disinflation in the one instance or inflation in the other. History, including the history of Canada, and all the research clearly indicates that. And that floating exchange rate, again, plays that shock absorber role.

[Dave Van Kesteren, Conservative, Chatham-Kent—Essex, ON]

That answers my question. Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Van Kesteren.

We'll go to Monsieur Vincent.

[Robert Vincent, Bloc, Shefford, QC]

Thank you.

You said earlier that if we reduced interest rates and our dollar were worth 85¢US, we would be in a recession.

Did I understand correctly what you said?

[Paul Jenkins]

If the dollar...

[Robert Vincent, Bloc, Shefford, QC]

If we want the dollar to be valued at 85¢US, we must lower interest rates. But if we increase interest rates, we could end up in a recession, if my understanding is correct.

[Paul Jenkins]

It depends. Again, we have to make an assumption about the level of the dollar for our projection. If the value of the dollar goes up or down, the first question we have to ask is what causes this fluctuation. There is no simple or direct relationship such as that you mentioned.