Good afternoon Mr. Chairman and members of the committee.
It's terrific to be here with a new Parliament. Thank you very much for having me.
I will be addressing you in English,
going forward.
So on the loonie, the loonie has been flying high, stalling and falling, and flying high again, and Canadians have been asking non-stop, and are asking me non-stop, what is steering its flight, whether it's a problem, and if it is, what to do about it.
These are huge issues, and pointed ones for manufacturers and others who sell into the world markets and bear costs that are priced in local dollars but whose purchasing has not actually increased at home. This is the classic price-cost squeeze for exporters, one that gets all the tighter as hedges run their course and contracts come due for negotiation.
So what's driving the loonie? The first answer, of course, is the U.S. dollar, which peaked in trade-rated terms--that's from the U.S. perspective--in 2002. I put a figure in front of you, and I believe it's been distributed; thank you very much to staff. Spring 2002 is the peak of the purchasing power of the U.S. dollar in terms of world goods. Since then the U.S. dollar has edged steadily downwards through October 2007, losing roughly one-sixth of its purchasing power in world markets.
This was predicted by many folks, and those predictions were made clearly correct when savers and investors more recently cooled their desire to hold U.S.-dollar-denominated securities. It had been their previous willingness to hold U.S.-dollar-denominated securities that held up the greenback in the face of remarkable stress on the U.S. economy. Consider, if you will, that for calendar year 2007, the U.S. merchandise and trade deficit will come in at nearly $800 billion. So the necessary balance of payments implication is that savers in the rest of the world need to send in about $2 billion a day in capital flows to the U.S. market in the form of portfolio stock and bond purchases or direct investment. As a matter of balance of payments arithmetic, those flows must balance, and in a floating exchange rate environment the currency will adjust until it does. So the first part of the story, of course, is a U.S. dollar story.
It's no surprise that Canada's tight trade alignment with the U.S. should expose our producers to U.S. currency risk. What is new is the pressure on Canada and the world demand for commodities, energy in particular. I have a figure that shows what's happening in energy markets and in commodities excluding energy, and you will see a tremendous recent run-up in energy as distinct from other commodities. My institute's policy analyst, Robin Banerjee, estimated what we fondly call the Bank of Canada equation, which shows that we are indisputably in possession of a petro loonie. This means that after accounting for the interest rate differential between Canada and the U.S. and the price of other commodities, changes in the world price of energy explain most of the price path of the loonie.
So energy prices and investor doubts about the outlook for the U.S. economy explain much of the positive stress on the loonie. There is more, of course. Investors in the U.S. who are doubtful about the U.S. dollar outlook might choose to bet on the oil price as a hedge, right? They're going to buy oil futures. That would exacerbate the upward pressure on the oil price, and on Canada's currency in particular.
How big a problem is all this for the Canadian economy? Clearly, for many Canadians this is a good news story, if not for businesses selling into the U.S. market. There are bright spots, and this goes beyond observing a trade that's been growing well in other markets. StatsCan figures from a couple of weeks back show that Canada's trade with economies other than the U.S. has been growing quite sharply. So not everything is bleak. Of course, we are hugely dependent on the U.S. for our trade market, so that still is, as I say, a huge issue.
The other bright spot I mentioned is that the price of oil is a good hedge on the U.S. dollar. This helps Canadian manufacturers for whom energy is an important input. The rising loonie helps reduce or helps stop energy costs from rising as much as they might have been for Canadian producers. Otherwise, life would be a little more difficult than it is now.
The other point is that the same strong purchasing power abroad makes capital equipment more affordable than otherwise, and this puts in place the conditions for investment in plants and resources that will make our labour force more productive, underpinning future job and wage growth in a non-inflationary environment.
That brings me to my last point--what to do about the dollar. The government and the Bank of Canada's agreement on the inflation targeting framework is an extraordinarily valuable thing. Clarity of purpose helped keep financial markets stable, if not predictable, when the loonie hovered around the 60¢ mark, and so too will it help clarify thinking as we adjust to near parity. We have an extraordinarily resilient export sector, which, while under pressure in many markets, also possesses the skills and tools to respond smartly to that pressure. I have no doubt that they will and that we will succeed in doing so.