Industry Committee on Feb. 26th, 2008

[The Chair, Conservative, James Rajotte]

Members, we are a few minutes late because the previous committee extended their time.

For the first hour, we have two witnesses who have graciously agreed to come back. We had an hour with them before, but we had so many questions that we asked them to come back. I want to thank them both for making themselves available again on very short notice with respect to the impact of the appreciating value of the strong Canadian dollar on the Canadian economy.

We have before us today two witnesses from the Bank of Canada. We have, first of all, the senior deputy governor, Paul Jenkins. Secondly, we have the deputy governor, Mr. John Murray. Welcome.

My understanding, Mr. Jenkins, is that as you gave an opening statement last time, we will use this hour for questions from members. We will start the first round with six-minute rounds.

We will start with Mr. McTeague, the vice-chair.

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

Thank you, Mr. Chair.

Mr. Jenkins, Mr. Murray, it's good to see you back. Thank you for being here.

The great opportunity we have is that last week I saw something I had never seen before, and certainly in the past year and a half. We've been known to have the petro loonie, and last week, as the price of crude skyrocketed back through the $100-a-barrel territory, we saw the Canadian dollar lose value. I'm wondering about this, because it costs a lot of currency, and on that particular day I caught off guard the two analysts whom I spoke to about this. But is it conceivable that the value of commodities—petroleum, in particular, which we export—is not necessarily the only factor driving the currency up or down? Really, the question is to what degree this is.

I only have one question, Mr. Chair, and I think Mr. Brison will take the rest from here.

Thank you.

[Paul Jenkins, Senior Deputy Governor, Bank of Canada]

The short answer to your question is that it is not the only factor. The exchange rate, as I mentioned before the committee the last time, is a relative price, in the sense that it's the price of the Canadian dollar relative to the U.S. dollar, or the Canadian dollar relative to the euro. So there are a number of factors that impact that exchange rate. In the Canadian context, commodity prices have historically proven to be an important explanatory factor for movements in the Canadian dollar over time, but there are other factors that influence the dollar as well.

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

Let me ask you about the hidden cost or impact of M and A, mergers and acquisitions. I'm hearing increasingly, or with greater frequency, that what is really behind much of this is a lot of activity, both in the States and in Canada, the acquisition of large or big cap companies and assets.

I'm wondering to what degree you think that is influencing the current currency picture that we see. That's my final question.

[Paul Jenkins]

I'll ask John to pitch in here, because he's done quite a bit of research on these issues, but I think the general point is that these foreign exchange markets are very large—in the trillions of dollars. So at times, when you do see a transaction taking place in the market, it can have an impact on movements in exchange rates. You call these M and A flows, but we get these flows going in both directions. We do live in a globalized world, so you have to think about flows coming into Canada and flows going out of Canada. Yes, you can see evidence of these flows having an impact, but over time, given the size of these markets, the underlying economic factors are really what move exchange rates on a sustained basis.

John, you've done some work on this issue of flows versus stocks.

[John Murray, Deputy Governor, Bank of Canada]

Very briefly, as Paul indicated, the normal daily flow through the Canadian foreign exchange market runs in the billions of dollars. So it takes a very large transaction to have an influence on those, and sometimes a large merger or acquisition could have such an influence. The important thing to note here is that the effect would typically be very temporary; once it passes through the market, it's then gone, as it's a flow. What we're typically more interested in are the continuing fundamental influences on the exchange rate.

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

Thank you, Mr. Chair.

[The Chair, Conservative, James Rajotte]

Take a few minutes, Mr. Brison.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you.

I just have a couple of quick questions to follow up on. As commodity prices go, as my colleague indicated, typically the Canadian dollar goes, because of the weighting of our economy on commodities. But there's been a lot of speculation about the decoupling of the emerging economies, like China, India, and others, from the U.S. economy.

First of all, I want your view on decoupling and the notion that some of these emerging economies will in fact continue to grow despite an economic slowdown in the U.S.

Secondly, if that is the case, or at least the possibility, will it have the capacity to effectively propel the Canadian economy forward based on commodities, their demands, and internal growth for commodities, and as such decouple the Canadian economy in some capacity from the American economy?

[Paul Jenkins]

I personally don't like the word “decoupling” because it's too easy an out, in the following sense. You have quite a few factors at play currently in the global economy. If you look at it from the point of view of the Bank of Canada, our role is to look at all these factors at play and add them up in terms of the overall impact on the Canadian economy.

At the moment, we have reasonably robust growth in Asia, China, and India. The growth we're seeing there has clearly been one factor behind the strength of commodity prices. The high price of commodities is a demand driven story. At the same time, we continue to have close trade links with the U.S. economy. Given the situation in the United States, primarily around the subprime mortgage market, i.e., the residential construction market, which has gone into a very significant and protracted adjustment, we know that exports of windows, doors, and lumber to the United States are going to be affected by that. Indeed, going back to our monetary policy report update, which came out just prior to when we first met, when you look at our projection for the Canadian economy, we have what we call the contribution from net exports being negative, a drag on the Canadian economy. A good part of that is because of these trade links with the United States. We see the impact of that on our exports. At the same time, we are seeing, through higher commodity prices, a positive impact on the Canadian economy coming from that.

To answer your question, decoupling suggests there's only one force out there, or maybe two. What we really need to do is look at all of those. We need to look at the strength of demand in Asia. We need to look at what's happening in the United States and add up all of that in terms of the implications for the Canadian economy. For us, that really is the challenge. Decoupling doesn't quite do it for me. It's a short way of suggesting that growth and age are going to continue. Even there, we know there are going to be spillover effects from a weaker U.S. economy because the U.S. is buying exports from those countries. So you've got to work through all these channels. It can be complicated, but it is important to work through that.

John, do you want to...?

[The Chair, Conservative, James Rajotte]

Just very briefly.

[John Murray]

It will be brief, just two short things trading on Paul's comments.

First, we do anticipate some easing in the growth of even the Asian economies because we don't think they will be able to completely decouple from the United States. The United States is just too important a trading partner, plus we see some easing as well in Japan and Europe. So all of this is factored in. The bottom line is that we still see fairly steady and strong growth in many of these countries, which will provide some support for commodity prices. From that, of course, it provides support for the Canadian economy, but we have such a close trading relationship with the U.S. economy that we would be even less decoupled than the Asian economies. It's a factor. It provides support. But I don't think you're going to see decoupling in Asia or especially in Canada.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Murray.

We'll go now to Mr. Vincent.

[Robert Vincent, Bloc, Shefford, QC]

Thank you, Mr. Chairman.

Good morning, everyone.

Last January 30, the last time you appeared, Ms. Brunelle said that if we were in a recession, the United States was also in one. You answered: “As I mentioned in my presentation, the Canadian economy will grow during the first semester, but according to our reference scenario, there is no recession in the United States.”

Here is what was published in Le Monde yesterday:

[...] the central bank revised its growth forecast for the American economy in 2008 downward by 1.3% and 2%. [...] To avoid the recession, Mr. Bernanke has been lowering the cost of money for the past two months at a rate unprecedented since the 1980s. However, in his desperate attempt to shore up the bank system and the households of the nation, he is taking a risk, if he fails, of being confronted with a catastrophic scenario. After feeding an inflationary spiral [...]

Another article states:

In its study, the IMF explained that it was unlikely that Canada could dissociate itself from what is happening in the United States, given the fact that the commercial and financial links between both countries are among the strongest in the industrial world. Seventy-five per cent of Canadian imports go to the United States. The IMF wrote that Canada should be able to face this situation fairly well, but it insisted that there is a great risk of a downturn and that the country could fall into serious recession if the American economy continues to shrink, and if the American dollar plummets along with commodity prices.

In an article in La Presse Affaires, the chief economist of Scotia Bank, Warren Jestin, was quoted as saying:

According to Mr. Jestin, a substantial downturn in production and in job creation may prevail in the economic landscape of the main developed countries during the first semester of 2008, and it will be followed by a long period of convalescence. [...] Given the balance of payments of the United States, nothing seems to indicate that the depreciation of the dollar is drawing to an end [...]

[The Chair, Conservative, James Rajotte]

Mr. Vincent, you are speaking too fast for the interpreters.

[Robert Vincent, Bloc, Shefford, QC]

All right, I will try to slow down a little.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

The recession is getting on your nerves.

[Robert Vincent, Bloc, Shefford, QC]

Yes, but above all, we are pressed for time.

Let me continue.

Mr. Jestin is expecting the Bank of Canada to reduce domestic interest rates by another half a percentage point during the first semester of 2008. In his opinion, the basic underlying economic barometers will probably make the loonie soar to great heights.

On January 30, you said that the Bank of Canada had lowered its interest rates on December 4 last and January 22. Presently, we see that growth in Canada has gone down to 1.8%.

What do you think of the news we heard this week? Do you think that we can expect a further drop in interest rates from you?

[Paul Jenkins]

First, let me repeat what I said when I last appeared before this committee. As I said then, the latest report on the monetary policy of the Bank of Canada, issued in January, forecasts an annual growth rate of 0.5% for the first semester in the United States, which is very weak. As I also said, we are expecting a reduction in American interest rates that should sustain the American economy in the future.

Our report also mentioned one of the risks involved in our reference scenario, which is a weakening of the American economy. We incorporated this risk in our forecasts. Thus, we are currently analyzing all the recent data and we have set a date, which will be next week. As usual, we are analyzing all the data regarding next week's decision. Once again, as we stated in our January report, we will probably have to step up the degree of monetary easing in our reference scenario soon.

[Robert Vincent, Bloc, Shefford, QC]

Can we expect a drop in the interest rates over the coming months as an attempt to stimulate the economy?

[Paul Jenkins]

I cannot tell you what the decision will be. I can only emphasize the messages in our report on January's monetary policy.

[Robert Vincent, Bloc, Shefford, QC]

The consumer price index can impact Canada's growth, in percentage terms. Lowering the GST also lowered the consumer prices. Had we left the GST rate at 7% instead of dropping it to 5%, would the slowdown in Canada's economic growth have been much less than 1.8%?

[Paul Jenkins]

The main factor for the Bank of Canada is the direct impact of the GST on the consumer price index, the CPI. We think that the impact of the drop in the GST on the IPC will be about 0.6%.

The impact on the inflation rate will be the same, but only for one year. After one year, the effect of the price decrease will be eliminated and the inflation rate will be the same as it was before the GST was decreased.

The monetary policy will have to determine the trend of the inflation rate by excluding the GST, because the impact of the GST rate will only be felt for one year. Moreover, this impact is on the prices, and not on the inflation rate.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Vincent.

We'll go to Mr. Carrie now, please.

[Colin Carrie, Conservative, Oshawa, ON]

Thank you very much, Mr. Chair. I'll be splitting with the member from Chatham.

Coming from Oshawa, I can see firsthand the challenges faced by our manufacturing sector. I'm wondering if you could comment on the suggestion by Canadian Manufacturers and Exporters that the Canadian dollar be around 85¢ or 90¢. Do you have an opinion on that, on how it would affect the manufacturers? Or is it even realistic?