It is not credible, if not indeed impossible, for countries to engage in competitive devaluation or currency debasement and, at the same time, make good on promises to defend their credit rating. In order to successfully erode debt, nominal interest rates on public debt must be and stay below the rate of growth in nominal GDP. Canada does not appear to have either of these aforementioned diseases.
Accordingly, one should not expect Canada to end-up with accelerating inflation rates. On the contrary, the central bank should be able to keep interest rates on debt lower than the anticipated 5% rate of growth in nominal GDP for years to come.
There has been no public suggestion by the Bank of Canada nor political motivation on the part of government to drop the policy of targeting inflation at 2%. A regime change to "controlled" inflation targets or monetization of public debt would considerably elevate the risk of creeping inflation and the possibility of high inflation. The Bank of Canada should not be pressed to change the manner in which it manages monetary policy because it is an enviable position.
Canada unquestionably has a preferred budget plan, stronger fiscal position, healthier financial system and more sustainable growth outlook for employment than all of the OECD countries. Should the Bank of Canada continue to follow an appropriately more prudent monetary stance than the US by holding on to a flatter yield curve, a higher level of real short term rates and a relatively lower monetary base, other factors like improving terms of trade and the viability of the balance of payments may significantly weigh on the out-performance of the Canadian dollar.
Moreover, the Canadian government is introducing important productivity measures like allowing foreign inflows of private equity capital on favorable tax terms and permitting Canadian industry to import capital equipment tariff-free. Given the reality that Canadian household spending is not in a free fall, a potential recovery in capital spending combined with planned infrastructure expenditures could surprise investors, who are either cyclical or structural bears, for it may raise nominal GDP growth to a level that would have a major positive impact on the budget deficit. Canada is attracting the attention of both private and official investors. In our judgment, to own investments denominated in Canadian dollars is the way to go, for the Loonie is likely to reach US dollar parity soon.
Hubert Marleau, CFO, Palos Management Inc.
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