Very interesting comment from Hubert. Lengthy but very much worth reading.
As predicted in the Palos Weekly Letter of January 29, and March 5, 2010, the value of the Canadian currency increased substantially against the US dollar in the past few months to trade above the 99 US cent level on Thursday.
The foreign exchange market is consistently digesting bullish Canadian news.
a) Canada’s conservative government has rebuffed all opposition to cancel the planned drop in the corporate income taxes to 15% in 2012 from the current 18%. The government intends to keep Canadian capital taxes globally competitive.
b) The Department of Finance said that it nearly balanced the books in January thanks to the first monthly increase in tax revenue in more than a year. Ottawa recorded a budget shortfall of $265 million. Prior to the January figures, the monthly deficits have tended to range in the $3 to $5 billion range. The budgetary balance deficits for the fiscal year ended March 31, 2009 and ending March 31, 2010 are on track to be quite smaller than originally expected. The Canadian budgetary deficit should account for 3.5% of GDP in 2009 and 2.0% in 2010. Canada is on a course to reduce its budget deficit to 1% of GDP in a few years.
c) Everything is in place for a Canadian productivity revival. Huge investment in productivity-enhancing technologies and equipment should come about very soon. Canadian businesses are emerging from a recession with healthy balance sheets under 1) a competitive tax system in the form of comparatively low corporate income taxes, tariff-free imports for equipment and accelerated depreciation rates, 2) an affordable cost structure in terms of a strong CDN dollar combined with low borrowing costs and 3) an ample amount of credit availability for government borrowings which are not large enough to crowd out the capital markets.
d) A KPMG Report shows that Canada ranks first among 9 key industrialized countries as a cost-effective place to do business. Such a comparative advantage combined with favourable terms of trade is drawing international firms to Canada.
e) The Bank of Canada has officially and flatly rejected the IMF idea that policymakers should set interest rate targets to achieve higher levels of inflation. The Canadian central bank wants to keep the annual rate of inflation near 2% and has discredited the IMF 4% target rule.
f) Even though Canadian Banks have come out of the global banking crisis in much better shape than most of their counterparts around the world, sitting on huge piles of liquid assets (16% of total assets) and a comfortable equity cushion (11% of total assets), the Office of the Superintendent of Financial Institutions has warned the Canadian banks and insurance companies not to do anything like raising dividends or making acquisitions that could jeopardize either capital or leverage ratios.
g) Obscurely, massive amounts of foreign capital in the form of portfolio investments have provided $109 billion to the government and business sectors in 2009 representing 6.6% of nominal GDP compared to only 2.7 % for the current account deficit. Judging from recent reports, the love affair with foreign investors is not over, for foreign sales of Canadian securities are not letting up.
h) The Canadian oil sands, the largest reserve of non-conventional oil in the world that closely matches the conventional oil reserves of Saudi Arabia, is attracting the interest of all the major oil players in the world. Several European companies including BP plc, Royal Dutch Shell, Total and Statoil Hydro are all in the oil sand play. Athabasca Oil Sands, which Petro China bought a 60% interest in last August for $1.9 billion, successfully raised $1.4 billion in the North American capital markets last week. Now, there are indications that the competition is heating up, for India’s state-owned Giant, Oil & Natural Gas Corp., is poised to make an important entry.
i) A number of counties are adding Canadian dollars to their official forex reserves as a hedging currency. This correlates well with growth that stems from Canada’s unique endowment of natural resources, and exposure to open trade; additionally, there are, also, deep and liquid capital markets.
j) Canada’ economic recovery kept up its rapid pace in the early months of 2010. The GDP advance of 0.6% in January equates to an annual rate of 7.2%. It would not be surprising to see GDP top the 5% growth rate posted in the fourth quarter of 2009. Parity with the US dollar is within reach and Canadians may have to live and adjust to a "new normal" level for the Loonie.
These phenomena may be underway, in that manufacturing sales are rising and the trade account has been being steadily improving for many months. Assuming that the China-US currency struggle does not turn into some form of protectionism and the Canadian monetary stance remains relatively conservative, the value of the Canadian dollar could strengthen another 5% by Christmas. There are too many signs that the US economic recovery is happening and is sustainable, as supported by Friday’s report of the biggest payroll employment increase in three years, and Thursday’s release of robust increases in manufacturing activity.
CANADIAN MONETARY POLICY: The Palos Monetary Index, which closely monitors relative Price Stability, Balance of Payments Viability, Fiscal Responsibility, Labour Market Capacity and Economic Growth, stood at 140 for Canada and 71 for the USA. The differential strongly suggests that the Canadian monetary stance should be easier than in the USA. Yet, a close look at the difference between the two countries’ change in money supply, real interest rates, yield curve and bank liquidity, clearly and unequivocally suggest that the Canadian monetary stance is much tighter than it is in the USA. Strangely, the prospect of the Bank of Canada raising its target rate way ahead of the FED has moved over the past few months from a possibility to a surety. A divergence in rate policies would definitely push the Canadian dollar upward.
THE CHINA-USA CURRENCY DEBATE: History demonstrates that when America is "pissed-off" and ratchets up its actions and rhetoric, China moves to accommodate. From the spring of 2005 to August of 2008, China permitted its currency to appreciate 20% against the US dollar, which was about the amount that Goldman Sacks argued for. With the advent of the banking crisis in 2008, China decided to effectively peg the Yuan at 6.83 to the Greenback. The US acquiesced.
This time around, the Chinese are financially and economically stronger and it is not like the previous series of direct and diplomatic insults that have been directed at them. The visit of Tibet’s religious leader to Washington, the accusation of abusive trade practices, the sale of armaments to Taiwan, the investigation of trade barriers on American agricultural exports and the pointing of human rights restrictions, have openly irritated China. The Chinese have not been indifferent and have reacted by
1) insisting that global imbalances are not of their making, but of bad economic policies in the West,
2) shutting International Corporations out of Chinese government procurements,
3) hacking attacks on Google,
4) putting on trial several Rio Tinto executives,
5) seeking free trade arrangements with India and
6) soliciting and gaining Japanese support.
There may be a lot of tension between both countries and a lot to complain about, but what is more important is that it is a geopolitical struggle. Neither faction wants to lose face as both want to manifest their importance. On one side, China has made it quite clear that it will make its own decision as to how to run its exchange rate policy. On the other side, the US is resolved to put the blame somewhere else, for policymakers cannot solve their internal problem of lack of savings by prolonging slow economic growth.
On this one, the USA is more wrong than China. Firstly, the USA has a trade deficit with more than 90 countries. The thing that the US finds intolerable is if the trade deficit is with one of the top world economies where there are no free currency markets. Demand for currencies finds its way in the foreign exchange markets, but supply is, for all intents and purposes, determined by a few major central banks (FED, ECB, BOJ, BOC), which have a total monopoly over money creation. In this connection, the FED controls the global supply of US dollars and has more influence on its value than any single participant.
Secondly, global economics is no longer a competition between Nations. Competition is more often than not, between producers, international brands, production agreements and supply chains. A vast amount of Chinese exports are hugely dependant on imports from the rest of the world. A recent study by the University of California concluded that the Chinese added value embedded in a 3G Apple i-pod account for only $4 of the total $150 cost. Yet, the entire amount is chalked up as a Chinese export. Other studies estimate that overall Chinese value added in all products exported from China averages around 35% to 50%, a large proportion but a lot less than gross export figures imply.
Thirdly, Chinese policymakers can rightly show that their fiscal stimulus has cut its current account surplus by more than half since 2007; Due to a wide and sustainable surge in imports, a trade deficit for March is in view.
Yet we do not believe that neither Beijing nor Washington wants to label China as a "currency manipulator" and face a major political confrontation that could get out of hand and end-up in trade protectionism in the form of higher tariffs and quotas. Many younger Chinese officials, like those in the Bank of China have officially recognized that China has handsomely profited from the erosion of economic, political, physical and technological barriers to production. There is no way in hell that China wishes to jeopardize the benefit of globalization. Without it, the huge regional wealth disparity and large population could subject the country to major political and social instability.
China needs globalization to ensure economic growth and, in turn, avoid civil strife. While the "Global Imbalances" is a big myth, there are enough false pundits and officials like the ECB, US Treasury, World Bank, WTO and IMF who believe that in order to have a sustainable global economic recovery, the global imbalances must be rectified. The Chinese can’t win and they know that. They will succumb to global pressure. China will adopt an upward crawling peg against the US dollar and will eventually surrender to a liberalization of the Yuan. That would be great for Canada.
P.S. The Obama administration decided over the Easter holiday weekend to delay a decision on whether to declare China a currency manipulator. Originally due on April 15, it vowed to press Chinese leaders on the politically charged issue of their currency policy during several high-level international meetings in the coming months. A nuclear security summit in Washington is scheduled on April 12-13. A US-China economic summit in Beijing is scheduled for May. A G20 summit meeting in Toronto is scheduled for June.
Hubert Marleau, Chief Investment Officer, Palos Management Inc.
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- Risks, Hedges and Opportunities: The Yuan
- RISKS, HEDGES AND OPPORTUNITIES
- RISKS, HEDGES AND OPPORTUNITIES: CANADA’S CENTRAL BANK COURAGE
- Risks, Hedges and Opportunities: Oh Canada!
- Risks, Hedges and Opportunities: In Praise of the Canadian Dollar
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“the China-US currency struggle” – That an undervalued currency boosts exports and harms trading partners via a kind of “dumping” effect is largely a myth. What a nation “gains” in currency undervaluation it must on the other hand shell out in higher imports prices. Since in a globalised exonomy exported goods are built with foreign implements and machinery, since workers buy also foreign products and demand their wages to pay for them, most of these alleged gains cannot materialise as they are kept in check by the unnaturally high prices for imports. No one can have their lunch and eat it. Trade envoys invoking the dumping claim when it comes to alleged currency undervaluation really are trying to do the same thing as a tariff would achieve but resort to bullying as tariffs are prohibited by the WTO they themselves signed!