Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 2 - Evidence - Meeting of November 24, 2004
OTTAWA, Wednesday, November 24, 2004
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:05 p.m. to examine and report upon the present state of the domestic and international financial system.
Senator Jerahmiel S. Grafstein (Chairman) in the chair.
[English]
The Chairman: Honourable senators, good afternoon. I wish to welcome viewers from across Canada. We are being covered today live. It is a great pleasure on behalf of the Standing Senate Committee on Banking, Trade and Commerce and on behalf of our esteemed deputy chair, Senator Angus from Quebec, to welcome Mr. David Dodge, Governor of the Bank of Canada, and Mr. Paul Jenkins, Senior Deputy Governor of the Bank of Canada.
Governor, as you know, this is our opportunity, which we have twice a year, to meet with you at a time when you can provide an insight into Canada's economic affairs. Your appearance today is particularly timely, given a number of recent events: the U.S. election, the continued rise of the Canadian dollar, the fast rise of the euro, and the movement with respect to interest rates both in the United States and in Canada.
A crucial role of the Governor of the Bank of Canada is to act as the guardian of our currency and to keep close watch on the state of the economic activity across the country. It is the task of this committee to seek answers on behalf of Canadians from the Bank of Canada on the state of our economy. This committee is like the constitution of the Senate, it is composed of senators from the five regions of Canada. It is with this in mind that we have invited you, governor, and your deputy to assist us on behalf of all Canadians in reflecting the progress of the Canadian economy and in considering the best course ahead. It is a sincere pleasure to have you both here with us today.
As usual, we will begin with an opening statement in whatever way you see fit to make. Then, as I am sure you are quite accustomed to, we will go to senators on the committee for questions from all regions of the country.
Mr. David Dodge, Governor, Bank of Canada: Honourable senators, I wish to extend my congratulations to Senator Grafstein on becoming chairman of this extraordinarily important committee that has over many years done such good work. It is a real pleasure on our part to be here with you this afternoon.
We really do appreciate the opportunity you afford us to meet with you twice a year following the release of our monetary policy reports. These meetings help keep parliamentarians and, through you, all Canadians informed about the bank's views on the economy, and about the objective of monetary policy and the actions that we take to achieve it.
[Translation]
When Paul Jenkins and I appeared before this committee last April, we told you that we judged the economy to be operating significantly below its potential. That is no longer the case. The Canadian economy grew faster in the first half of the year than we had projected, largely because of a surge in exports. The economy is now operating near its production capacity and continues to adjust to global developments.
Our latest monetary policy report, released on 20 October, presents the bank's base-case projection for the period to the end of 2006. It calls for aggregate demand for Canadian goods and services to expand, on average, at about the same rate as potential output.
Given the effects of higher oil prices and the past appreciation of the Canadian dollar, economic growth in the report is projected to be slightly less than 3 per cent in 2005, and slightly more than 3 per cent in 2006.
[English]
With the economy expected to remain near its production capacity throughout this period, core inflation is projected to move back up from the current level of 1.4 per cent to the 2 per cent target by the end of 2005. This is essentially the same projection that we made when we met with you last April. However, in October we expected that total CPI inflation would rise to near the top of the 1 per cent to 3 per cent range in the first half of 2005 before falling slightly below core inflation in early 2006. That projection incorporates the path suggested by the futures prices for crude oil in mid-October, which was when we finalized the report.
Honourable senators, it was against this background that the bank raised the target for the overnight rate to 2.5 per cent on October 19, which was our most recent fixed announcement date.
The base-case projection in our October report assumes further reduction of monetary stimulus over time to keep the economy near its production potential and to achieve the inflation target. We also emphasized in the report that the pace of interest rate increases will depend on the bank's continuing assessment of the prospects for factors that affect pressures on capacity and, hence, on inflation.
Mr. Jenkins and I have just returned from last weekend's meeting of the G20 in Berlin. The issues we discussed there line up closely with those issues that we identified and analyzed in our report, namely: commodity prices, realignment of currencies, global imbalances and the growing presence of emerging market economies such as China and India.
While we remain broadly comfortable with the global growth scenario that we outlined in our report, and we can discuss that this afternoon, discussions this weekend and at other recent international meetings suggest a slight moderation in global growth prospects, despite the fact that both spot and futures prices for oil have declined somewhat over the last month. Since the October report, one of the most significant developments has been a further depreciation of about 5 per cent in the value of the U.S. dollar against all other major floating currencies, including the Canadian dollar.
If current exchange rates were to be sustained, and if all other economic and financial factors were to remain unchanged, this would have a dampening effect on the aggregate demand for Canadian goods and services. Since monetary policy aims to keep aggregate demand and supply in balance in order to keep inflation close to our target, we need to assess the implications of movement in the currency for aggregate demand and the context in which they occur; that is, in the context of changes in other economic and financial factors.
Honourable senators, in conclusion, I wish to stress that the bank assesses the full set of information before each of its fixed announcement dates, and we will do so again before our December 7 announcement. Mr. Jenkins and I will now be pleased to take your questions.
The Chairman: Thank you.
Senator Tkachuk: Welcome, Mr. Dodge and Mr. Jenkins. Mr. Dodge, it is the seventh time that you have appeared before the Banking Committee. Much has changed during that time. The inflation numbers that you talked about are good news for many Canadians and the strong Canadian dollar is now at U.S. 84.06 cents. Some in Canada are not enjoying the new strength of the Canadian dollar. Exporters, especially those in the high-tech sector, are complaining in the media that they are having some difficulty. Our strong dollar, as compared to the weaker U.S. dollar of our largest trading partner, may be great for people who go south for the winter, but may have economic ramifications for both Canada and the United States. Do you believe that it has been a policy, spoken or otherwise, of the U.S. Federal Reserve to weaken the U.S. dollar in order to stimulate U.S. exports and help solve the American trade deficit?
Mr. Dodge: Honourable senators, far be it from us to impute motives to anybody in this respect. The Americans have been relatively slow in moving to correct their fiscal deficit. They have a weak overall savings performance and they have had interest rates, at the extreme short end, which have been zero or close to zero now for a long time. Given the lack of savings, it is not surprising that the counterpart is a large current account deficit. Actually, algebraically that has to be true. In those circumstances, one would expect that there would be corrections to try to bring that back into balance. One of those normal and expected corrections would be some depreciation of the U.S. dollar against all other currencies from the very high level that it had reached at the beginning of the year. Without imputing motives, the fiscal and monetary policy stance has been such that indeed it would be expected in the normal working of the economy that there would be some depreciation of the U.S. dollar.
Senator Tkachuk: It has been remarkable how much it has changed over the last year. Was the Bank of Canada able to forecast this? Did you see it coming at such a rapid pace?
Mr. Dodge: Exchange rates are probably the most difficult thing to predict. Directionally, it was clear that at least some adjustment in the U.S. exchange rate would be required but we do not attempt to forecast levels or the speed at which those adjustments would take place.
Mr. Paul Jenkins, Senior Deputy Governor, Bank of Canada: Honourable senators, if I may give you a couple of additional thoughts. In our monetary policy report, this section is in the context of what is happening in the United States. Chart 7 in our report shows the recent growth profile of the United States going back to 2000, 2001 and 2002. You can see that there was an extended period of low growth in the United States then. Based on some calculations, the U.S. economy was in a modest recession for part of that period. Coming back to your initial question, in the context of federal policy, they have been running a policy of low interest rates to re-stimulate the U.S. economy, take out the excess slack that opened up during that period of slowdown and, certainly, that period of low interest rates would be one factor behind, as the governor suggested, the exchange rate adjustment in the United States. That cyclical component is part of the answer to your question.
Senator Tkachuk: We used to have this discussion with former Governor of the Bank of Canada, Gordon Thiessen. He would say that the dollar was low because commodity prices were low, at the time. We used to talk about interest rates and whether Canada was deliberately lowering its dollar, keeping its interest rates low and, therefore, getting the dollar down to 65 cents. That, of course, makes things a little easier as far as paying back our debt is concerned, and helps our interest rates and our deficit. The subject was always commodities. Now, Mr. Jenkins says that it is U.S. and Canadian interest rates that are partly responsible. I see commodity prices, such as oil, have gone up. What is it that changes the dollar?
Mr. Dodge: Let's be careful. There are two separate strands in these events. The first relates particularly to Canada — rather strong commodity prices and a rather strong world economy and, hence, a rather strong demand for Canadian goods and services abroad. The second is a depreciation, which would normally exert an upward pressure, quite appropriately, on the Canadian dollar.
On the other side of it, we have an adjustment — a big imbalance in the U.S. economy — that is exerting a downward pressure on the U.S. dollar. They are quite distinct forces, although they are both working in exactly the same direction at the moment.
Senator Tkachuk: I want to get back to this but I will do it on the second round.
The Chairman: Our next questioner is Senator Fitzpatrick from the robust economy of British Columbia.
Mr. Dodge: Newly robust.
Senator Fitzpatrick: Mr. Dodge and Mr. Jenkins, thank you for being here. I guess you have just flown back from Germany. This is the first time since I have been on the Banking Committee that we have been dealing with such a substantial increase in the value of the Canadian dollar compared to the American dollar, which presents a number of new issues for the government and, I presume, the bank over the next year or several years. I am sure that you have a handle on all of these issues.
I am interested in your opinion on the effect this change in currency values will have on our economy. I am particularly interested in the Canada-U.S. trade balance. I have several short but connected questions.
First, what effect do you believe it will have on our balance of trade with the United States over the next year? As you probably know, we have already seen a decline in exports in 2003 of some $17.3 billion, or 4.5 per cent.
Next, what effect do you think this will have on the balance of trade between Canada and the United States on a longer-term basis? In your opinion, can we adequately counter these changes with improvements in productivity and competitiveness?
Can give us your opinion on how fast — and I heard what you said earlier — the Canadian dollar will continue to increase in value with respect to the American dollar over the next six months or year?
Mr. Dodge: First, let me take the balance-of-trade issue. Obviously, this depends on a lot of factors, most importantly, the strength of growth of final domestic demand in the United States and in Canada. Obviously, the stronger the growth of final demand in the United States and the weaker the growth in Canada, then that moves the balance of trade in Canada's favour and, vice versa, against Canada.
Our outlook, senator, as we stated in the report, and we have not changed that view very much, is that we will see U.S. growth probably at a little less than 4 per cent next year, maybe about 4 per cent in 2006, fairly robust, certainly, and at or above their level of capacity growth. That bodes well for sales in the United States, although, clearly, if we could resolve the softwood lumber and the BSE issues and so on, that would make an important difference, as I do not have to tell you.
In terms of Canada, as you will see again from our report, we expect a rather strong domestic demand. Thus, in terms of demand factors, what one would argue is that they, in and of themselves, would not probably lead to a huge change in the real balance of trade, although the nominal balance can move around significantly, depending on the price of oil, metals and so on. The real balance, one would argue from that, probably would not change all that much.
Over the longer haul, it is very difficult to say what the effect of a higher exchange rate would be because it really depends on the factors that are keeping that exchange rate up. If that exchange rate is remaining strong, to go back to Senator Tkachuk's question, because of strong prices for energy, natural gas, lumber, metals and so on, then one could see even a stronger trade balance with the United States, despite a higher exchange rate.
If, on the other hand, the exchange rate is high for different reasons that do not relate to trade, then we could get the opposite effect. It is not possible a priori to actually answer your question because you have to know the reason behind the higher exchange rate.
Your third question is whether we can counter this with productivity improvements. I think you put your finger on perhaps the most important, if you will, microeconomic issue facing Canada, and that is how we improve our productivity over time. That is extraordinarily important if real standards of living are to rise at a time when our labour force is not growing very rapidly. That is an extraordinarily important issue for us all.
The final question is about future changes. I do not speculate on that. When we produce our report, and we are careful in this, we always assume that the Canadian exchange rate will be within its trading range going into the future. That is what we did in April and in this report.
Senator Fitzpatrick: I was wondering how fast we would have to increase our productivity in relation to how fast the exchange rate might go up, but I understand what you said.
Mr. Dodge: Regardless of what happens, you have put your finger on the right issue, and that is, whether we are in government, run a private corporation or run the Bank of Canada, we should all be focused on the productivity issue.
The Chairman: Mr. Dodge, you will be pleased to know that yesterday the committee unanimously approved, and the Senate adopted, a resolution inspired by our colleague, Senator Angus, to study productivity, and we will be doing that early in the new year. We will draw on the expertise of the bank to assist in that.
Senator Oliver: It is always a pleasure to have you here. I have one question with two parts. It is a broad question. It arises from what some people call the ``rise of the China factor,'' its effect on our economy in Canada and how China's demand for Canadian commodities will potentially impact the long-term economic growth. Part of my question is about the effect on the dollar. The other part of my question is the effect on monetary policy.
When you testified, governor, before the House of Commons Standing Committee on Finance in October, you said that Canada's strong economic growth since the Bank of Canada released its monetary policy report update in July was ``...largely due to a surge in exports.''
As you know, Mr. Dodge, about a third of Canadian exports are commodities. The Bank of Canada commodity price index, which tracks the price of 23 Canadian commodities sold in world markets, rose to the highest rate on record the week of October 20. As you said, this is due largely to China's huge demand for Canadian commodities such as copper and nickel. This demand has pushed commodity prices through the roof and has reawakened Canada's resource sector.
China's economy has continued to grow at an average annual rate of nearly 9 per cent over the last 25 years. It is already the sixth largest economy in the world, and its share of the global economic input is expected to double by the year 2020.
With all of that information in mind, a Canadian economist with BMO in Chicago said that Chinese demand for commodities, of which Canada has an abundance, will continue to support our dollar.
Has the bank taken a good look at the potential long-term impact of the growing Chinese demand for raw materials? Has the Bank of Canada taken any look at the overall implications for monetary policy, given the potential impact on both trade and investment flows?
Mr. Dodge: The short answer is yes, and for the long answer, I will turn to Mr. Jenkins.
Senator Oliver: It does have an effect on the dollar.
Mr. Jenkins: Mr. Chairman, anticipating some interest in China and that part of the world, we have actually put together a little package that, if time permits, I would not mind just spending a couple of minutes on with the committee. I leave it to you. I think it addresses this quite directly.
The Chairman: Do you have copies?
Mr. Jenkins: Yes, we do.
The Chairman: Please circulate them.
Mr. Jenkins: This is a complex set of issues. You have touched on most of them in one way or another. I would like to take a minute to touch on at least two aspects of the global economic trends that reflect very much what is going on in Asia.
First is the issue of current account imbalances, we have touched on that a little already, but the other is the emergence of China; and we would include India in terms of looking ahead to the global economy.
Senator Oliver: Are there Asian countries other than China and India that you look at?
Mr. Jenkins: We look at them all. Although a lot of what I will say will be in the context of China and India, you need to think about Asia as a group. I will touch on that particularly in terms of exchange rate regimes, because at the moment China is fixed to the U.S. dollar, but most other Southeast Asian currencies are either explicitly or implicitly tied to the yuan. You really need to think of these issues from a broad Asian perspective.
The first chart basically shows this issue of current account imbalances. We were talking a minute ago about that in a bilateral context, but it really is an issue for the global economy. We are seeing a very large U.S. current account deficit. That reflects a number of factors at play. The first chart of that package simply shows the size of the U.S. current account deficit and that a large percentage of the offset — if one country is running a large current account deficit there have to be surpluses elsewhere — is, in fact, a surplus within Asia. It is in terms of your point, senator, that we are looking at Asia collectively here.
Senator Oliver: Asia and Canada?
Mr. Jenkins: Canada is running a current account surplus, but it is very small compared to the surplus that Asia is running against the United States. Canada is plotted on that graph. It is the red line. As you can see, on this scale, it is really quite small. One of the points is that when you think about these issues, you need to think about them from a global perspective.
The second chart shows what we have already touched on, which is the large U.S. fiscal deficit. That, in part, reflects a shortage of domestic savings in the United States. Part of that shows up in the large U.S. current account deficit. That second chart shows the size of that; it is currently running in the order of 5 per cent of GDP.
The flip side of all this is chart 3, which shows the reserve accumulation. The blue and the red hatched parts of that bar, particularly, on the right-hand part of that chart show the massive accumulation of reserves in Asia. Again, you have a large U.S. current account deficit that is being financed by Asia and a very large accumulation of reserves in those countries.
Here we have a set of issues that very much reflects these global imbalances and there are clear implications for how those play out as we look ahead for the global economy.
The second set of charts goes to the other aspect of your question, which is really what I call the new players. This chart shows that measured on a slightly different basis than what you were using, senator. This is using a concept called purchasing power parity. I do not want to get into the technical aspects of that, but it tries to equalize prices across the country for the same basket of goods. This is what most economists would use in comparing countries.
The simple point here is you can see the blue line, which is China, rising very rapidly. It is now, on this basis, accounting for 15 per cent of the world economy, making it the second largest economy, and that compares to 3 per cent in 1980. Likewise, you can see India, which is the green line, rising from less than 3 per cent in 1980 to over 5 per cent right now. You have two large economies that are growing rapidly.
Just to complete the story, the next chart shows exports as a percentage of total global exports, and the simple point I want to demonstrate here again is the blue line, which is China. Their exports have risen to the point where they are now the fourth largest exporter in the world, surpassing Canada, which is the red line.
The final couple of charts again show the same story, but in terms of imports. Here again, you can see that imports in China have risen dramatically. China is now the third largest importer in the word economy.
We can conclude that there is a lot happening in the world economy, but of course we have seen these sorts of phenomena in the past, with the Industrial Revolution, Germany and the U.S. in the latter part of the 19th century and so on. The difference here, and this is the last chart, is that when you look at India and China together, they represent 40 per cent of the world population. Therefore, there are some significant short-term issues here for Canada and for the world economy in terms of these global imbalances, but also longer term in terms of the emergence of these countries into the world economy.
Senator Oliver: What specific effect would it have on our dollar and on our monetary policy?
Mr. Jenkins: Let me try to bring it back to that question. One of the issues, certainly, is you have a global economy that is growing rapidly. Over the last couple of years we have seen strong world economic growth. Part of that has been in Asia, but not exclusively. We have seen the U.S. economy rebound. Therefore, you have a backdrop of a world economy that is expanding rapidly. Our exports have actually been growing fairly rapidly. This reference is in our report for the first half of this year.
We clearly have to take the strength of demand in the world economy, in terms of its implications for Canada, into our monetary policy deliberations. That would be one aspect of it.
The other aspect is this issue of exchange rate regimes. Here again, it is a longer-term issue, but with some near-term consequences. You have China and most of the rest of Asia on a fixed exchange rate, whereas the rest of the world is on the flexible exchange rate. That raises some important policy questions, not just for Canada, but for the world international monetary order. There are some important issues here going forward. We are spending a considerable amount of time on these issues and their implications for Canada.
The Chairman: These charts provoke a lot of questions. Our next questioner will be Senator Moore from the province of Nova Scotia.
Senator Moore: Welcome to both of you. I found your comments with respect to China interesting. I was looking at an article here in the Financial Times yesterday. Here is the People's Bank of China telling the United States to get its financial house in order. I would think that the people south of the border would have to be wondering what is going on and what happened.
One of the comments here is from Mr. Lee, the Deputy Governor of the People's Bank of China.
It says that the savings rate in China is more than 40 per cent. In the U.S. it is less than 2 per cent. They spend too much and they save too little. He said that U.S. workers enjoyed relatively high wages but remained excessively engaged in low-value-added industries such as textiles and agriculture.
In addition, he said that U.S. policies that restricted exports of military and high-tech products to China were also partly to blame for Beijing's huge trade surplus with America.
On the other side, his remarks appear designed to defuse mounting U.S. and European pressure on Beijing to allow an appreciation of its currency, which is, I think, what you were leading to, Mr. Jenkins. Apparently, their currency has been pegged to the U.S. dollar since 1997-98 and not been allowed to float. This is the global monetary situation that we are facing, which is impacting negatively on the U.S. and, therefore, I presume on us.
Mr. Dodge: There are two questions here. Let me start off.
First of all, on the issue that Deputy Governor Lee raises, the numbers are right. The issue is, however, that without growth in demand worldwide, there is no growth in production.
There is an imbalance in the United States, with savings too low, as I said in response to an earlier question. However, if indeed the United States is to reduce that imbalance by increasing its saving, and the world economy is to continue to grow, then the rest of the world, with higher savings rates, has to do exactly the opposite. That is an extraordinarily important point to remember.
The second issue, though, is the one that Mr. Jenkins started to raise — which I tried to address in a very cursory way in my speech to the Canada-German Chamber of Commence when I was in Berlin — that is, this issue of the world monetary order. We discussed it also at the G20 meeting.
Here we have a very real problem, senators. We have part of the world that is operating on the basis of a fixed exchange rate, where there are certain mechanisms for adjustments, and part on a flexible exchange rate. There is a very real debate, and should be a very real debate, about that monetary order — should it persist?
It is important to recognize that even in a fixed exchange rate world, in which China, and most of Asia, more or less, operates, there is a mechanism of adjustment. That mechanism would not be to build huge reserves of foreign currency, but rather to allow that to spread out into the domestic economy, which would produce inflation, which would bring about a rebalancing of exchange rates.
Senator Moore: Inflation in Asia.
Mr. Dodge: In Asia. The very real problem is that at the moment the authorities in China, and to a certain extent, therefore, in the other Asian countries, are what we call in technical language ``sterilizing'' those inflows of dollars by building up reserves. Hence, there is no mechanism to allow for the rebalancing. Regardless of which set of rules you think you should be playing by, whether it is the Breton Woods rules, which is the fixed exchange rate world, or the floating world, it is very important that you do play by the rules of those games. Our problem at the moment, as indicated by those massive build-ups of reserves, is that the fixed exchange rate part of the world is not playing by the rules.
Senator Moore: And that is 38 per cent of the game, Therefore, the 40 per cent of the global economic activity that is playing by a fixed —
Mr. Dodge: The problem is that you cannot get an adjustment between these two blocs. We do not have a mechanism to allow the adjustment to take place. That is a serious problem.
Senator Moore: As of 8:46 Greenwich Mean Time today, the U.S. debt was $7.5 trillion, and their deficit as of September 30 was $412 billion. Are these numbers historically high, low, beyond the pale?
I do not hear any talk about the debt. I hear about deficit and so on, but that debt is apparently increasing at the rate of $1.7 billion per day; somebody has to get some adjustment going and take this in hand. If it is such a big player in the flexible rate bloc and this is their financial order today, how does a country like Canada impress upon them that they have to do something, or is this the way we should be going? It is not the way we normally run our own households, so how does the country continue to do that and expect to get back to productivity and a stabilized life for the citizens?
Mr. Dodge: There are really two different issues here. With respect to the debt levels in the United States, it really does depend on your historical perspective. Of course, the United States and Canada ran much larger debts in relation to our productive capacity during the war years. The size, per se, is not impossible to handle. In the world context, it would be in the middle of the pack in terms of the share of GDP.
The real issue is the imbalance on the savings side, that the Americans continue to consume a lot more than they produce. It is that, and the opposite case, which was exactly Paul's point, in Asia. You can go on for a long time, but you cannot go on forever, without those imbalances correcting themselves. The real job that the international economy faces is to bring about a smooth adjustment of those imbalances, and not through a big crash.
The second part of your question is extraordinarily interesting and I think we will come back to it. It is very much in Canada's interest to get a resolution to this world monetary order because Canada has been appreciating relative to the Chinese currency and the Asian currencies; and we compete vigorously with the Chinese and Asian economies at home, of course, but particularly in the U.S. market.
Even more than the United States, Canada, along with Australia and Europe to a certain extent, is much affected by this world monetary order that is out of whack; it is a kind of pivot around which the fixed rate world revolves and the floating rate world revolves. We will come back to that in later questions.
The Chairman: We will start supplementary questioning with Senator Plamondon from Quebec, an independent Senator — very independent.
[Translation]
Senator Plamondon: Canadians often wonder whether the economy is performing well. When I look at the debt level of Canadians, the growing number of people making use of alternative credit, and the number of soup kitchens in all the regions, I can't help but be concerned. The most recent media reports note that child poverty is increasing. That reflects badly on our performance.
Can you tell me the extent to which individual indebtedness may be a significant element in your policy?
Mr. Dodge: In our report on the financial system to be published next December 9 you will find an in-depth analysis of this question. I can provide you with a brief overview of this analysis today. It is a fact that the ratio of household debt to disposable income is high, more than 100 per cent of annual available income. But the interest paid yearly on this debt is lower than the average for the last 20 years. The payment of interest on the debt is not a problem. That is the first point.
In simulations of what will happen in the event of a significant rise in interest rates, it is only in the extreme situations that a problem would occur if interest rates return to a more normal level, such as in the past decades. The service of the debt would be within the average observed over the past 20 years.
So from that point of view it is not really a problem. There are always individual households that are too deeply in debt. That is always the case and it is so at the present time. But there is no reason to believe that the situation is any worse than normal. In fact, we believe that it is not as bad as it normally is.
Household assets are also very high and the debt-to-equity ratio, particularly houses and so forth, is somewhat smaller than normal. So it can be said that there is no problem even if interest rates increase and we return to a more normal situation.
Senator Plamondon: Can you tell me how high household indebtedness would have to rise before you would become concerned?
Mr. Dodge: I don't understand.
Senator Plamondon: You say that household indebtedness is at 110 per cent. In your view, how high can this go without being a cause for concern, how much debt can households carry?
Mr. Dodge: There is no problem. The issue of household debt service is less severe than it normally is. Even if interest rates return to a more normal level, there will not be a problem, but there are always households that do have problems.
Senator Plamondon: That does not answer my question. When will it become a cause for concern? Does that mean that people should still buy on credit since there is no reason to be worried?
Mr. Dodge: No doubt, there is a certain amount of leeway.
[English]
The Chairman: It is time to turn to another senator. I have asked if honourable senators would restrain themselves in terms of the length of their questions. I have been a little too liberal, but I think we should turn conservative now. Governor, perhaps you could be a little more precise, because time is running out and we want to give everybody an equal opportunity.
Our next very distinguished questioner is Senator Angus, the deputy chairman, and long-serving member of this committee. We will be very interested in what he has to say.
[Translation]
Senator Angus: I would like to add a word of welcome. As a senator from Quebec, I would like to display a little bit of my Westmount French. The subject I would like to raise today is rather delicate. I hope that you can reassure Canadians. My question is the following.
[English]
The buzzwords we hear so often these days have to do with national security, anti-terrorism and the war on terrorism. Of course, we have heard over and over again in that context, of the consequences of any attack on our financial systems or on our financial institutions themselves. We recognize the vulnerability, naturally, of these things, particularly of the systems, perhaps through a cyber attack, or the institutions themselves through physical terrorist attacks.
Does the bank have a crisis management plan in place to deal with any such unfortunate occurrence here in Canada?
Mr. Dodge: The answer is yes. If you would like elaboration, I will ask Mr. Jenkins to do that because he is in charge of ensuring that that is in place.
Mr. Jenkins: Yes indeed, we have a robust business continuity plan at the bank, and it was not too long ago that we had to activate that, around the blackout of August of two summers ago. We think about this from the perspective of the bank as an institution and the safety of our staff. That security is critical to us, but we are also working with our partners, nationally as well as internationally, on these issues to take the measures that would be required under a particular event or scenario to ensure that the Canadian and the global financial systems continue to operate. I can assure you that we have had examples of that over the last several years.
Senator Angus: To follow up on that — I am very pleased to hear that you do have something — in terms of the systems that are so vital to the integrity of our financial system at large, we know that these al-Qaeda people and so on have targeted financial security in the past. What kinds of backup systems do you have? Without going into classified information, can you enlighten us a little on that?
Mr. Jenkins: I will stay at the general level. You are absolutely right. We have a number of them, and you used the correct words, ``critical operating systems,'' for example, linked to the payment and settlement systems that represent what I call the plumbing of the financial system, the systems that are in place that you see the results of day in and day out but are there and are complex. We have legislative oversight to ensure that those systems are risk-proof.
Yes, we have identified those systems that are critical from that perspective. Those are not the only ones. There are others in our capacity as agent for the government, but it is those critical operating systems that we have spent considerable time and energy on to ensure that they are properly backed up.
Senator Angus: One of the things that we have also learned since that sad day in 2001 is that the government reacted here by establishing what I believe is called the Ad Hoc Cabinet Committee on Public Security and Anti-Terrorism, similar, I suppose, to Homeland Security south of the border. Are you gentlemen, one or both of you or other colleagues of yours, integrally involved with that security body?
Mr. Jenkins: Yes, we are.
Senator Angus: Are there modes of precaution in place other than the ones you have already mentioned?
Mr. Jenkins: As I mentioned in the context of these critical systems, this is from a national perspective, but there is also considerable work done at the international level to ensure that central banks are working together. You mentioned the events of September 11. The international central bank community very quickly got together to ensure that the facilities necessary to keep the global financial system operating were put in place right away.
On an ongoing basis, through organizations like the Bank of International Settlements, central banks do work closely together on all these sorts of issues. I can say with a fair degree of confidence that there is a concerted effort nationally as well as internationally.
The Chairman: Our next questioner will be our most distinguished ex officio member of this committee, Senator Kinsella. We are pleased and privileged to have him here. He is Leader of the Opposition in the Senate. He is not often a member or attendee of this committee, but his questions are always interesting. We have asked him to intervene, and I ask the indulgence of other committee members.
Senator Kinsella: Mr. Dodge, I may be wrong, and therefore I ask the question for your correction if I am, but it seems this government has failed to produce the guidelines to deal with bank mergers and ground rules for consolidation. If I am not wrong, they were supposed to produce these guidelines by last June 30. To your knowledge, has anything been done there?
Mr. Dodge: I am sure they are working on it, senator.
The Chairman: As we all are.
Senator Kinsella: Let me ask you this question, Mr. Dodge. What is the state of play, domestically, and internationally in the global economy, on bank mergers today? Has that environment changed? Could you share with us some of your thoughts?
Mr. Dodge: I could talk more about the international situation. We have observed internationally over the last decade a breaking down of the barriers that prevented institutions across national boundaries and across pillars from consolidating. As those barriers have fallen, we have seen worldwide a consolidation of financial institutions. We have seen this regardless, almost, of country. We have also seen the globalization of institutions. That is actually what has been going on in the world.
That means that these institutions have a larger base over which to spread their overhead costs and they are able to package services for their customers in a way that smaller institutions could not. A major change in the world has occurred over the last decade or so.
Senator Kinsella: It seems to me that the chairman and members of this committee have been seized with the sole issue of bank mergers in the past. I wish to know, in light of the testimony of the governor just now, whether or not we are handicapping our Canadian banks or fettering them somewhat in being active players in this global environment. Mr. Dodge, if we do not deal with that, will it have an adverse impact on banking in Canada?
Mr. Dodge: I am not sure I am the best qualified to answer that question, senator. Whether it is in respect of financial institutions or financial markets, achieving efficiency is really, in the long run, to the benefit of all Canadians. We should keep efficiency as a goal in front of us as we look at any modifications to legislation, regulation or whatever.
The Chairman: I should remind Senator Kinsella, and all members of the committee know this, that this is one aspect of the studies of bank mergers that this committee has not looked at. The last part of it is the cross-pillar analysis. That is something that is left for this committee to explore. I thank the honourable senator for bringing that to our attention, and we thank the governor as well. This is an important issue, and we will no doubt take a final look at that in the near future. This committee has dealt with all of the other issues but not that final issue.
Our next questioner is Senator Hervieux-Payette, a long-time member of this committee and a member of the steering committee.
[Translation]
Senator Hervieux-Payette: You were with the Department of Finance when we adopted Bill C-8. I was wondering whether the Bank of Canada conducted a study on the changing behavior of the large Canadian banks with respect to business loans.
Recently, I received a study indicating that Canadians banks are no longer interested and that they are inclined to prefer more lucrative transactions in securities, an area where there is a significant void. The report also notes that businesses are having a lot of trouble obtaining credit. I am talking about small- and medium-sized businesses that are unable to pay large costs with foreign financial institutions, such as American ones, when large amounts are not involved. It almost has to be a $100 million loan if you want to do business with an American bank. Is the Bank of Canada keeping a watch over this change in behaviour?
It is very important since we will be studying productivity. If our companies are unable to finance their expansion, then there won't be productivity. Have you done any studies on changes that occurred following the removal of the barriers between the securities sector and the banking sector in Canada?
Mr. Dodge: We do a quarterly survey of businesses and ask them their opinions about credit conditions.
We observed that at the present time, most businesses, including small- and medium-sized businesses, have good access to credit. It is not a problem. The Canadian Federation of Independent Business came to the same conclusion. It is true that the large banks allocated a greater part of their loans portfolio to small- and medium-sized businesses than to large corporations.
[English]
The Chairman: Our next questioner is Senator Meighen. Senator Meighen is from Quebec, but has the unique experience of being actively involved in business, as well as in the social, cultural and economic life, in the provinces of Quebec and Ontario. He can bring us a unique perspective on both regions of the country.
Senator Meighen: That applies to the governor as well.
The Chairman: Of course.
Senator Meighen: Welcome, governor, and Mr. Jenkins. It is nice to see you here today.
I thought that perhaps I would change topics to give you some relief. You will be happy to know that even though Senator Tkachuk indicated that, sometimes, the same old questions come back year after year, and we have the pleasure of hearing from the governor of the bank, I will not be asking about monetary union and common currencies. Those topics seem to have faded from the screen dramatically, which perhaps has something to do with the 20 per cent increase in the value of the loonie.
I want to ask you about the intentions of the bank as far as transparency is concerned. It seems to be a double-edged sword. On the one hand, you state in your October monetary report that further reduction in monetary stimulus will be required to keep inflation on target. I think everybody quite rightly interprets that as bankese for interest rates are going up. If interest rates are going up, does that not artificially stimulate everybody to rush out and buy a house, an appliance, a new car, or whatever, which will create a bubble in demand?
On the other hand, I note that the bank has been criticized in a report by the monetary policy committee of the Bank of England, which says that the Bank of Canada ``does not communicate to the public the diversity of internal views about current and future economic prospects in general and the inflation outlook in particular.'' It goes on to say that the bank was rated third from the bottom for its commitment to explaining policy in a clear and transparent fashion.
I do not think you could be much clearer than you were in your report. However, it does seem to set up a problem of artificial demand. You are being criticized for not explaining all the factors that are being debated within your shop. Where do you come down?
Mr. Dodge: The Bank of England should be a little careful in their criticism. They are kind of johnny-come-latelies to being a transparent institution.
The Chairman: Governor, do you know that you are on air?
Mr. Dodge: That is why I chose my words carefully, senator.
The Chairman: I am glad you are not being very candid with us.
Senator Meighen: If you had stopped at ``johnny-come-lately'' it would have raised some eyebrows.
Mr. Dodge: First, you raise an extremely important question, senator. It is one with which every central bank wrestles.
I will deal with the specific issue raised, that we do not have a diversity of views. We operate under a statute that says the governor is responsible for monetary policy. What my predecessor did and what I have continued is to say, ``No, that is a little on the dangerous side, to have it all reside in one person.'' In fact, we make decisions collectively in the governing council, which includes Mr. Jenkins and the four deputy governors. Thus, we speak as a bank.
As a result of that, we try to put out, as best we can, the risks associated, at any point in time, with a statement and thereby get the diversity of views. However, we do speak, clearly, with one voice.
We have a monetary policy report, which honourable senators can read. I defy you to look at the inflation reports of most other countries and get much out of them.
We publish, semi-annually, a very readable financial system review.
We try to give, at least once between each fixed action date, a rather clear indication of developments, if any, over that period of time.
We come before this committee and your counterpart committee in the House twice a year.
We have made all efforts to communicate clearly. However, we do communicate with one voice. I think that is appropriate.
Senator Meighen: Is there a danger in so doing? Would you disagree that by pretty clearly signalling — and perhaps you are even locked into it — a further rate increase you bring about an artificial bubble in demand?
Mr. Dodge: Let us go back one step, senator, because this is a very important question. We have a clear paradigm against which we are working. That is to say, to try to keep inflation at or close to 2 per cent, and when we are off, to get there over the next 18 to 24 months.
That means that we will try to be moving when we have what we call an ``output gap.'' When output has fallen below potential, we will try to adjust policy to increase growth, and vice versa when we are above potential. That is extraordinarily clear.
As we said in our report, the implication is that, by our conventional measure, we are fairly close to capacity at the moment. The implication of that is that we should be removing monetary accommodation. That is what we have said. That is the clear implication.
We would be unhelpful to Canadians if we did not spell out the implications of our analysis.
The Chairman: Our next questioner is Senator Harb, a new addition to the Senate and to this committee, but a long- time and distinguished member of Parliament, from the Ottawa region.
Senator Harb: How much reserve do we have and in what currency is it held, euros or U.S. dollars?
Mr. Dodge: We have roughly $30 billion of reserves in the exchange fund account. That account is owned by the Government of Canada and we manage it on their behalf. We have a little over half of that in U.S. dollars, a little less than half in other currencies.
Senator Harb: My second question deals with the depreciation of the U.S. dollar and the appreciation of the Canadian dollar. The trend over the past few months has been the U.S. dollar going down and the Canadian dollar going up. I believe there will come a time when we will also start to see a decline of the Canadian dollar because of the dependency of the Canadian economy on that of the U.S., and foreign investors will look at Canada as a risky country for investment because of that dependency.
At what point would the Bank of Canada, using the interest rate factor, decide it is time to get involved and take action? What, in your opinion, is the best approach to dealing with a decline that might occur at some point?
Mr. Dodge: It is very hard to answer a hypothetical question, senator, without knowing everything behind it. I really cannot answer that independently of the circumstances that surround it, as I said in response to an earlier question. It is not that I am unwilling; it is just that I cannot do it.
Senator Harb: That is fine.
My final question deals with the international monetary situation. We are seeing a blocking of currencies. We have seen a number of countries depending on the U.S. dollar. Others are now gravitating toward the euro, and there seems to be a movement in the Asia-Pacific to gravitate to the RMB or the Japanese yen. The common denominator in this is that there does not seem to be a meaningful discussion on the establishment of a proper international currency that everyone can subscribe to, thereby reducing risk and setting rules so that everyone understands what we are trading against.
You were talking earlier about the distortion that already exists. One can say that distortion will continue to be a factor for years, unless someone steps in to say that the party is over and we have to have meaningful discussions about establishing an international system so that everyone can play by the same rules.
Mr. Jenkins: I will try to respond to that by talking about two paradigms. First, I will talk about what I will call the gold standard, that is, a world of rigidly fixed exchange rates such as we had during the inter-war period. In that world, a number of issues arise for individual countries as to how they will adapt to changing circumstances in their own economies.
I would argue that if we were to have a world of fixed exchange rates, or to go back to the gold standard, every country would have to have a high degree of flexibility, so that if they experienced a shock specific to their own economy they could perform the necessary adjustments. If you do not have that, what happens in another part of the world is transmitted to your country, even if the shock is affecting you in an adverse way. That paradigm can be quite rigid for individual countries.
The other model would be one of flexible exchange rates with a rigorous policy framework, as, I would argue, we have here in Canada, a monetary policy anchored to low and stable inflation with a flexible exchange rate that plays its appropriate role as a shock absorber, so that if something happens in the world, either positive or negative, that flexible exchange rate can help us to adjust. It gives us a tool to manage our own affairs.
The other advantage of a flexible exchange rate in that world is that you can participate in globalization — trade, financial flows — to your benefit. We argue that at the moment, there is somewhat of a disconnect in two parts of the world, and that has to be addressed. That needs to be debated and discussed. However, if you believe that the world benefits from free trade, open markets and capital as well as goods and services, then that participation in a global economy is much more conducive to growth if you are in a world that has a lot of flexibility, that is, under a flexible exchange rate regime.
The Chairman: Our next questioner is Senator Banks from Alberta.
Senator Banks: It is good to see you, gentlemen. I am glad you brought the comic book version of the numbers, what we used to call the ``classics illustrated'' version.
Everyone knows that if you just continue the lines on the same gradient on a graph, you get a wrong answer, because shifts happen. However, these lines are leading to not only a sea change, but to a perfect storm of realignment of fiscal, demographic, financial and trade factors in the world. You do modeling, I presume. Based on these models and the projections that you have done from them, where will we be in that alignment in the next 5, 10, 15 years? Will we still have the same friends? Will we still be able to rely on the same relative certainties on which we have relied since the war, in general terms?
Mr. Dodge: Obviously, the weightings in world trade are changing rapidly, as Mr. Jenkins indicated. The real issue is the nature of the trading order going forward. We have done a lot of work since the Havana Convention in 1947 that established GATT, and we have kept the world moving forward in terms of opening up to trade, to the huge benefit of citizens. China is now opening up to trade, to the huge benefit of Chinese citizens. The real issue is that there have to be ground rules in both the trade order and the monetary order to facilitate adjustments, because imbalances will occur from time to time and we want those to be worked out in a relatively smooth manner, not in the way they were worked out after 1929 and the Great Depression.
That is why we at the bank stress so much the importance of working on a world monetary order that will allow for the facilitation of those adjustments without risk. To be quite candid, there is a real risk that if those things do not work out smoothly, protectionism will rear its ugly head again. That is why we are working as hard as we are on that issue, but it is not easy.
Senator Banks: It is not easy, and protectionism on the part of one of the major players is a significant factor that affects all of us each day. Based on the way these things are going and the enormous debt that exists in the U.S., do you see that as a prospect to which we must look forward and prepare?
Mr. Dodge: I truly hope not, senator. We have been arguing vigorously at the bank that if we get a monetary order that allows for these adjustments without an appearance of unfairness — part of the problem at the moment — then indeed we will benefit tremendously. Canada, one of the most open trading economies in the world, has a special responsibility to play a role in ensuring that that international monetary order facilitates trade and reduces — you can never eliminate — the possibility of protectionism.
The Chairman: Senator Angus raised an important question on the external risk to our financial system, which is, as we all agree, the plumbing or the mechanics or the engine of growth in our economy. I would like to talk to you about an internal risk and the question of derivatives. In a rising interest rate environment, derivatives become a sensitive issue. What is the size of the derivatives held by our major financial institutions, to the best of your knowledge?
Mr. Dodge: Senator, I cannot give you an answer to that. Derivatives cover a huge multitude of different instruments, from straight currency hedges carried out by Canadian corporations that trade around the world, to highly complex and high tech, if you will, instruments to parcel out risk, to just a wide variety of other things. I cannot give you a single number on that.
The Chairman: Could you give us an indication of the order of magnitude of derivatives held by the major financial institutions compared to the book capitalization of these institutions?
Mr. Dodge: I cannot give you that off the top of my head. However, you are driving at the issue of counter-party risk. Clearly, the Superintendent of Financial Institutions watches closely to ensure that the boards of our major financial institutions have appropriate procedures in place to manage that counter-party risk. That is the real issue.
The Chairman: I understand. Again, in terms of a rising interest market, you will recall what happened in the United States in 1998, when rising risk derivatives, severely out of control, caused a major financial crisis. It is an issue of concern that I wanted to raise.
Mr. Dodge: Absolutely, it is an issue of concern, and internationally, we make many notes of comparison on it when we meet at the Bank for International Settlements, BIS. We do much of that bilaterally with the Federal Reserve, for example. This issue commands a tremendous amount of attention, and certainly at the time of LTCM, there was not an appropriate management of those risks by financial institutions in place. There has been considerable improvement since then. At some point, you may want to have Mr. Le Pan before the committee to review how the superintendent deals with the management of those risks.
The Chairman: Indeed, we will do that.
Senator Tkachuk: Governor Dodge, someone handed me a note saying that at 3:40 p.m., our dollar was U.S. 84.67 cents; at 5:27 p.m., it was at U.S. 84.8 cents. It has gone up 18 basis points since you have been here. If you are here until midnight, we might hit U.S. 90 cents. Your answers are helpful to our dollar.
At the same time, I have a writer's press release giving your answer to my first question that arrived at 4:30 p.m. The world is changing awfully fast.
I want to follow up on our discussion in the first round of questioning on the dollar and how it fares against the U.S. dollar. Although our dollar has increased substantially against the U.S. dollar, it has remained remarkably unchanged against the pound and the euro. Perhaps you could enlighten a non-economist on how the Canadian dollar has fared against the British pound and the euro and why there has been no change at all compared to what is happening with the Canadian and U.S. dollars.
Mr. Dodge: Certainly, recent experience has been a depreciation of the U.S. dollar against a basket of currencies. The recent experience is such that against the major currencies, the U.S. dollar is down roughly 5 per cent, although there is some variation. It is down more against some currencies and less against others. This is a matter of depreciation of the U.S. dollar in this recent period.
Senator Fitzpatrick: Governor Dodge, I appreciate your comments on productivity, and as the chairman indicated, the committee will examine that issue later this year. It is not likely that we will have you appear before the committee for that purpose. If I may, I would like to take advantage of your presence today and ask if you would care to state your opinion on what effect the elimination of barriers to interprovincial trade would have on our economy and productivity.
Mr. Dodge: Senator, that is beyond my capacity to answer. We do work on productivity at the bank and we publish it. This distinguishes our work from that of the Ministry of Finance or the Ministry of Industry. We have to be concerned about the aggregate issues and so we are not working on some of the micro issues. Appropriately, other people work on that to a much greater degree than we do.
Senator Fitzpatrick: I am not surprised by your answer but I thought I would try.
Senator Oliver: I have a specific, short question on counterfeit currency. In your annual report of 2003, you said, and I quote:
The Bank of Canada is responsible for providing Canadians with secure bank notes that can be used with confidence. In recent years, this confidence has been threatened by the rise of counterfeiting made possible by the proliferation of technically advanced equipment, available at affordable prices.
In 2003 there were more than 400,000 counterfeit notes in circulation. That is double the number of such notes in 2002. Why is it that the Bank of Canada, in spite of your best efforts and ever-expanding lists of new security features, is unable to keep ahead of counterfeiters?
Mr. Dodge: Senator, 2002 and 2003 witnessed the advent of technology that allowed extremely high-quality, professional counterfeiting of our old series bills and allowed the kids to make not-so-good-but-passable $10 notes for use on Saturday night.
That is the reason for introducing the new bills, starting with the $100 bill last spring, the $20 bill in September and the $50 just on the seventeenth. We will proceed to use the same features on an upgraded $10 bill to be introduced next spring.
Those features make it much easier for cash handlers to tell a genuine note from a fake. They make it very hard for the counterfeiter to produce high-quality fake notes.
Mr. Jenkins has just offered to give you a $20 bill.
Mr. Jenkins: Just for effect.
Senator Oliver: This time next year, you will have a much —
Mr. Dodge: It may take a little longer. We are withdrawing the old notes reasonably rapidly, but they are still legal tender. The old series notes are still in circulation. We will have to address that issue at some point in the future, of how to deal with the fact that those old series notes are out there. However, we think that these features will have a significant impact.
Senator Moore: On November 16, the Minister of Finance, whilst appearing before the House of Commons Standing Committee on Finance, indicated that the surplus as of March 31, 2005, for the Government of Canada would be $8.9 billion. Does the Bank of Canada calculate and track the surplus or deficit?
Mr. Dodge: We are very interested in the position of all governments collectively on a national accounts basis because that impacts on the economy. Therefore, we make estimates of that, senator.
We do not compile public accounts. We do not deal with that because it does not directly impact on our business, other than as the manager of the government's bank balance, but that is more on a week-to-week basis.
Senator Moore: Do you share that type of calculation with Finance?
Mr. Dodge: Yes. We discuss the issue of the national accounts projections. They can differ quite substantially from the public accounts. The purpose of the national accounts is different from that of the public accounts.
Senator Moore: Is that something you do monthly or quarterly?
Mr. Dodge: We try to do our review quarterly because the national accounts numbers come out quarterly.
Senator Moore: Is it better for the economy of Canada for the government to continue to pay down its debt, or to spend the money on programs?
Mr. Dodge: I will answer that in two ways. The government has a policy to reduce the debt-to-GDP ratio to 25 per cent, roughly speaking, in the time period before the first baby boomers retire. It seems to me that that is a well- articulated policy and makes a lot of sense, because it means the debt servicing costs at that point will be considerably lower, and so, for the same level of taxation, the Government of Canada will be able to provide the additional services required by an aging population. It seems to me to be an extraordinarily sensible objective to continue to pursue.
Senator St. Germain: My question is very basic. It relates to the industries in British Columbia, the region that I represent. My concern is, logically, the increase in value of the Canadian dollar. Is the productivity of the nation adjusting as quickly as the dollar is rising? If not, what can be done to alleviate the pressure on a lot of these businesses that export most of their products to the U.S.?
Mr. Dodge: I will take the first part of that question, senator, because it has general application to a number of sectors in a number of parts of the country. It is an important question because, as I said at the start, over the last four weeks, the Canadian dollar has risen about 6.5 per cent against the U.S. dollar. That rapid rise in our currency is clearly having negative effects for certain sectors, certain industries and certain firms in our economy.
For many companies, as you know, it is been the speed of the appreciation that has been particularly difficult to adjust to. We at the bank are aware of the difficulties that that causes. Indeed, for well over a year it is been one of our central themes to focus our analysis on the adjustment that the economy needs to go through, adjustment to the global economic and financial developments, including that high dollar. The challenge for us has been to look at the overall or the macroeconomic consequences. That is what we are really about, which is why I will duck the second part of your question.
Even getting into macro issues requires an assessment of the reasons behind the exchange rate movements. I am sorry, Mr. Chairman, to take a little longer, but this is important. In broad terms, there have been two forces at play. One is the strength of our economy, in B.C. in particular, because of the strength and the size of our primary product sectors. They have been very strong, reflecting strong world demand.
The second factor has been the one we talked about earlier, the rather broad-based decline of the U.S. dollar against the whole basket of currencies, which is why, when you look at the Canada-euro rate or the Canada-Australian dollar rate, they look like they have been relatively stable.
In any event, we clearly cannot insulate ourselves from the world forces. It is very nice to have the price of minerals and so on go up, but it is not so easy to adjust to a declining U.S. dollar.
As I stated in my opening remarks, in terms of monetary policy, our job is to assess the implications of movement in the dollar for aggregate demand, adding up all those pluses and minuses, and in setting policy we have to keep aggregate demand and supply in balance.
That is a problem, and we recognize that some industries and some firms are in fact caught in the adjustment process.
Since mid-October, the U.S. dollar has depreciated further against major floating currencies. This has occurred over the last four weeks, at a time when commodity prices have not been rising. Indeed, oil and natural gas prices are down a little. Between now and the time we make our decision in December, we have to work hard on looking at the implications of what has been happening here in the currency markets, but of course, lots of other things are happening.
In the weeks before our fixed announcement date of December 7, we will be taking all the information that has come in, the full set of information we have, and as we do before each fixed announcement date, we will have to assess that.
Senator Angus: Governor, I would like to complete the circle on this subject, which I agree seems to be the kernel of the basic message you are bringing today. I wrote down and underlined a two-letter word that you used in your opening statement. You said ``if'' current exchange rates were to be sustained, and ``if,'' and you emphasized it, all these other factors you just discussed remain the same, then it could have a dampening effect. Yet last week, as I understood it, and perhaps referring only to the level of the Canadian dollar and not all those other factors, you said that you did not consider these levels to be inappropriate. That is how you were quoted in the local media.
What are you predicting at this point; will it remain at these levels or not?
Mr. Dodge: Senator, I am really pleased you asked that question because it gives me a chance to correct the record as reported in the newspapers.
I said that at the time we wrote the monetary policy report four weeks ago, and as stated in the report, the general movement of the Canadian dollar upwards against the U.S. dollar over that period was not inappropriate, given the strength of commodity prices and of world demand. That is what I said, and that was referring to what we had said here, not to anything that has happened since we released that report.
``Not inappropriate'' means, very much in economic terms, that a price moves up or down to try to balance supply or demand. As demand for Canadian products was moving up, it was not inappropriate that a price, namely, the price of the Canadian dollar, moved up. We had improvement in terms of trade, and it is not very surprising, therefore, that we would have an appreciation of the Canadian dollar.
Our job, when we meet before our fixed action date of December 7, is to assess what has been happening since then, which is a little different, because we have had a depreciation of the U.S. dollar and terms of trade not having changed much over that period.
Senator Meighen: I returned two days ago from London. There was a great deal of consternation there about the level of the American dollar. In fact, there was talk in the press about propping it up. I think there was an article in the National Post this past Friday, speculating in a similar vein.
Is there any statutory prohibition that would prevent the Bank of Canada from participating if it became necessary to prop up the American dollar, and how would you go about it?
Mr. Dodge: First of all, we manage the exchange fund account on behalf of the Government of Canada. We have a clear policy, articulated with the government, as to when we would intervene. That policy is on our website. I invite everybody to read it. It does say that only in the most unusual circumstances of a market disruption would we consider intervention. Otherwise, quite frankly, we are a lot better off letting market players bet against each other than betting against Her Majesty.
Senator Meighen: ``Intervention'' means both domestically and, for example, a worldwide effort to prop up the American dollar?
Mr. Dodge: Senator, thank you for coming back to that. It means intervention in foreign exchange markets.
Senator Meighen: Can you intervene in the Canadian market, for example, on your own initiative?
Mr. Dodge: I do not know what you mean by ``intervene.''
Senator Meighen: I am old enough to remember when we were concerned that the Canadian dollar was dropping too far. If memory serves, the Bank of Canada did buy Canadian dollars, or sold American dollars.
Mr. Dodge: That is what I thought you were asking. We do that on behalf of the Government of Canada. The Government of Canada owns the exchange fund account. We operate on its behalf, as agent as opposed to principal.
Senator Meighen: Therefore, it is under their instructions?
Mr. Dodge: That is correct.
The Chairman: Governor, and deputy governor, I thank you for your attendance here. I found this exchange interesting, candid and informative.
I must say to you, governor, that in my travels across Europe, wherever I go to talk with members of any financial institution, they tell me how your bank's reputation precedes you. We see ourselves more clearly abroad than we do here. I want to tell you and all your staff how highly the bank is regarded in any quarter of the world. That is one of the reasons we have a sound economy and a sound set of books. I want to thank you for your evidence today.
Mr. Dodge: Thank you, senators. It was pleasure to be with you.
The committee adjourned.