Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 1 - Evidence - February 3, 2016
OTTAWA, Wednesday, February 3, 2016
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:18 p.m. to study the present state of the domestic and international financial system (topic: The causes and effects of the recent decline in the Canadian dollar exchange rate).
Senator David Tkachuk (Chair) in the chair.
[English]
The Chair: Good afternoon. Welcome colleagues, and welcome witnesses. This is the Standing Senate Committee on Banking, Trade and Commerce. My name is David Tkachuk, and I am the chair of this committee.
It's the first of several meetings scheduled for our special study on the Canadian dollar. As everyone knows, the dollar has been down considerably for some time now, trading today at around US $0.71, which is a bit of a rally, actually. It traded, not so long ago, at near parity with the United States dollar, and your committee thought it would be wise to have a look at some of the implications of the dollar's slide, including its causes and effects and the implications for everyday Canadians.
Today, we have before us several witnesses. From Finance Canada, we have Phil King, Director of Economic Analysis and Forecasting from the Economic and Fiscal Policy Branch. The division advises the Minister of Finance on all aspects of Canada's macroeconomic performance and outlook. Mr. King has held a number of positions of increasing seniority at Finance Canada since obtaining his master's degree in economics at the University of Western Ontario.
From the Bank of Canada, we have Stephen Murchison, the Advisor to the Governor. Mr. Murchison was appointed to this position effective May 4, 2015. In this role, which focuses on the Bank of Canada's international activities, Mr. Murchison helps to develop the strategy for the bank's global engagement, supports the governor at meetings of the bank for international settlements, and coordinates the bank's work with other international partners and forums. Mr. Murchison has a master's degree in economics from Wilfrid Laurier University.
From Export Development Canada, we have Peter Hall, Vice-President and Chief Economist. Mr. Hall joined Export Development Canada in November 2004. With over 25 years of experience in economic analysis and forecasting, Mr. Hall is responsible for overseeing the EDC's economic analysis, country risk assessment and corporate research groups. Mr. Hall has degrees in economics from both Carleton University and the University of Toronto.
We have asked the witnesses to have opening statements of between five and seven minutes. We are going to try to keep it as much of a discussion as possible, so what I have advised the witnesses is that, if a senator asks a question and one of the members answers it, if the other members want to get into the discussion, I have urged them to please do so. We are here to listen to them. Without further ado, we will start from my right to the left.
Phil King, Director, Economic Analysis and Forecasting, Economic and Fiscal Policy Branch, Finance Canada: Thank you, Mr. Chair, honourable members. Good afternoon. Thanks for the opportunity to speak to you today on the topic of the Canadian dollar. In my opening remarks this afternoon, I will speak briefly about recent changes in the level of the dollar, the factors that can affect the level of the dollar and how changes in the dollar impact different parts of the Canadian economy.
In talking about the dollar, I refer mainly to the nominal bilateral Canada-U.S. exchange rate. In other words, this is the amount of U.S. currency that you can buy with one Canadian dollar.
The dollar has fallen significantly since July 2014, when it averaged about 93 cents U.S. It again fell rapidly starting in November of last year, from a high of over 76 cents that month to about 71 cents today.
The last time the dollar was trading in the low 70-cents-U.S. mark was in 2003. It is not a coincidence that global crude oil prices are broadly at the same level today as they were back in 2003.
Canada is a global-scale producer and net exporter of many commodities. As a consequence, fluctuations in global commodity prices have an impact on the level of our dollar. The depreciation of the dollar over the last year and a half has been, to a very large degree, driven by declines in global commodity prices, particularly crude oil prices. The price of West Texas Intermediate, the global benchmark, has declined by about 70 percent since mid-2014 until today.
Beyond commodity prices, a number of other domestic and external factors can also affect movements in the level of the dollar. For example, the level of the dollar is linked to the overall strength of the Canadian economy. A stronger Canadian economy makes Canada a more attractive place for foreigners to invest, on the prospect of higher financial returns. This raises demand for the dollar, which, in turn, causes it to appreciate. Of course, the opposite would also hold true.
International interest rate differentials or the expectation of future differentials can also influence the level of the dollar. Relatively higher rates in Canada can increase foreign demand for the Canadian dollar as foreign investors seek out higher-yielding Canadian bonds.
In addition to these factors, there are a host of other influences that are constantly affecting the level of our dollar. These include inflation-rate differentials, the current account balance, productivity developments, sovereign debt positions and general investor sentiment.
When the level of the dollar rises or falls, it affects different parts of the economy in different ways. The current lower level of the dollar presents both challenges and opportunities to our economy.
A lower dollar raises prices for imported goods and services. This impacts both businesses and consumers by lowering their purchasing power.
One negative consequence of this is the potential impact it can have on investment, in particular on investment in machinery and equipment. A substantial portion of machinery and equipment purchased in Canada is imported from abroad. As the dollar falls, this makes such investments more costly. When investment is hampered, future output and productivity growth can also be affected.
However, a lower dollar can also lead to import substitution, where domestic consumers switch from now more expensive foreign-produced goods and services to Canadian-produced services and goods. This benefits domestic producers.
Similarly, a lower dollar also makes Canada's exports cheaper and, therefore, more competitive in the United States and elsewhere in the world. In the current context of a sharp decline in commodity prices, this will be an important factor lending support to the broader Canadian economy over the coming quarters.
A lower Canadian dollar can also help to cushion the impact of lower crude oil prices for domestic oil producers as oil is priced and sold in U.S. dollars. For Canadian producers, a lower dollar means an exchange-rate gain when these U.S. dollar-denominated sales revenues are repatriated into Canadian funds.
There are also other benefits and costs to a lower or higher dollar, but rather than enumerating all of these, I think the final point I would like to make to the committee is that, overall, Canada, as a country, has been well served by its long-standing floating exchange rate policy.
Fundamentally, a floating currency acts as a shock absorber. It can help to mitigate the domestic impacts of negative economic events.
The current case is a very good example of this. While the recent decline in crude oil prices has had a negative impact on energy-related industries, the lower dollar is providing an important boost to non-energy exporters, thereby supporting other segments of our economy. Overall, it is far less economically disruptive for such positive offsets to come from a lower exchange rate than from lower domestic prices or wages.
Stephen Murchison, Advisor to the Governor, Bank of Canada: Good afternoon, Mr. Chair and honourable senators. Thank you for the invitation to appear before this committee to talk about the Canadian dollar.
Since 1991, the Government of Canada and the Bank of Canada have had a formal agreement that says our monetary policy should be directed at controlling inflation. Over time, we have seen that keeping inflation low, stable and predictable is the best way the bank can fulfil its mandate to promote the economic and financial welfare of Canadians.
We have one main monetary policy tool — our control over the target overnight rate — and we use this tool to help maintain the rate of inflation at the agreed 2 percent midpoint of the 1 to 3 percent control range. This means that Canada must have a floating currency. Since we have a target for inflation that aims to preserve the domestic value of the Canadian dollar, we cannot also have a target for its external value.
At the bank, we describe the flexible exchange rate system as an "economic shock absorber.'' By that, we mean that movements in the currency help the economy to adjust to shocks, such as swings in both the demand for and the prices of the goods and services that Canada produces. These swings cause shifts in our terms of trade — the terms of trade being the ratio of the prices Canada receives for its exports relative to the price that we pay for our imports — and these shifts require economic adjustments in response. The adjustments can be very difficult for the individuals and companies that are directly affected, but experience shows that it's less painful for those adjustments to take place through the exchange rate rather than only through movements in wages and domestic prices.
Since roughly the middle of 2014, we have seen very large declines in the prices of many commodities that Canada produces and exports. Oil is the most obvious example, but it is not the only one. Others, such as copper and aluminum, have also fallen sharply. Resources have always been an important part of our economy, and the Bank of Canada's commodity price index, which tracks the world prices of our most important resources, dropped by more than 50 percent between mid-2014 and the end of 2015. Over the same period, Canada's currency depreciated from about 94 cents U.S. to about 72 cents U.S., which is not far from its current level.
[Translation]
Before I talk about the adjustment process, there are two points I want to stress. First, this is not the first time that Canada's economy has had to deal with sharp movements in resource prices. When former governor Gordon Thiessen appeared before this committee, in April 2000, he said:
The downward movement of the Canadian dollar was largely a response to the sharp decline in world prices of the primary commodities that Canada exports. Our economy had to adjust to this reality; the exchange rate decline facilitated a shift in activity from the primary sector to manufacturing and other export sectors.
The same could be said today. Further, let's remember that the dollar appreciated as commodity prices and our terms of trade rose from 2003 until roughly mid-2014, helping to smooth the required adjustments during that period.
[English]
The second point is that Canada is not the only country that is adjusting to falling resource prices. Let me draw your attention to Chart 5 of the Monetary Policy Report that the bank published this January. This chart, which has been distributed to you, illustrates the evolution of the terms of trade and the real effective exchange rates of various countries since about the middle of 2014. It shows that commodity-rich open economies such as Canada, Chile, Australia, New Zealand and Brazil have all seen both their terms of trade and their currencies weaken. In contrast, net commodity importers such as the U.S. and the U.K. have seen their currencies strengthen.
In the same report we spell out how we expect the Canadian economy to adjust to this decline in the terms of trade. The first response is a restructuring of our resource sector. We have already seen cuts in investment and employment among commodity producers. This has happened relatively quickly. We also expect to see a broader impact from the loss of income. This loss will weigh on household spending and business investment outside of the resource sector. The impact is more protracted and is not forecasted to peak until next year.
At the same time, the decline in commodity prices is sending a signal to shift productive resources back to the non- resource sector. This will be a long and complex process, but movements in the exchange rate are helping in this regard. Governor Poloz spoke about this adjustment in some detail in a speech in Ottawa last month. Let me recap some of the key points.
First, the depreciation of the dollar partly offsets the drop in commodity prices, since commodities are usually priced in U.S. dollars. In other words, resource exporters see their Canadian-dollar revenues fall by less than their U.S.-dollar revenues.
Second, the depreciating dollar helps Canadian exporters outside the resource sector. Those that set their prices in Canadian dollars experience improved competitiveness, while those pricing in U.S. dollars get a boost in revenues.
We are already seeing signs of this effect. Among industries that are sensitive to exchange rate movements, 21 are showing an upward trend in shipments. This represents almost 30 percent of non-energy goods exports. Included in this group are industries such as pharmaceuticals, motor vehicle engines and parts, and industrial machinery, which have also seen higher employment since the middle of 2014. Statistics Canada's labour force survey is also showing a more general increase in manufacturing employment since the beginning of 2015.
[Translation]
The final impact of the lower Canadian dollar I will mention is that it raises the prices of imports. On the one hand, that means all Canadians lose some purchasing power for imports, including goods such as fresh produce that have no simple substitute. It also means price pressure for companies that rely on imported inputs.
On the other hand, the depreciation makes Canadian goods and services more attractive relative to imports. Consider tourism, for example. We are seeing more international visitors choose Canada as a destination. Tourism spending has increased for 10 straight quarters in real terms. On balance, the depreciation ultimately leads to increased demand and sales, which means more growth, investment and employment in the non-resource sector.
Finally, let me say a few words about how the currency affects the outlook for inflation. The impact of the resource price shock on inflation is complex. The loss of income from resources means less demand in the economy and, therefore, slower inflation. There is also the direct impact of lower energy costs. At the same time, the depreciation in the currency is raising the prices of imports and, therefore, boosting inflation. In the January report, we estimated that the pass-through from the lower dollar added between 0.9 and 1.1 percentage points to the total rate of consumer price inflation in the fourth quarter of 2015. In addition, because the currency had depreciated further in recent months, we said there is a risk that the pass-through will remain higher.
[English]
It is important to note that we expect these forces currently affecting the inflation rate to be transitory; that is, we expect them to drop out of the annual inflation rate so they won't feed into people's expectations of future inflation. However, Governor Poloz and other members of the governing council have been clear that they will watch closely to ensure that longer-term inflation expectations don't become unanchored from our target. The bottom line is that we are forecasting that total inflation will return to almost 2 percent by the end of 2017.
To sum up, the depreciation of the Canadian dollar reflects the sharp decline in global resource prices and our terms of trade. As Governor Poloz said, the impact of this shock is complex and the required structural adjustments will be lengthy and difficult for many Canadians. However, our system of inflation targeting with a floating exchange rate is best for helping these adjustments take place as easily as possible.
Peter Hall, Vice-President and Chief Economist, Export Development Canada: In the interests of saving time, I will not reiterate any of the points that I agree with, only acknowledging that I do agree with most of what has already been presented.
In December of 2014, when it was clear that there was something considerable going on with the Canadian currency, we at Export Development Canada wanted to gauge what the impact of this was likely to be on our exporters. The effect of dollar movement was one thing; the commodity price movements that were in large part giving rise to the shift in the currency had their own effect on a segment of Canadian exporters. I'm not sure if that is something the committee desires to discuss, but there is a whole range of negative effects on a very special segment of Canadian exporting, primarily the energy and mining sectors as well. Our purpose was to gauge the effect that the currency was going to have on the full body of exporters. It was our judgment at that time that the negative effects that would arise out of the currency change that happened at that time would be almost entirely offset by the positive effects that they would generate inside the economy.
In terms of the exporting community as well, most of those predictions were actually realized. Mr. Murchison outlined those in his comments. We have observed large double-digit declines in the industries that have been affected by commodity price plunges but large double-digit increases in those industries that are particularly sensitive to movements inside of the currency. To the list that was provided, including the auto sector, pharmaceuticals and other consumer goods that we export, and third, machinery and equipment, to that I would add a large initial positive effect in the aerospace sector as well. We observed those happening throughout the year, and it was our purpose to try to address those shifts as much as possible inside of our strategic plan for the year, to make adjustments in real time to accommodate the needs of the Canadian industry.
So, largely, what we expected to happen was realized in those shifts. When we look at the movement in our currency versus currencies around the world, again, there is no debate from me on what has actually happened. Currencies that are commodity-dependent have indeed moved, much in the same fashion as Canada's currency has moved. We tend to compare ourselves with our large neighbour to the south, but they and the U.K. and, to some extent, China are anomalies inside of what's happening around the world. In country after country, we see large double-digit changes, depreciations in their currencies. So this is not so much a Canadian thing that is happening as it is a global phenomenon that's been driven by one of the drivers of the currency that is maybe the most obvious one but hasn't been mentioned yet, and that is that we happen to be on the flip side of the U.S. currency. There are certain particulars that drive that currency sometimes against all currencies in the world, and we need to be very mindful of the fact that, from time to time, this will happen. So we have included it in our five-part model that determines, as much as possible, where we believe the currency is going to head.
So, very quickly, our five-part model is this: First of all, energy prices; second of all, all other commodities. We're thankful to the Bank of Canada for providing us with the non-energy commodity price index. We embed that into our model. Our third element is the differential in U.S. versus Canadian short-term interest rates, and we use 90-day treasury bills as that benchmark. The fourth driver is the U.S. dollar and when there is something unique that is moving the U.S. dollar versus all other currencies. Fifth, we added a subjective element in there because in the post- crisis period of time, Canada was clearly experiencing a portfolio effect, a halo effect, that was moving portfolio money into Canadian instruments. We would say that that was a flight to quality that was happening, but it was engendered by the interests and the particular strengths that the Canadian economy had at that time.
So, to some degree, all of those elements are actually affecting the downdraft of our currency, but when we compare ourselves against other similarly placed economies, we see very little difference between our movements and the movements that they have actually experienced.
I think I'll bring my comments to a close there. Thank you.
The Chair: Thank you, Mr. Hall.
We'll try to keep to one question, and we'll see if we can finish everybody off and then start again. I've asked the witnesses to, in response to a question, if any of the other two wish to add, please feel free to do so so that we have some discussion among them. We're here to listen to them. We'll start with Senator Black.
Senator Black: At this moment, I have three questions, but I've heard your instruction. I'll do one and come back.
The Chair: We can compromise. Do one and, if the second one is rather quick —
Senator Black: Okay, whatever works. Gentlemen, thank you very much for being here, and thank you very much for responding so comprehensively to the questions that are on our minds and, I can assure you, are on the minds of Canadians. As you know, these hearings are televised, and people are watching very carefully because Canadians are deeply concerned about this development in our currency.
I want to try to get at today some questions that I have that perhaps are accurate and perhaps are not. I want to start with the point that has been made, principally by Mr. Hall, representing Export Development Canada, that, notwithstanding the low effect of the dollar and the dislocation and pain that that has caused to industries directly involved in that, somehow that has been balanced out by an increase in other exports. You have given examples like pharmaceuticals and others.
My general understanding from the work that I have done and have had done for me is that, in fact, the falling price of oil that has caused the falling dollar has not been reflected in a general uptake in Canadian exports as was anticipated, indeed, by the Governor of the Bank of Canada in his comments before us. Yes, it has been good for pharmaceuticals, and yes, undoubtedly it has been good for some other industries that simply don't have the economic value of the energy industry. On balance, this has not resulted in what we had expected to see. Do you agree with that?
Mr. Hall: I believe that in answering that, context is crucial.
Senator Black: Of course.
Mr. Hall: In the course of the work that I do, I get to rub shoulders with upwards of 5,000 to 6,000 exporters every year, and I'm as interested to hear what they have to say about the market as I'm hoping they are interested to hear what I have to say about the world economy. What I'm picking up anecdotally from them and what I'm seeing inside of the data is that the context that they have faced is a drought in investment and international trade activity that has been quite protracted in the post-crisis period of time. The recession left many, if not all of them, with an excess capacity that they have spent many years absorbing with whatever activity has actually come their way.
If I were to say, from all that I have learned from them and seen in the data, what I thought was the principal cause of perhaps a greater lag in a pickup in activity, it's the ethic in investment that has been absent for quite some time. So, typically, as we measure econometrically, from a positive economic event actually happening to the point in time when a business will actually put money down and invest in equipment and in physical capital, buildings and so forth, there's usually a year to two lag in those two events happening. This time around, it's likely more protracted because of the circumstances that they faced over the last seven or so years.
The initial hit that I'm talking about is largely a margin hit to companies. Their flows have continued. Real volume activity has gone up, not as much as anticipated, but the actual monetary gain to them through the change in the currency has been in great part what has given those double-digit numbers.
What I would expect to see is that, as the expectation of the persistence of that lower currency gets embedded into companies' strategic plans, those investment plans would actually follow.
Concurrent with that, there is an American situation where they, in many industries, are at full capacity at the moment and don't have the capacity to expand as they otherwise might. We are looking at certain key investment announcements that have been made in sectors like the auto sector as evidence that what was not expected to occur is actually occurring because of capacity constraints stateside. So those are really the context pieces behind why we haven't seen the —
Senator Black: But you agree with me that we haven't seen the uptake that we would have expected?
Mr. Hall: Correct.
Senator Black: Thank you very much. I just wanted the record clear on that. We hope we do, but today we haven't.
Mr. Hall: Correct.
The Chair: Pop another one. I've only got six here out of all of us, so we have some room to manoeuvre.
Senator Black: I'd be interested in your views on what you believe is the optimum value of the Canadian dollar versus the American dollar.
Mr. Murchison: No race to the microphone. I can kick things off. My answer, I think, is a fairly simple one: We don't have a view on a fair value of the dollar. I think in the current context the most important thing to keep in mind is that based on the estimation work we've done at the Bank of Canada, the decline in the dollar that we've seen and that we each referred to in our opening remarks is well in line with the decline we've seen in commodity prices.
There's a great deal of emphasis on the fall in the price of energy, and that is the biggest component of the decline, but it is somewhat more general than that — the overall decline in the terms of trade. We see the two as being broadly consistent in terms of the dynamics that we've seen over the course of 2015.
Senator Black: We understand the dynamic. I'm interested in your view of what the optimum is. If you were the boss of the world, what is best for the Canadian economy? Are we happy where we are now at 72 cents? Are we happier at 69? Would we rather see it go to 59? Would we rather be at 84? What do you think?
Mr. Murchison: It's important to keep in mind that there's a whole myriad of factors — we refer to them in the opening statements — that determine the value of the dollar. Those are constantly changing. You can't think of it as being a static thing. Even in our models that we use at the bank, where we say, "What's the long-run value that the dollar would eventually go to if all other things were unchanged,'' it jumps around. There's a tremendous amount of volatility in it. So the bottom line is we don't have a number.
[Translation]
Senator Bellemare: We are currently experiencing a supply shock, with the situation related to the price of an oil barrel, as oil-producing countries have decided to increase the production supply. This is a bit different from the supply shock in 1976, when the price of oil increased significantly, leading to a rise in inflation. I remember that period very well. The supply shock led to inflation and unemployment at the same time. The unemployment rate increased substantially. As it was an inflation shock, the bank increased interest rates. Some of those watching us will remember the mortgage rates of 18 percent to 20 percent in Quebec — a pretty extraordinary situation.
This is a very different supply shock. The drop in the price of oil is coupled with a major decline in the Canadian dollar. Mr. Murchison, you reassured me by saying that the current effect on inflation is from 0.9 to 1.1 percentage points. However, let's assume it was higher, in the context of the current global economy. We know that China's growth has slowed down. The global context is also not very stimulating for the demand. We have a supply shock and a demand shock. Could we experience a shock with an inflation rise higher than your targets? Could the employment rate decrease and, in circumstances where you are targeting inflation, could you increase the interest rate? The Canadian economy may have a hard time making the necessary adjustments to diversify its economic structure. Can you comment on that?
Mr. Murchison: Your question is very relevant. The difference between 2016 and other eras when we experienced supply shocks is that the anticipation of inflation in Canada is now well ingrained. In the past, there would initially be an inflation reaction. However, over time, the impact on inflation has increased. That is not at all what we are currently seeing or what we have seen since we established our inflation target.
When we look at the difference between the total CPI, which includes the price of oil, and our measure of the tendency, we see that, when there is a shock or a movement in the price of oil, the impact on the total CPI is strictly temporary. If we look at the year-to-year data, we see that the impact lasts about one year, and then the figures drop again. That means it is not reflected in market expectations. That is what we mean when we say that Canada's monetary policy is credible.
I would add that the governor, as the bank is remaining highly vigilant, pointed out at the press conference held in the wake of our Januaryreport that there is always a risk. When a very high exchange rate experiences very quick movements, there is always a risk it will start to be incorporated into the expectations in terms of inflation and total CPI. We are closely monitoring that phenomenon. However, we have a number of anticipative measures for market companies and we are not seeing anything in the data so far.
Senator Bellemare: I have another question. In summary, we may think that the Bank of Canada would be accommodating, in terms of the upcoming fiscal spending, so as to stimulate the economy somewhat and foster diversification of the economy in the context of major infrastructure projects.
Mr. Murchison: We have lowered the policy rate twice by 25 basis points. The governor mentioned that it is currently difficult to anticipate what will show up in the budget. That is indeed a growing risk, as we did not take it into account in our forecasts. Once we have updated our forecasts, in April, we will have more information. It seems premature to guess at what will happen. It is preferable to wait.
Senator Maltais: I have two short questions. Much is being attributed to the declining price of oil. However, that is not the only reason the Canadian economy is sluggish, you will agree.
When it comes to metals, iron and zinc exports have dropped off precipitately. The price of aluminum is at its lowest, given the cost of energy. I am talking about aluminum because 95 percent of aluminum plants are located in the St. Lawrence Valley, in Quebec. The price of bauxite is rising. Energy costs are high. However, in China, the cost of bauxite is low, and energy comes from coal, which is much less expensive and more polluting, and China is dumping on the international market. We cannot do the same in Canada.
Yes, the price of oil is dropping. However, what about our grain exporters? That market is currently profitable for Canada. We are not paid in pesos, but in U.S. dollars, and a balance is established. I think that oil has a direct impact, as it generates exceptional revenues. However, I do not think we should sacrifice the Canadian economy for one factor. What do you think?
Mr. Murchison: As I said in response to another question, the dollar is not depreciating only because of the drop in the price of oil. The depreciation is more due to the generally decreasing price of commodities. Other factors, such as the drop in the price of metals, affect the dollar. It is not just about the price of oil, but also about our exports of commodities.
Data is data, and I agree, as you noted, that there is definitely an oversupply of certain commodities, such as metals. Let's consider that factor, combined with the fact that the Chinese economy is experiencing a slight downturn. Those two factors combined largely explain the cause of the drop.
Senator Maltais: I agree with you. China's economy has slowed down. However, it went from 15 percent to 6.5 percent. Many OECD countries would gladly take that kind of gross domestic product growth. China is experiencing a downturn, but the situation is not catastrophic. I just came back from a trip to China, and things are far from being catastrophic. Clearly, with 1.6 billion people, a drop of 6 percent, 7 percent or 8 percent in the gross domestic product calms things down and negatively affects international markets.
My last question is about consumers, who are an important factor. Apparently, the price of fruits and vegetables from abroad is a heavy burden on a five-person family's food basket. Will families be able to cope with this situation much longer, or must we wait for our salads to bloom? What will happen from now until May?
Mr. Murchison: As I said in the beginning, it is true that households are going through hard times, especially those who buy more fruits and vegetables, and even more so since it is winter, as our exports are higher in the winter than in the summer.
What you are saying is very true. The only thing I can add is that we have to look at the situation from both sides. On the one hand, with the dollar's depreciation, the price of our fruits and vegetables is much higher, and that is reflected in the total CPI. On the other hand, the price of oil has decreased significantly. When we try to calculate the purchasing power of an average household, the two factors are not far from being equal.
Senator Maltais: That means that, as of June, for example, imports of fresh fruits and vegetables will decrease.
[English]
Senator Tannas: I have questions around the impact of financial markets in general. Again, because Canadians watching and many are postulating lots of different theories, I would like to get your input as to some of the potential impacts that might be there and what your view is of them, of speculation and short selling. Does that kind of activity, speculation and short selling of the Canadian dollar, have any sustained impact on our exchange rate, first of all?
Second, in the same fashion that happens in equity markets, where there is a tracking mechanism for short sales and the increasing or unwinding of that, do you monitor that? Are there mechanisms by which you monitor how much folks are leaning in on our currency?
Also, on top of that, because it's related, what about the hedging activity of Canadian exporters to try and protect this spread that we have right now? Does that have any impact on the currency? If so, is it a sustained impact?
Finally, with respect to bond sales by both governments and by corporations, when we see this kind of currency volatility, if you will, for Canada, do you have any estimate as to what the interest costs might be in bond sales in terms of the premium interest that's paid on bonds denominated in Canadian dollars because of currency concerns?
Mr. Hall: I will give Mr. Murchison a break here for a couple of minutes at least and go back to the same way that I answered the first question that was posed and say context is everything.
For some time at Export Development Canada, we have been tracking what we believe has been a grand distortion in financial markets that has persisted since the crisis occurred and extraordinary stimulus came into place. The coincidence of massive fiscal stimulus and quantitative easing was, arguably, much written about, very little practised; so some of the unintended consequences of what has generally been a successful policy are what we're dealing with now.
It was our considered opinion as far back — I think it's documented — as the fourth quarter of 2011 that a tremendous amount of financial market distortion was going on at that time. Unfortunately, in my view, it didn't register at the time.
But inside of commodity markets it was quite evident that something unusual was happening. Usage rates were down, inventories were high and rising — and they were extraordinary in some cases — yet prices remained high. That shouldn't happen. So that was a signal that something was going amiss or awry with the pricing of financial market instruments. I think it was a clue that, on a number of counts, such as stock markets, currencies, carry trade plays, bond markets — at one point in time, Zambia's interest rates on its bonds were lower than Spain's, and the risk profile of those two different countries did not justify that. We lumped that together with what was happening in commodities and what was happening in the riskier end of bond markets on the corporate side of things and judged that the excessive amount of liquidity was making its way into the market in extraordinary ways, and wave after wave of liquidity was persisting or was causing the persistence of this mirage inside of markets. We also reasoned that at the moment this excessive liquidity was not needed anymore, there would be a great unwind.
I would say almost right on time — when it became obvious that there was forward pricing anticipating the Fed's move — all four of those grand categories started either going into a period of volatility or were outright unwinding. That is the context that we see around this. We are still just counting the days after the Fed's move — probably the most anticipated economic event in the last five to six years.
I would say yes, absolutely, there is a grand short that is going on in marketplaces because, if you have been out of equilibrium for six to seven years inside certain markets, the market doesn't actually know and has lost the concept of what their anchor is regarding equilibrium pricing. They are trying to determine that at the moment. Many statistics are being used to justify whether it is at this level or at another level, or whether there could be a rebound, or what have you. Our reasoning would say that this is a period of time when the market will push the lower limits on a number of different counts. Our history has shown that there is actually a mild rebound that happens after that. I am getting into forecasting now, but that is our best estimation of what is actually going on at the moment.
To answer another of your questions on hedging activity, I believe that is part of the reason that we haven't actually seen some of the positive effects of a lower currency get into the marketplace at the moment, because contracts, hedging and different instruments that just-in-time global supply chains have to employ in order to maintain stability have put an additional rigidity into the market that hasn't permitted the full benefits of a lower currency to the extent that we anticipate it will continue for a while — the full benefits of that to accrue on the exporting side of things.
Yes, those hedges are in place — from what we can see and from what we can measure in export markets — and they are being employed as a means of guarding against volatility.
Senator Tannas: Thank you.
The Chair: Mr. Murchison or Mr. King, do you wish to add anything to that?
Mr. King: I think figure 3 of the opening remarks I handed out to you shows you the growth in exports mapped against the level of the dollar. There is a six-quarter lag where you get a fairly strong association. This is just the actual realization of some of the things that were mentioned — contracts and hedging — and the fact that it takes time.
Just because the dollar goes down doesn't mean your sales instantly start to pick up. There is some work to be done; you have to get back into the global supply chain.
Senator Tannas: You are saying that while there may be a lag, the amount of speculation, sentiment and so on eventually gets squished out just by the sheer size of the amount of exchange of real goods and real currency for real value and that it may artificially go a little longer, or be a little shorter, but in any kind of sustained period the effect is nominal. Is that what you are saying?
Mr. King: I think so. Ultimately, if you keep betting on one side and keep getting it wrong, you start betting on the other side. The fundamentals do go through.
This touches on the question about bonds as well. Canadian bonds are highly in demand. The yields are very low because everyone wants to buy them still. That is a reflection of the fundamentals that we have — a good fiscal position, a very well-educated population and a high employment-to-population ratio, and a well- diversified economy. Beyond the shock to oil, which is big and is definitely difficult for people across the regions, these fundamentals are reflected in the fact that the rest of the world still wants —
Senator Tannas: We have not seen any difference in the spreads between us and the U.S. as a result of our volatility?
Mr. King: No. Canada is still very much seen as a safe haven and a good place to invest.
Senator Tannas: Great. Thank you.
[Translation]
Senator Massicotte: I want to thank the witnesses for joining us this afternoon.
[English]
Obviously, we hear you. We have read about this. There is no surprise about what you are telling us. The world sees us as a commodity country, and our relative interest rates hurt our dollar.
I am sure you can appreciate that to the consumer, to the business person that tries to manage their business, to the employee caught in Alberta, this is an immense setback in their life and in their employment situation. They need a comfort, which is partially why we have these sessions. It is a comfort to say, "All this is okay. It is scary and it is an immense change, but someone is in control.''
The governor has been frank at the Bank of Canada. He has actually said that the models we have used in the past are not proving to be very accurate. He is pretty frank in saying that. Many of the projections that were made in the last six or seven years proved to be wrong. Why? All this change and it looks like we are a loose ship in a storm. Where do we get confidence after the fact? It is like sports. Everyone has a good answer, but nobody can predict the future; nobody knows for sure. Is everything okay? Do we have the right people at the helm? What is going on?
Mr. Hall: If I may, in answer to that, when the crisis actually happened — and it's amazing how quickly this is lost to all of us — Canada was looked upon as the model economy in the OECD. Because the crash happened, the nominal value of our exports went down. We lost a quarter of our exports almost overnight. Normally, that would be enough to bring our entire economy to its knees. However, when stimulus was actually unleashed on the Canadian economy, that came together with very well-managed fiscal policy, a banking system that all of a sudden was on the radar screens of everyone around the world, and they were looking to the overseers of our banking system to guide everyone else on how to reregulate an international system. So there were a number of Canadians that were prominent on international committees to advise them on that.
There were two key strengths: We had the resources that the rest of the world wanted — and they still wanted them back then in much greater quantities — and we had a domestic economy that was fundamentally strong. This was the Canada of then. We see an upheaval that is taking a hold of our economy at the moment, but those fundamental strengths remain there.
If we find any comfort at the moment embedded in my response to the previous question, it is that what is actually happening turbulence-wise out there is not a result of the world re-weakening. It is actually a function of the world getting back to growth again. The Fed is raising rates because of the fundamental strengths inside of the U.S. economy and the fact that they are bumping up against some severe capacity constraints. It is the transmission of that growth to the rest of the world that is maybe taking a bit longer than we are comfortable with, but there is evidence of the transmission of that growth to the other big, rich block of economies in the world — the Western European economies that are growing ahead of their growth potential quite consistently on a quarter-by-quarter basis, which has been going on for five quarters now. And there is evidence that, outside of China, smaller emerging markets are participating in that growth as well.
Senator Massicotte: I hope you are right. I am not the expert that you are, but I don't get that feeling. Looking at the Federal Reserve in the last little while, they bumped up rates. I think the vice-chair of the Fed said this past week, "We're not sure about the next,'' because they had planned some more increases. England was doing well; now it isn't. Brazil and Russia have significant downturn. In China, the growth came in two percentage points less than they were hoping.
I hope you are right, but I have to tell you that from what I read, there is an immense uncertainty, and many experts are writing to say maybe the old economic model is not working. We have concentrated on controlling inflation. We didn't care about the dollar, but maybe 10 years from now we will write that we need a new theory. Now we have a new one. The old one was erased, like controlling of money supply.
It is not comforting. I read a lot, but it is not comforting. Many experts, as you know, are predicting catastrophes. I hope you are right, but the emerging countries are not doing very well.
Mr. Hall: Yes, we are fundamentally weaker as a world economy now structurally because of all that we have been through, from the great recession through the weak years of world growth. So are we back to a structurally sound position that we might have seen in the early new millennium that would be the superstructure for a protracted period of very strong growth? No. We are still in repair mode. So add a fair amount of turbulence to world markets that is not well understood, and, yes, confidence, all of a sudden, can be a very big determinant of where we go forward.
So this is not a risk-free environment that we are in, but, at its core, the re-tightening of monetary policy in the world's No. 1 economy really isn't about trying to take the global economy out at the kneecaps. This is really trying to make sure that they accommodate growth appropriately inside of their economy and keep themselves from a situation where they are overgrowing and then have to react much more quickly to an impending inflation situation.
Senator Massicotte: In other words, you are saying we are structurally sound, but the world has told us that the value of our country, the value of our currency and the wealth of our consumers — because, obviously, a lot of what we consume is imports — are a lot poorer because the value of our currency has gone way down and the value of our country, effectively, is way down. We are structurally sound, but we feel sick. It's going to come.
Mr. Hall: I want to be clear about what I'm saying. I didn't actually say that this economy is structurally sound. We have sound pillars in place at the moment, and we carry that into the next growth period with us. But what I wanted to say is that the fundamentals behind growths inside of our principal customer are very strong, and they are pointing upward.
Senator Ringuette: I have two questions, one for Mr. Murchison and one for Mr. Hall.
My first question: Because of the financial crises of 2008 and 2011, and because of the current state of the value of the Canadian dollar, should we not review the basis of the Bank of Canada's monetary policy based on an inflation- rate scenario?
Mr. Murchison: On the contrary, I think that, through these very difficult times, the inflation-targeting framework has served Canada very well. It was precisely the framework that we needed in response to the financial crisis. In the end, the Bank of Canada was not required to use unconventional monetary policy, such as large asset purchases, otherwise known as quantitative easing. Within our inflation-targeting framework, we were able to use a specific form of forward guidance in the form of our conditional commitment to maintain the policy rate at what, at that time, we thought was the lower bound on the policy rate. That had the desired effect on longer-term interest rates, and we had a fairly rapid rebound following the sort of acute phase of the crisis.
As I explained in my opening remarks, I think that the inflation-targeting framework, in combination with a flexible exchange rate — and those two really go together — is the right framework for dealing with the consequences of what we are going through right now in the form of lower commodity prices. That is not for a minute to suggest that monetary policy, in conjunction with a flexible exchange rate, can completely offset the impacts of the shock. In my opening remarks I referred to the exchange rate as a shock absorber. If you think about a shock absorber on a car, when you drive over a bump, you still feel the bump; you just don't feel it as much as you would without the absorber there. I think that is the right way to think about what we are going through now. It is clearly a very challenging time, not only for those directly linked to the energy sector but also for those with indirect supply-chain links — those that supply equipment to those sectors — and for those who are grappling with much higher prices, notably in the grocery stores.
As I said in my remarks, while neither this framework nor any other framework can completely eliminate the effects — and there are going to be distributional effects no matter what policy is adopted — I think it is the best policy that the central bank can have in this situation.
Senator Ringuette: Just as a small follow up to that answer, do you do comparative study of monetary policy to see, effectively, if the policy that we have in place in Canada is providing exactly what you want in comparison to other fiscal policies in other similar economies?
Mr. Murchison: Yes, we do. Every five years, we renew our inflation-targeting agreement with the Department of Finance, and usually that process begins with a few questions around how we could improve the framework. We've looked at a number of them. We've looked at whether 2 percent is still the right level of inflation to target. We have looked at whether we should move away from inflation targeting and move more to something like a price level target. We have also done research, in the past, on whether Canada would be better off with moving to a fixed exchange rate.
I think the key consideration, when we are looking at the advantages and disadvantages of a fixed exchange rate, is that whenever you talk about a fixed exchange rate, you are fixing with another country. In this case, the most obvious choice would be with the United States. Where the difficulty really arises with either a currency union or a fixed exchange rate is when the two economies are out of sync. If you had two economies that were sort of always moving perfectly in sync, then you could make a more compelling case, but not when you have economies that are hit either by different shocks or by the same shock that has very different effects across the two countries. The current fall in commodity prices is a good point because Canada is a net exporter; the U.S. is a net importer. What is a negative terms-of-trade shock for us is a positive terms-of-trade shock for them. Totally different effects. You want to have that flexible exchange rate to act as the buffer in the middle there.
To come back to your question, yes we do. We are constantly exploring alternatives to see whether or not we can do better than we are doing now.
Senator Ringuette: Thank you very much for that explanation. I have a question for Mr. Hall.
The Chair: Okay. Go ahead.
Senator Ringuette: Around 2010, at this committee, we heard — and I am sorry; I cannot remember the witness — that Canadian companies had over $30 billion in reserve and were not moving toward the purchase of equipment and so forth at the time when the Canadian dollar was almost at par with the U.S. dollar. There was no incentive to try to get them to do the capital investment and efficiencies required. Now we're in a situation where they probably still have around $20 billion to $25 billion in reserve, but in order to do the capital improvements, with the value of the Canadian dollar, they don't want to do it either. Since 2008, this reserve has not serviced the good of the Canadian economy with regard to acquiring efficiencies and seeking greater exports. In 2008, they were sitting on the money because of the fiscal situation. Today, in 2016, they're still sitting on the money because the Canadian dollar is too low to purchase the equipment they need to modernize and be a more efficient manufacturing entity. So what is the solution?
Mr. Hall: We can probably carve those investors up into two different camps. During the period of the post-crisis that you identified, mining and energy companies were investing gangbusters at that time and were trying to increase their capacity as much as they could. That gave rise to all of the arguments that followed that the world was running out of resources. There was Plan Nord and the Ring of Fire, and all the energy mining development projects. There were the oil sands, there was conventional and unconventional oil, and there were actual investment going on inside those camps.
The references to dead money sitting on the balance sheets of companies talked about the other side of investment. Companies are not in the business of stimulating an economy because they're altruistic. They invest when they need to invest. The situation that was faced by many of those companies was that they had overinvested in frenzy years ahead of the great recession and had spare capacity. The need wasn't there for them to upgrade their equipment or to expand their factory's base.
Now we come to a position that is equally problematic because low commodity prices have all of a sudden got mining and energy companies saying, "How can we cut back?'' This is the two-year crisis period where in order to get writedowns on contracts that had been inked on projects that are supposed to go ahead, one has to create a sense of crisis. It's not as if this is a charade; these are real issues. They simply cannot afford to go ahead at the prices that had been inked. Money is coming off the table during this period of reconciliation, and until the parties can come to terms and make a viable project, that will continue to be in limbo.
As I've argued before, that other side that we might say should be investing at this point in time has come off a seven-year drought of investment. It's going to take a lot of encouragement in the form of running out of capacity north of the border here, and a full understanding and a belief that orders are going to maintain their strength going forward. They do have the resources to invest. Anecdotally, in the auto sector, that is happening. Some very significant new investments have been announced, but context is everything. It's important to understand the interplay of the energy and mining sector versus the rest, and what their incentives are for investing and how one is going in one direction, and the other is going in the other.
There is early evidence that those who have the funds and the business incentive to invest are going forward with investment plans now.
Senator Ringuette: Thank you.
Senator L. Smith: I have two questions that are very different. A simple one first: If you had to look at the energy sector in oil, are we faced with the reality that there appears to be an abundance of product available for world consumption? The price is at an all-time low. Will we see major countries cutting back production to create a new balance of price? You could say it's collusion, but there's a reality that if you have the cheapest labour and you're selling oil at $125 per barrel, and now you still have the cheap labour and you're selling at $30 per barrel, you're still making money, but making less. Is there a reason why you continue to pump out the product? Do you see some form of a balancing of that sector?
Then I have a second question, which is my magic wand question I want to ask you for the people watching us who may not understand the points we're discussing today.
Mr. Hall: There's no question there's high drama in the oil market. Let's rewind back to early 2008 when a famous Canadian book was written strongly advocating that we were going to $200 oil and it wasn't going to stop there, and now we're talking about perpetual $30 or $20 oil for 5 to 10 years out. I prefer to sit back in a situation like this, but again context: How has the market actually developed?
When you get persistently artificial high prices over time, you're going to attract investment to that sector. Canada was investing, and other countries were investing. Technology is never static, so it was developing over this period of time, bringing on non-conventional supplies in ways that weren't imaginable before.
We have had six to seven years of those high prices, and the investment that has followed. Throughput has come as a result of that, and we are, at the moment, awash in oil. Inventory levels are well ahead of the high band of the five- year average stateside and in other parts of the world.
It's a very different situation than the early to mid-1970s, when there was a realization in the Middle East of the market power and the inelasticity of the demand curve for crude oil, and the ability one would have to significantly cut back production but increase revenue because of the power of prices being to be able to rise. It's a very different situation now. There was comfort with high prices, there was an Arab Spring that elicited very heavy fiscal commitments in oil-producing states and others that were affected by that, which required, in order for them to balance their budgets fiscally, to have anywhere from $95 to $125 oil just to pay their bills.
There are fiscal handcuffs around certain countries at the moment that make the game much different than it was. The capacity to actually cut back production significantly in the hopes that that inelastic demand curve is still out there and that revenues can be maximized to the point that you can balance your fiscal books, as far as I'm concerned, isn't there. It's just not possible to do that this time around. The way we've seen the game being played is this: If I'm a low- cost producer and my marginal recoverable is say $9 or $10 per barrel, I can still on the margin make money and try to drive some of my competition out of business. That's the way the game is being played at the moment, arguably resulting in greater supply being available on the world market. But there isn't that same capacity, as far as I can see, to be a swing producer. No candidates are coming forward to be swing producer, and there seems to be very little coordination because of the fiscal dilemma those countries are in at the moment.
I'm hoping that puts an appropriate context around the question and sort of answers that for you.
Mr. King: I think I would add something to that as well. It's important to keep in mind that the global oil market today is not enormously oversupplied. Estimates are somewhere between a million and a million and a half barrels a day in the context of 93 million or 94 million barrels a day of demand. This is very different from the situation of the mid-1980s, when OPEC opened up the taps and Saudi Arabia said, "We're not going to be the swing producer anymore.'' You had about 10 million barrels a day oversupply in the context of a much lower global demand, so it wouldn't take too much to soak up that demand quite quickly.
The global economy has been fairly weak, so we haven't been able to absorb that excess supply as quickly as many people thought we would. But it wouldn't take much for that to be soaked up through a geopolitical event, for example, in the Middle East, and they happen all the time.
We have really ramped down investment in the last year. It's likely to happen again this year, so the supply going forward will also be much more limited. I don't think it's a consensus, but perhaps some people believe that we're going to have $30 oil for the foreseeable future; nor will we have $110 oil for the foreseeable future. Things will improve, likely toward the end of this year or early 2017.
It's a very different circumstance today than, say, 10 years ago. There isn't an enormous oversupply of oil. And in some respects Canada is insulated from this because something like 80 percent of our supply today comes from oil sands production. These are very large projects with very long return horizons, like in decades, 30 or 40 years. So we just don't shut these down.
The U.S. is shutting down. The rig counts in the U.S. have fallen dramatically, and the volumes pumped will follow. But in some sense we will be insulated from this for quite a while, at least. Our volumes of production have gone up, even though prices have come down. We're not suffering as much, and we'll be reasonably well placed when prices will eventually pick up.
The Chair: Are we returning to more of a free market in oil? We had a cartel system, that's what we had, a monopoly with monopoly prices, which in a free market economy is going to create all kinds of problems. Of course, they believed all those books. They thought there was no more oil to be found, so they thought they would be able to continue to do that.
But it seems to me what we're having now is more of a free market in oil, which I think would be good for the world rather than what we've been through over the last number of years with the Arab cartel.
Mr. King: It's very much the case that the preponderance of the growth in new supply has come from non-OPEC countries, such as the United States, Canada and South America, and that will erode the power of OPEC to set prices in the future.
Senator L. Smith: My second question is sort of a magic wand question. I know you don't like to forecast necessarily, but for the folks watching this discussion today and who may not necessarily be inclined to understand the depth of the analysis that you folks are able to present on the economic side, among the three of you, are there three or four or five points that you see as critical for creating a new economic balance that's going to propel us to a more positive position?
In a simplistic way, is there any way to talk about three or four elements that need to take place? We have the five elements that affect the value of the Canadian dollar, which have been clearly defined and discussed, but from an economic perspective, in simple terms, are there three to five steps that need to be taken to put Canada back into a much better economic position?
The Chair: Senator L. Smith wants the glass half full rather than half empty. We'll start with Mr. King.
Mr. King: I think in many respects there are some positives in the global economy and domestically in the U.S. A lot of the headlines about oil crashing and the volatility overstate how negative the situation really is.
Certainly China is slowing. Its industrial production is slowing a lot more than its production of services, and this is intentional on the part of the Chinese government. They're trying to move to a far more sustainable rate of growth. It will be lower than over the past 10 years, but it will be far more durable. They could have decades of growth that we can only dream of. It might not be 10 to 12 percent any longer, but it will certainly be strong.
Europe is slowly repairing itself. In the United States, as pointed out, the Federal Reserve is actually raising interest rates there because it's consistent with a stronger economy.
In Canada, our exchange rate has come down. This is helping facilitate the transition away from a more energy- based economy and helping Central Canada more. We have a very strong fiscal position. We have a very well-educated population. There are very many positives happening in the country. I think it's important to keep sight of those as well, beyond just the negative news headlines that you see.
In many respects, we have a lot of things in place already. It will just take time for the positive benefits of what we have in place to become manifest.
Senator L. Smith: So we need to communicate a balanced perspective?
Mr. King: I think so. It's also very difficult — and I recognize this — that we can talk at a high level about the complex adjustments that the economy is undergoing and that are taking place and say the exchange rate movements are good and benefit us, but we do realize that it's cold comfort on an individual level to somebody who is suffering in a certain region or a certain industry.
It really is cold comfort to talk about these things, but I think in particular we're talking about the dollar here today. We're far better off and we will be far better off under the floating exchange rate regime we have than any other system. The adjustment costs will be far harsher. Again, it's not much comfort for the individual, but for the economy as a whole it's beneficial.
Mr. Murchison: I would just add a couple of points. Just to pick up on what Phil was saying, I think the way we see it is that the essential ingredients to a continued recovery are there; they're in place. I think it's a matter, in some sense, of continuing to be a little bit patient. When we're talking about the impact of the dollar, we had the dollar basically begin to depreciate about a year ago. As we have been discussing here today, the lags are reasonably long and they're very hard to pin down, but our view is you get your maximum kick after a couple of years.
We've already seen compelling evidence for a wide range of sectors that historically have been exchange-rate sensitive, that those sectors are responding; they're growing quickly. When we put them all together, the ones that we see as more exchange-rate sensitive, the year-on-year growth rate as of 2015 Q3, which is the latest data we have, was just under 9 percent in real terms.
So there are signs that the fall in the valley of the dollar is having the desired effect. I don't think we've seen all of the benefits yet.
I think the other piece of the puzzle is the continued strengthening in the U.S. economy, specifically continued strengthening in private U.S. domestic demand, because that's the sort of sector that really demands a lot from Canadian exporters.
There is the combination of those two things, and Phil referred to Canada's fiscal position. Monetary conditions continue to be extremely stimulative in Canada. And at a regional level, what we would expect to see in a situation like this is migration from the resource sector towards other sectors in the economy, other provinces in the economy, and that's what we're starting to see in the data that we have for the second half of 2015. We're already starting to see that show up.
So I think the things that need to happen are already happening and will continue to happen, but as Governor Poloz has stressed on a number of occasions, it's a complex process, and it's a process that's going to take time.
Mr. Hall: Is it possible to add a couple of things to that response?
The Chair: Sure.
Mr. Hall: I'll go quickly. I believe if there is hope that can come to the viewing audience here from what's going on in the world economy, it's really going to come from the export side of things. So the question before us really is, can we see that happening?
First, very quickly, Mr. Murchison has already mentioned this, but let's not forget that lower commodity prices are having a huge stimulative effect inside of commodities that are net users of those commodities, and that's absolutely huge. In the United States, consumers got a $110 billion bonus last year as a result of lower gasoline prices. In Europe they got something on the order of $125 billion. This is something that can be and was spent on other things; it wouldn't have otherwise existed.
Second of all, I would say the fundamentals in the United States are very strong on the consumer side of things. Look at the way jobs are growing. Look at the unemployment rate and how low it is. Look at real wages and how they've started to increase. Look at consumer confidence stateside. Despite all this volatility that is going on, add that to their $110 billion bonus and they are fundamentally strong. They have a fundamentally strong housing market, and the prospects for domestic business investment that supports that are very strong. That's only point two.
Point number three is China. It only takes 6 percent growth inside of China now to add the same amount of GDP that nominal growth of roughly 18 percent added to the economy back between 2004 and 2008. Just given the size of the economy, that absorptive capacity remains there. If we're worried about commodity prices continuing to fall through the floor, you have to take seriously the size of China and its absorptive capacity now. That was my point number four. There is going to be an eventual rise in commodity prices, and I would agree with Mr. King that it is not far off. I didn't mean to suggest in my remarks that that wasn't on the way.
We are still expecting a revival of investment to happen. If I didn't have anecdotal evidence to support that in the non-energy sector inside of Canada there was investment going on, I'd have much less faith in that.
Senator Campbell: Thank you. I believe that the Bank of Canada is doing quite an amazing job, quite frankly. Like Senator Bellemare, I remember the 1970s. I locked in at 21.75 percent; it went to 22. Now you know why I'm on the Banking Committee; I'm still trying to figure this whole thing out.
I have a couple of questions. First, we use an inflationary model. You want to keep inflation within 2 percent. This is what it seems to be. What other models are there? What other models are other countries using, and how are they working — or does everybody base their banking policy on keeping inflation in check, which shows the other benefits we have? What other models are there?
Mr. Hall: I'd ask the Bank of Canada to handle that question.
Mr. Murchison: Without question, inflation targeting as the main monetary framework has gained a tremendous amount of popularity over the quarter century that it has been used. I think part of that is a reflection of the fact that for those countries that do have a lot of experience with it, countries like Canada and New Zealand, which was the trailblazing pioneer, it has been an overwhelming success. I think that's why you've got more countries moving in that direction.
Some countries have sort of longer-term inflation objectives without having a strict target. Some countries have an asymmetric range and don't want inflation to go above a certain level, but there's no symmetric lower bound, whereas at the Bank of Canada we have a 1 percent to 3 percent range, and 2 percent is the midpoint.
When you're looking at the majority of highly developed industrialized economies, this is sort of the workhorse framework. Obviously there are other countries that, for reasons that are specific to those countries, choose to give up, in effect, their monetary autonomy by having a fixed exchange rate. That's what having a fixed exchange rate means: that you cannot have an independent domestic monetary policy. In effect, you adopt the monetary policy of the country to which you are fixing.
Senator Campbell: Okay. You spoke of a bonus that Europe and the U.S. got. How much of a bonus has Canada got with our oil prices dropping?
Mr. Hall: We get a bonus, but this is all done on a net basis. You use the world energy statistics. We used a compendium that British petroleum puts together. The net hit to us is $25 billion under the same static analysis.
Senator Campbell: Loss?
Mr. Hall: The net loss. This is all done on a net basis. On a gross basis, yes, every consumer benefits from lower gasoline pump prices, but we're looking at net usage here. That's how we made those calculations. We did those at the end of 2014, and they were right almost to the dollar at the end of the year.
Senator Campbell: I don't know if you can answer this, and I'm not a conspiracy theorist, but what happens if Saudi Arabia and other OPEC countries keep on going? They're making money at $30 a barrel. There's some suggestion that one of the reasons this is happening is that they're trying to put people who are fracking, who are going to oil sands, who are finding different ways to harvest their resource, out of business in that area. First of all, is there any validity to that, do you think?
The last question I have is Libya has the third-largest resources in the world. What effect will it have when they get their government together and it starts flowing again to Canada and our oil industry?
Mr. Hall: I don't mind starting that. With respect to the game that is being played, let's say, on production, I'm not sure that I can see much other reason for a country like Saudi Arabia to overproduce at the current point in time, other than trying to play the competitive advantage here. The interesting thing about that, though, is that if you're expecting to get a price increase out of that, the ability of U.S. shale to switch on and off is very sensitive around well-known price markers. The dilemma for a nation that was playing the game that way would be how far up can you drive up prices before that supply comes back on again and all you have is a volatile situation where the price is going to be less than what you actually need to break even fiscally.
I can only guess. We're trying to get our minds around that as much as anybody else is, but that's what seems most reasonable to me.
What I would say is that this isn't a game that can be played infinitely because certain Gulf states have remarkably had to tap international financial markets by going out and borrowing in them. These were ones that had multiple hundred-billion-dollar solid wealth funds that didn't need to tap into international markets and are maybe doing this just to set the stage. I don't believe they need the money at this point in time, but the annual cost to a place like Saudi Arabia of $60 or $50 oil is the flip side of the benefit that a Europe or a U.S. would have. To them alone, by our estimations, it cost them $100 billion at a price of $40 to $45.
There isn't an ability on their part, or on the part of other Gulf states, to play this game into perpetuity without there being significant consequences.
The Chair: We'll go to 6:15 p.m. if that's all right with the witnesses. We'll kind of zip through here because I want a few minutes for us to discuss a study resolution that we can continue on regarding interprovincial trade. I've got Senators Black, Maltais and Massicotte right now for a second round.
Senator Black: In that regard, with some direction from you, I don't have so much a question as a series of observations based on what I've heard. I want to know whether you think it's appropriate for me to share my observations or not.
The Chair: Why don't the people who have questions finish and if there is time, I would love to have that.
Senator Black: Thank you.
[Translation]
Senator Maltais: I have a very quick question. Could the depreciation of the Canadian dollar compared with the American dollar tempt U.S. investors to acquire Canadian companies?
Mr. Hall: That is quite possible. They currently need capacity. So it is quite possible they may see an opportunity here based on their capacity and the price of our currency. Every company can see such opportunities.
My concern when it comes to the U.S. economy is that it may be unable to create the capacities it needs when it comes to its orders currently. That is why I am not sure we are vulnerable right now, but the opportunities are there.
Over the past 18 months, some amazing investments have been announced in the automotive and auto parts sector. That was the case at Ford, Fiat, Chrysler, Honda and Toyota. I believe that was a primary wave of U.S. or international investments in Canadian companies.
Senator Bellemare: I have a quick question. It has to do with the concerns of senators Ringuette and Campbell. As part of the monetary policy, why don't the Bank of Canada and the Department of Finance agree to have the same objectives as the U.S. Federal Reserve, where the monetary policy is focussed not only on containing inflation, but also on maintaining a solid level of employment? People would be reassured by knowing that the monetary policy is officially taking that aspect into account.
Mr. Murchison: In the vast majority of cases, those two objectives are well served through a target for inflation. When a negative shock occurs in the demand, we see that employment and inflation decrease. By reducing the interest rates, we stimulate the economy, and that is how inflation is increased.
At the Bank of Canada, we see that there is no real compromise, in most cases, between those two objectives.
Senator Bellemare: That would be a good reason to include it. We would then be reassured that the concern is real.
Mr. Murchison: I would add that, when the governor talks about our forecasts for the economy and the reasons why we are decreasing or increasing interest rates, as well as about forecasts for inflation, he is talking about our outlook for the real economy, the output gap and the gross domestic product growth rate. As I said, I believe that the two go hand in hand.
Senator Massicotte: I would like to continue somewhat along the same lines. We know that the dollar is suffering tremendously because Canada is seen as an economy based on natural resources. Am I wrong to say that 25 percent of the GDP comes from natural resources and 15 percent comes from oil and hydrocarbons?
Mr. Murchison: Commodities, including the energy sector, account for 16 percent to 17 percent of the GDP.
Senator Massicotte: What about hydrocarbons, excluding all natural resources?
Mr. Murchison: If we exclude other sectors, oil and natural gas account for 5 percent of the GDP.
Senator Massicotte: When we look at the transactions from the perspective of our dollar on the market, what percentage or figure represents the trade of imported and exported products? What percentage represents investments? Are those real trade transactions of products and services?
Mr. Murchison: The fact that a reaction is occurring so quickly is anticipation that the demand for the Canadian dollar will drop, since the price of our exports has decreased. I don't think this is speculation. As I said in the beginning, the falling dollar we have seen so far is totally consistent with the drop in the price of oil and commodities. When we look at the situation from that perspective, there is really no room for speculation.
[English]
The Chair: Could I ask one last question before I go to you, Senator Black?
Senator Black: You are the chairman.
The Chair: It is not that we haven't been through this before and had the same conversation about oil and the Canadian dollar. If the economy strengthens, are there other things that will drive up our value of the dollar compared to the U.S. dollar, even if oil prices remain between $40 and $60 a barrel? Is there anything we can do to increase the value of the dollar, or do we just wait for gold to go up?
Mr. Murchison: It comes back to the fact that it is supply and demand. You can have an increase in demand for Canadian dollars because the price per unit you are selling is high, or you can have strength in the Canadian dollar because the quantity that you are exporting is strong. A country that has a strong current account because they are receiving very high prices for their goods, or because they are very competitive and are exporting a lot quantity-wise — either one of those can have an important bearing on the value of the dollar.
The Chair: Anything we can do to make Canada an inviting place for business, that is what we are looking at. We are looking for people who want to come in and spend money in this country, and that will have an effect on the Canadian dollar.
Senator Massicotte: A low dollar helps.
The Chair: Not necessarily. I am just asking that question.
Mr. Murchison: There are a whole host of factors. Any factor that drives up the demand for Canadian dollars will have that effect.
There is evidence that in the past countries that have taken measures to improve their competitiveness have tended to see an appreciation of their currencies.
The Chair: Thank you. Senator Black, you have a couple of minutes.
Senator Black: It is important that you know that we feel well-serviced by you folks thinking about these problems. I am sure that Canadians watching this are encouraged by the level of commitment and intelligence that is being shown.
Having said that, I know that my parents —
Mr. Hall: Are we going to have a chance to defend ourselves?
Senator Campbell: No, there is no time left.
Senator Black: It is a simple observation from a Prairie lawyer, recognizing that I am a senator from Alberta.
What folks in Alberta would have heard today from this is in terms of the increasing value of the Canadian dollar, which I think folks that I talk to would take as a good thing. People feel the dollar is too low now, whether they are business people or consumers.
People have heard today that we are hoping that China will stabilize. We are all hoping China will stabilize. We're hoping that the growth in the U.S. and the U.K. will continue because a rising ship raises us all, and we are hoping that energy imports and exports will recover — all matters basically outside of Canada's control, people are hearing. But people know that oil has always been our largest export. People know that that is currently constrained. People know, to the question that Senator Massicotte asked, that the direct and indirect value of the GDP of energy, writ large — mining — comes in around 20 percent or a little bit north of that. That can't be replaced by tourism or pharmaceuticals or auto parts. It's not going to happen, and Canadians know that it's not going to happen. They know that until we get the price of oil up, the value of the dollar is going to stay down.
So I am just simply suggesting to you, respectfully, that a large part of your policy thinking, in all of your various branches, needs to go to encouraging market access for our energy. That is the block in the system now. We cannot sell our product. Our largest competitor is now the U.S. You now know, of course, that they can export oil. That situation has only become worse, and we are constrained. The price of Canadian oil is now the lowest in the world. That is why the dollar is low. Until we deal with that, I respectfully submit, the dollar is going to stay low.
So I urge you because clearly you all get it: Do what you can in your respective areas to get the nation to start addressing this issue. If we fix that, we fix a lot of problems. So ends the sermon.
The Chair: You can't just let him get away with that, Mr. Hall.
Mr. Hall: And I don't feel the need to defend myself.
What I will say in response is that Export Development Canada has been a huge proponent, over the last decade at least, of diversification of our markets beyond our traditional markets. Not to ignore our traditional markets — they are our bread and butter — but diversification and in all industries. The least diversified industry that we have, on the export side of things, is oil and gas. That's all I'll say.
The Chair: Okay. Thank you, witnesses. That was excellent today. Tomorrow, we meet again at 10:30. We have the leading economists from four major banks here tomorrow, so we have quite the witness list. We will start at 10:30. In the meantime, I want the room cleared so that we can go in camera to discuss a resolution to take to the Senate on a future study. Only staff and senators remain, please.
(The committee continued in camera.)