Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 1 - Evidence - February 4, 2016
OTTAWA, Thursday, February 4, 2016
The Standing Senate Committee on Banking, Trade and Commerce met this day at
10:30 a.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.
The Chair: This is the second meeting of the standing committee on the
issue of the dollar. My name is David Tkachuk, and I'm the chair.
As we talked about yesterday and as I mentioned yesterday, the dollar has
been down considerably for some time now, and it has risen moderately lately,
opening today at 72.56 cents and now a little bit over 73 cents. So maybe we
should just keep on talking.
Today, we have a panel of fabulous witnesses from the financial institutions,
who are going to give their perspective. I'd like as much discussion as
possible. We're asking that all of them participate for five minutes so that we
have lots of time for talk and discussion. Witnesses, if you want to intercede
when someone is giving an answer and someone else wants to add to it, I
appreciate that as well.
From BMO Financial Group, we have Doug Porter, Chief Economist. From the
Canadian Imperial Bank of Commerce, we have Royce Mendes, Director and Senior
Economist. From the Desjardins Group, we have Jimmy Jean, Senior Economist. From
the Royal Bank of Canada, we have Dawn Desjardins, Vice President and Deputy
Chief Economist. From Scotiabank, we have Jean-François Perrault, Senior Vice
President and Chief Economist. And from the TD Bank Financial Group, we have
Derek Burleton, Vice President and Deputy Chief Economist.
We'll proceed with the opening statements and then move to senators'
I have to vacate the chair at maybe quarter after 12 or thereabouts. I know
we're slated to go to 12, but, if we have to go to 12:30, that would be great.
So I'll ask a member of the steering committee to do that if the deputy chair is
not here. Anyway, we'll leave that with you.
I'm going to call on the first witness: from BMO, Doug Porter, Chief
Doug Porter, Chief Economist, BMO Financial Group: I'm very pleased to
be here with you and the members of the committee and my economist colleagues
for the discussion on the causes and effects of the recent decline in the
As a little bit of a backdrop, 2015 was the Canadian dollar's second-worst
year on record, when it fell by 16 percent in the calendar year. Earlier this
year, it was down further to a 13-year low, hit by financial market volatility
globally, disappointing economic data, another deep dive in oil prices, and
geopolitical surprises, before it rebounded in recent days.
We believe that there have been three primary factors behind the steep
decline in the past few years. The biggest weight, in our view, has been the
relentless plunge in oil prices, which have plummeted to multi-year lows. Our
estimate is that for every $10 move in oil prices, the Canadian dollar tends to
move in the same direction by 3 to 5 cents, so, arguably, this plunge in oil
prices alone explains the lion's share in the drop of the currency in the past
The second factor is that there has also been direct divergence in monetary
policy between the U.S. and Canada, with the U.S. Federal Reserve raising rates
last year, at the end of the year, and the Bank of Canada cutting rates twice.
Suffice it to say, it is exceptionally unusual to have the two central banks
travelling in opposite directions. The closest parallel that we can find in
recent decades was in 2002 and 2003, when the shoes were on the opposite feet.
That episode was also characterized by a violent reset in the exchange rate;
2003, in fact, saw the Canadian dollar have its best year on record, when it
rose by more than 22 percent in a single year.
The third factor is that there has been underlying broad-based strength in
the U.S. dollar. The U.S. dollar has risen against every major currency in the
world in each of the past two years, and we still believe that there's reason to
believe that 2016 will make it three years in a row where the U.S. dollar will
be the strongest currency in the world. This does imply that the Canadian dollar
is not alone in its plight, with almost all major currencies dropping deeply
against the greenback in the last two years.
Those are the three biggest factors driving the currency. However, we would
submit that another factor chipping away at it could also be a little bit of
concern over Canada's fiscal outlook. It's now almost conventional wisdom that
the coming budget will reveal a deficit target considerably larger than the
previously pledged limit of $10 billion. After all, if the government's
medium-term goal is to keep debt to GDP stable or falling, that allows room for
deficits of as much as $20 billion annually, assuming that nominal GDP growth is
around 3.5 percent.
On top of that turnabout in federal finances, many provinces remain under
fiscal pressure, with even Alberta losing its triple-A credit rating late last
Looking through the rest of this year for the currency, it appears that most
of these underlying factors are not going to go away, so we believe that that
leaves stabilization or potential stabilization in oil and other resource prices
as the last line of possible defence for the loonie. Given that we don't expect
oil prices to meaningfully stabilize until later this year, we think that the
currency is likely to remain under pressure and end the year not terribly
different from where we find ourselves today. Based on our projection for oil
prices, we then look for the dollar to return to the mid 70-cent level by the
end of 2017.
There are several implications to this lower level of the dollar. For
domestic businesses, we believe it is a double- edged sword. It's a common
refrain to say that the weaker loonie is an economic positive, given that it
provides a lift to exporters and really anyone who has to compete
internationally, and it definitely strongly benefits the tourism industry.
Manufacturing does generally benefit from the drop in the currency, as its
products become more competitive and/ or profit margins expand, but it's
questionable whether Canada still has the export capacity to fully take
advantage of the more competitive currency.
Certainly, a weaker loonie helps existing firms, but the currency probably
isn't quite low enough for long enough yet to attract significant new
investment. Moreover, there are some downsides for businesses from the weaker
currency, most notably higher import costs, and even manufacturers that would
seemingly gain from the lower currency can see negative side effects as many
domestic products have quite high import content.
Meanwhile, for consumers, the lower currency is clearly bad news. The low
value of the currency is clipping Canadian consumer buying power, especially in
the form of higher import prices, most notably for fruit and vegetables so far.
In fact, over the past year, Canadian prices for fresh vegetables are up by more
than 13 percent as of mid- November. Just to put that in perspective, U.S. fresh
vegetable prices, over the same period, have risen by just 0.4 percent, so that
entire 13 percent rise can be put down to the weakness in the currency alone.
All in, the hit to consumer buying power points to a period of slower real
consumer spending growth versus the U.S. and versus the rest of the economy. In
fact, we would argue that a weak currency is probably a bigger risk to Canadian
consumers at this point than record household debt.
On the investor side, meanwhile, for those choosing to remain in or come back
to Canada, it's useful to note that the energy sector is one of the larger
beneficiaries of a lower currency, at least from an earnings perspective,
although weak commodity prices are dominating that effect.
Export-intensive industries with costs predominantly in Canada, as well as
banks with U.S. operations, stand to see a small earnings boost. Those sectors
with a large share of imported costs could struggle before accounting for any
Mr. Chair, thank you for the opportunity to be here today. I look forward to
answering committee members' questions.
The Chair: Thank you, Mr. Porter.
Royce Mendes, Director and Senior Economist, Canadian Imperial Bank of
Commerce (CIBC): Good morning, Mr. Chair and honourable senators. I would
like to thank you for inviting me to share my analysis of the causes and effects
of the recent decline in the value of the Canadian dollar.
Let me begin my opening remarks by making two brief points that summarize my
views. First, the cause of the decline in the exchange rate has largely been the
result of the sharp fall in global oil prices. While the divergence in monetary
policy between Canada and the U.S. has also been blamed for the depreciation,
that deviation occurred only as a result of the fall in oil prices.
Second, the only brief statement I can make about the effects of the decline
in the Canadian dollar is that I simply cannot make a brief statement. The
effects will be complex and wide-ranging. As a result, I will spend much of my
opening remarks discussing these dynamics.
To be clear, while the fall in oil prices is a negative for Canada's economy,
the decline in the exchange rate will mitigate the effects. It will act as a
shock absorber and spur necessary adjustments within the economy. The weaker
Canadian dollar will cause both labour and capital to migrate towards industries
that will benefit from the depreciation in the exchange rate. That being said,
the process will not be smooth, and the gains will not be evenly distributed.
Moreover, the negative aspects of the depreciation are front-loaded. Weakness
in the Canadian dollar has already added more than half a percentage point to
inflation, notably in the prices of imported goods. Indeed, the prices of
certain imported food items have made headlines recently given that they are
placing a disproportionate burden on lower income households.
But, it's important to keep in mind that this is part of the adjustment
process; and, over time, the net result of the depreciation will prove
beneficial for Canadians by supporting the labour market and increasing global
demand for our exports. Indeed the depreciation in the currency has already made
our exports more competitive on the global stage. Although it will take more
time for capacity to be built to fully take advantage of this new environment,
the seeds of growth have been sewn.
That said, it should be noted that external headwinds will cause this
adjustment process to take even longer than in past cycles. Weak global growth
combined with the depreciation of other currencies is making it more difficult
for Canada to fully take advantage of the decline in the exchange rate.
Moreover, while the U.S. has been one of the lone bright spots in the global
economy, its manufacturing sector has been suffering from the effects of a
strong dollar. With a large portion of Canada's manufactured goods feeding into
U.S. supply chains, that weakness has also been felt north of the border. Over
time, these headwinds should fade; but it's important to keep in mind that
absent a weaker Canadian dollar, our nation's exporters would be in even worse
While goods exports often take the spotlight, our analysis at CIBC suggests
that more focus should be given to Canada's exportable services. Economics 101
textbooks suggest that services are difficult to export; as the old saying goes,
you can't export a haircut. But technological advances combined with Canada's
highly educated labour force have put the country in a unique situation to
increase service exports. To be sure, after taking into account the exchange
rate with the U.S., the services of Canadian Web developers, aerospace engineers
and architects cost roughly half of what they do in the U.S. While those are
some of the most extreme cases, they are useful illustrations of how competitive
Canadian services have become on the global stage. As a result, the rebuilding
of capacity in tradeable goods sectors should not be the sole barometer of the
effects of the weak Canadian dollar.
To sum up, the negative shock from oil prices and the associated decline in
the Canadian dollar have set in motion an adjustment process that will take time
to make its way through the economy. Areas of growth in Canada are shifting
across industries and regions. While it's proving to be a bumpy road to
recovery, it is a necessary process, given the shock the economy has sustained.
This concludes my opening remarks. I look forward to the ensuing discussion.
The Chair: Thank you, Mr. Mendes.
Jimmy Jean, Senior Economist, Desjardins Group: I will make my
introductory remarks in French, but I will be able to take questions in both
It is a pleasure and an honour to be part of the conversation today about the
depreciation of the Canadian dollar. Clearly it is a subject at the heart of the
economic debate, given the implications of a weak dollar on a variety of
macroeconomic parameters, be it inflation, regional growth dynamics in the
country, sectoral dynamics, or the overall purchasing power of the Canadian
consumer. Several of these dynamics were discussed by my colleagues. We will
probably have an opportunity to expand on these topics, but for now I will make
the following preliminary remarks.
First off, it is very difficult to talk about the Canadian dollar without
mentioning oil. There is now talk of an oil supply shock, but how did we get
here? There are a variety of factors I could list, but I want to draw your
attention to the impact of worldwide prolonged and accommodative monetary
policies that have contributed (and still contribute) to reducing the cost of
credit and stimulating demand for capital. When you put this together with
significant productivity gains in the energy sector, particularly in the U.S.,
and with what many have called — rightly or wrongly — a commodity price "super
cycle,'' we see more and more what is beginning to look like a speculative
bubble, characterized by the classic symptoms of overestimating profitability
outlooks and underestimating risks, and therefore by overinvestment. So to make
link with monetary policies, the irony is that the policies that were
implemented in response to previous bubbles may well have sown the seeds of
From there, to get to our question of the Canadian dollar, it is simply a
story of correlation. Historically, oil and North American rate differentials
explain most of the trends in the exchange rate. The depreciation of the
Canadian dollar therefore reflects nothing more than the fulfillment of an
almost immutable law. Oil dictates our terms of trade, and therefore our
With respect to impacts, we know them pretty well. Based on the past, we can
say that there will be some upward impact on inflation as the prices of imported
goods cost more. This makes intuitive sense and, besides, we have seen it
happen. But the uniqueness of our economic situation is that the vast majority
of our economic agents are also net consumers of energy products, so the same
products that are the source of the weaker dollar. So we must also take note of
the fact that what we are currently losing in purchasing power for food, for
example, we get back in the form of lower energy costs. In the first three
quarters of 2015, households spent $6.7 billion less on fuel compared with the
same period in 2014, equivalent to savings of $470 per household. That is not
And that brings us to the question of regional differences. In the producing
provinces, revenues are highly dependent on oil and unemployment is currently
rising. So the positive effects of the dollar's depreciation pale in comparison
to the headwinds caused by adjustments in the petroleum industry. However, in
other provinces like Quebec, the impact is clearly positive. According to the
results of our research, Quebec is one of the best-positioned provinces to take
advantage of the dollar's depreciation, because of the structure of its exports.
What we are seeing at this time is that there is a positive response from Quebec
exports, but there are capacity constraints that have capped exports in this
most recent period. Still, 10,000 manufacturing jobs were created in Quebec
between December 2014 and December 2015, and if optimism holds, we may see
We are also not just talking about Quebec. In fact, 2015 was the best year
for employment in the Canadian manufacturing sector since 2012, with 37,400 jobs
created. This is a rather rare phenomenon. Since 2000, there have been only five
years that the net employment change was positive in manufacturing. That is a
point that must be taken into consideration. Various polls and surveys from
manufacturers confirm that what we are seeing is not due to chance. For example,
the Bank of Canada's latest business outlook survey, released last month, says:
Exporters not linked to commodity production anticipate significantly
stronger sales growth than other firms.
So we are seeing some ambivalence in terms of impacts. Whether it is a
question of inflation, regions or industries, there are pros and cons, winners
and losers. The great uncertainty that we must acknowledge is the degree of the
various impacts and the time horizon over which these effects will occur. It is
a difficult forecast, especially since it requires a lot of assumptions about
key parameters, and slight changes in these assumptions can fundamentally alter
the conclusions. So even though at Desjardins we remain cautiously optimistic
about the ultimate impact of the weaker Canadian dollar, we recognize that the
range of risk with which we must now deal is wider than usual.
So, in the end, and I will conclude on this, it is natural to wonder how we
got here with the Canadian dollar. Canada had high-value assets that it managed
perfectly rationally according to the information it had during the raw
materials boom. However, in my view, the global context, the cyclical and
geopolitical characteristics inherent in oil prices, and the effect of policies
put in place to overcome the 2008-09 crisis are among the factors behind the
current volatility of oil prices and therefore the Canadian dollar. That said,
the drop in the Canadian dollar could well mark an important turning point for
our economy because it is happening at the same time that our economy has a
crying need for rebalanced sources of growth. The weaker currency should, in
many ways, facilitate this shift, but the results will likely be measured in
years, not quarters. Thank you.
The Chair: Thank you, Mr. Jean.
Dawn Desjardins, Vice President and Deputy Chief Economist, Royal Bank of
Canada: Thank you, senators, for inviting me here today.
When we look at the Canadian dollar, we certainly see, since the beginning of
this century, some really discernible patterns in terms of its direction. We saw
it hit an all-time low in 2002, and after that we had a very steady period of
Canadian dollar appreciation interrupted by the great recession. Then we did see
the currency move back towards parity until about late 2013, and that's when we
started to see some deterioration. But it really took hold in June of 2014, and
since that point we've seen the Canadian dollar lose about 25 percent of its
value against the U.S. dollar. It's not coincidence that, in fact, that is
exactly the point when we started to see a sharp drop in oil prices. As we know,
oil prices had a recent high of about $108 in June 2014, and today they stand at
about $32 per barrel. That same period saw the currency move from about 92 cents
to today's rate, which is around what you said, 72.5 cents U.S.
So we look overall at the relationship between the Canadian dollar and oil,
and I think that when you just look at a simple chart, you see that in fact it
is a very close relationship. When we look at the future for the Canadian
dollar, then of course we have to take into account what is likely to occur to
oil prices and what that might mean for our currency.
At RBC, we tend to think that oil prices will begin to rise as we go through
the latter half of 2016. Global growth, in terms of demand, will continue at
about a 1 percent pace per annum, but we think that this oversupply that is
continually coming to the market will diminish over time. In fact, supply and
demand will become more closely aligned. This will give a lift to oil prices,
which we expect to end this year at around $50 per barrel, so there's a fairly
significant lift. We think this will be one factor that supports an appreciation
in our currency as we go through the course of this year.
It begs the question: Why is oil having such a disproportionate effect on the
Canadian currency? Of course, as a large exporter of energy products, accounting
for about 22 percent of the volumes of Canadian exports and, more recently,
about 12 percent of their value because of the sharp price decline, we have seen
a significant reduction in the revenue we're getting from that production.
Profits have fallen, and, of course, this is putting stress on government
Additionally, we're seeing downward pressure on the economy because producers
are pulling back in terms of investment, and they're shedding jobs. So, overall,
we do see why this is so important, and why investors would be looking at the
Canadian dollar in the context of what's happening in one of our key export
Now the Bank of Canada, I think, refers to this as a negative terms-of-trade
shock. The price of what we're exporting has fallen relative to the price of our
imports, meaning we have generally less income in the economy, and of course
this is taking its toll on economic growth.
Now, when we look at the value of the currency and what the main drivers are,
our model, which I think is similar to many others, as my colleagues have been
discussing — we look at energy prices. We look at short-term interest rate
differentials, and we try to determine what the value should be, given where we
see prices today.
So our models suggested that three quarters of the decline that we've seen in
the Canadian dollar reflects this drop we've seen in energy prices. About 14
percent of that drop we can attribute to non-energy commodities and only about 2
percent to that interest rate differential. We have seen interest rates in
Canada shift relative to the U.S. In June 2014, we were issuing two-year bonds
with a gain of 60 basis points vis-à-vis the U.S. We're now at about minus 30.
So even that 100-basis point move really only accounted, by our calculation, for
2 percent of that move.
That doesn't capture everything. We know that risk, appetite and sentiment
toward Canada's currency are also at play, not to mention the independent
strength of the U.S. dollar, which has appreciated against most currencies.
Now, when we look at the future, we do think, as I said, that oil prices will
move up and that we will, in fact, see the Canadian dollar appreciate along with
it. Currently what our model suggests is that the fair value of the Canadian
dollar, with oil prices around $31, will be about 76 cents U.S., so a little bit
of an overshoot recently, when we saw the Canadian dollar plummet to 68 cents,
and even compared to today's level. As we go through the year, we think we'll
see a further upward move toward that 76-cent rate by the end of this year.
As my colleagues have discussed, there are several different channels by
which this affects Canada's economy. In some ways, it is a help having this
weaker currency because the weaker currency helps energy and all commodity
producers when they repatriate their U.S-dollar revenues into Canadian-dollar
Additionally, for those that are non-commodity exporters, they also have this
opportunity to get a little bit of a buffer in terms of their revenues. A pickup
in exports, we think, really is going to be forthcoming because, of course,
Canadian companies that are exporting to the U.S. have a little more room in
terms of their pricing ability and can in fact reduce their prices because they
know that, when they convert them to Canadian dollars, they are getting that
We think that we will see this competitiveness advantage actually increase a
demand for Canadian exports. Over time, this will result in a pickup in
investment and employment, so that's the upside from the weak Canadian dollar.
The downside, of course, is that the price of imported machinery and
equipment has moved up, and Canadian companies rely on investing in this
machinery and equipment from abroad in U.S. dollars. So those costs have risen.
When we look at the prices of imported machinery and equipment, they're up 20
percent relative to a year ago. That's a pretty big disincentive for some
companies in terms of investment.
Recently I was visiting a client, and they were talking about the types of
machinery they buy. They buy massive machinery, and they said that three years
ago $1 million bought them a piece of machinery. Now they're paying $1.4 million
for that same piece of machinery, and they aren't going to be getting any more
productivity out of it. It's difficult for them to pass on those costs to their
clients. So it definitely causes some trouble in terms of this chain of
investment as we go forward.
The Bank of Canada, in their recent survey, said that these higher costs of
imported machinery and other items saw some Canadian companies report that they
are going to switch from foreign-produced equipment to Canadian suppliers.
Additionally, a few firms said that they're going to move their production back
into Canada. So, again, that is the bright side, I guess, of that particular
Finally, the impact on consumer prices has already been discussed. We have
seen prices for fruits and vegetables, furniture, appliances and reading
material all move higher. This does take its toll on Canada's consumer. On the
opposite side of that, the decline in energy prices means we're paying a little
less at the pump.
On net, it seems that the Bank of Canada believes that the exchange rate
pass-through to consumer prices has boosted our inflation rate about one
percentage point. If we see a change in the direction of the Canadian dollar
affirming, we think we will see the easing of these pressures as we go forward
and, therefore, a little less pressure in terms of the consumer outlook as we go
The Chair: Thank you Ms. Desjardins.
Jean-François Perrault, Senior Vice President & Chief Economist,
Scotiabank: It's a pleasure to be here and to help the committee develop its
understanding of the impact of the Canadian dollar on the economy. As I think
most of you know and probably have heard, I suspect yesterday from some of the
folks you talked to, the dollar is the single most important price in the
economy. It's a shock absorber whose value has a large influence on just about
every facet of our lives. It determines in part the competitiveness of our
exports and has a large impact on the price of imports. Because of this, it
affects the value of our firms, household balance sheets and, fundamentally, our
standard of living.
It's tempting to think of the impact of the dollar in isolation from other
economic and financial developments. That's a mistake. By and large, the dollar
reflects fundamental economic and financial forces, and it moves to help the
economy adapt to these forces. That's why we call it a shock absorber. These
underlying forces have an impact on the Canadian economy and the dollar, making
it difficult at times to separate the impact of the drivers of the currency
movements on the economy from the impact of currency itself.
So when asking questions about the impact of the dollar on the Canadian
economy, you are really asking what is driving the dollar, and what are those
factors doing to the economy. Generally speaking, the dollar only really has an
independent impact on the economy when it moves beyond what would be suggested
by economic fundamentals.
You've heard this a number of times, but our dollar is typically driven by
three key factors: commodity prices, both energy and non-energy prices; interest
rate differentials; and, over a longer period of time, productivity
differentials. The relative importance of these factors changes over time. Add
to this shifts in market sentiment and risk appetite, and you can see that
movements in the dollar can be hard to explain at times. That's why you have us
Nevertheless, the dollar is usually driven by the fundamental factors I
mentioned. There has been a clear correlation between the dollar movements and
oil but also other commodities more broadly. Also, a divergence in expectation
to growth and monetary policy in the United States and much of the rest of the
world has caused investors to invest in U.S. dollar assets, putting downward
pressure on the Canadian dollar and other currencies. At times, this has been
amplified by what are called "risk-on risk-off sentiments,'' triggered most
recently by developments in China.
Despite being perceived as a commodity play, the Canadian dollar seems to
have been affected more than other commodity currencies. Quite honestly, this is
a bit of puzzle. For instance, our dollar had depreciated against the Australian
dollar, which is just as heavily exposed to commodities, in fact more exposed to
China than we are. Short positions against our currency were roughly four times
as large as those against the Australian dollar, once we adjust for turnover in
the foreign exchange market.
It is unclear why the sentiment was so negative, but this negativity is being
unwound rapidly. Since its low of just above 68 cents two weeks ago, the dollar
has appreciated by about 7 percent to about 73 cents. Though volatile, oil
prices are roughly where they were two weeks ago. Part of the change in the
dollar reflects altered expectations for the path of monetary policy in Canada
and the United States. It is too early to tell, but this does suggest that the
dollar had undershot somewhat the level one would consider in line with economic
Where do we see the dollar going from here? Obviously, it depends on what
happens in the global economy and commodity prices and, to some extent, the
nature of the shocks that will affect us, which are by nature unpredictable. Our
view is that the dollar will remain roughly at current levels throughout the
remainder of the year and appreciate to best 79 cents by the end of next year.
This view is based on a forecast of relatively stable commodity prices this year
followed by modest pickup next year. We think there will be a sizable fiscal
stimulus package in Canada, which will remove the need for further monetary
easing in Canada. We expect the bank's next move to be to raise rates, but only
well into 2017. These factors in combination with the strengthening global
economy from mid-2016 should lead to an appreciation in the Canadian dollar. In
fact, we are already seeing this.
I will turn quickly to the economic impacts of the dollar, and I will remain
at a fairly high level. Movements in the dollar create winners and losers. It is
a relative price, after all, and that's why folks worry about currency wars. By
and large, a weaker currency implies a lower standard of living for Canadians.
It has the obvious impact of raising the cost of imported products, like food,
raising inflation and making foreign travel more expensive. These are just a few
examples. There is a range of impacts, as you have heard, but its impacts are
much more fundamental than that. For instance, well over 60 percent of the
machinery and equipment used by Canadian firms is imported. A lower dollar
raises the costs of these investment goods. Given the importance of business
involvement to the economy and the headwinds faced by firms nationally and
globally, higher costs for investment goods represent a real drag on activity.
That being said, the dollar is a boon to exporters, and we're seeing strength in
non-resource exports despite the higher cost of investment.
It's also great news for the Canadian travel industry, and, it seems somewhat
unexpectedly, it's a boon to housing markets. The average price in U.S. dollars
of a house in Canada is nearly 6 percent lower than levels one year ago, whereas
about 12 percent higher in Canadian dollar terms. These kinds of positive
effects are what we mean when we say that the dollar is a shock absorber. It
offsets a portion of negative shock to the economy. The magnitude of the
dollar's impact on the economy is heavily dependent on the length of time that
it stays at a particular level. A significant portion of firms with foreign
exposure hedges or foreign currency exposure — so variations in the currency
have a modest impact on their financial plan if moves in the dollar are
short-lived. As hedges run off, so does the financial impact of the depreciating
dollar. Smaller companies are less able to protect themselves against foreign
currency risks and are more affected by movements in the dollar. This is a
pretty straightforward argument to make.
Extended weakness or strength in the dollar also impacts firms' pricing
decisions. Firms may not pass through short-term movements in currencies to
clients, such as households, but they eventually do if the change in the value
of the currency is long-lasting. This is in part why food prices have risen so
much in Canada. This can have an impact on monetary policy to the extent that
this pass-through affects inflation, and inflation, expectations.
Over a longer period of time, a weak dollar reduces competitive pressure and
can allow less competitive firms to remain profitable. This is of course an
important political and economic issue.
With that, I look forward to your questions.
The Chair: Thank you, Mr. Perrault.
Derek Burleton, Vice President and Deputy Chief Economist, TD Bank
Financial Group: I am happy to be with you today talking about this
all-important subject. I think about how history repeats itself. In the 1990s we
went through a similar discussion in Canada as the dollar fell from the nineties
into the eighties, the seventies, and the sixties. At the time, there were calls
that it would go as low as 50 cents. Recently, I heard a 59-cent call, not that
it's a mainstream view. But we're starting to hear similar refrains: Will we get
into discussions about fixing our exchange rate with the United States? It has
not gone that far yet, but that was some of the discussion we had back then.
I dug back into the research from the 1990s to see what was talked about.
Back then, a list of a number of factors driving the Canadian dollar were all
kind of negative at the time. We are talking about 10 or so. Some of the ones
we've heard and also some of the more structural factors like productivity
growth differences, taxation differences, fiscal differences, and government
finances. These are inherent longer-term structural drivers of growth. As well,
you get into the commodity prices, which were drivers back then, too.
This time, you look at the landscape and compare Canada with the United
States and many of the competitors. Governments have done a lot to fix a lot of
these challenges, at least do a good job. I would argue that the government
fiscal position federally is not bringing down the Canadian dollar at all. The
debt levels are low, so that's not an issue; and our tax situation is much
better than it was, particularly on the business side. It really comes down to
what we have heard about time and time again: This is an oil price story. It's
delivering a big shock to Canada. We heard from the Bank of Canada governor that
this is creating a multi-year adjustment. The Canadian dollar is a shock
absorber to help transition to more export-led growth away from consumer — that
rotational story we need as an economy. From that perspective, it's a good
One of the factors as well back in the 1990s was a large capital outflow from
foreigners. I don't get the sense based on the data we see monthly that it's
been a huge issue this time. I would argue that in the last few months, it has
picked up. We've seen less foreign demand for Canadian dollar securities; but it
has not been a stampede out. There is still a strong demand for government
securities and corporate securities, even if it has come off its peaks.
That leads me to the outlook, that to the extent that this is not a
full-blown competitive challenge with Canada's structural issues across the
board — yes, with some structural issues at play with the transition away from
resources over time — I am hopeful we will see stabilization of the Canadian
Again, it comes down to oil prices, and I think most of us are of the mind
that oil prices are not going to keep falling and falling over time, but there
are prospects for a bit of a bounce. I do think the Canadian dollar will be
helped by that, and also it will lead to fewer concerns about the cyclical gap
in economic performance more than anything between Canada and the United States,
which I think is key.
Much like my colleagues here, I do see scope for the Canadian dollar to
stabilize and perhaps bounce up a bit over the next six months to a year.
In terms of effects, I won't go through all of them. I think two of the
effects I'm watching are more the positive effects. We've heard of some of the
negative effects in the short term. Because people want a low dollar they don't
want to see a falling dollar, and I think it does impede confidence, it leads to
more uncertainty, but the benefits will increasingly play out as we go through
this year going forward.
It's really partly a manufacturing story. I think there is about a
six-quarter lag. We're still seeing those benefits of a more competitive
currency playout. That said, we've done our research, and I'm a little less
optimistic than I was. Mr. Mendes talked about some of the structural challenges
in manufacturing, like lack of capacity and some of the supply chain issues with
the U.S. manufacturing sector hurting. That's going to limit the upside. The
other observation we've seen in terms of those areas within manufacturing that
are most sensitive to a lower dollar, they tend to be the smaller ones and not
the big auto sector, such as the rubber, plastics and lumber. They are not
insignificant, but they may account for 20 percent to 25 percent of
manufacturing. That said, we still see improvement there.
Another positive effect that we're hearing more is that we tend to think of
trade being more about goods, but what about service trade? I think tourism is
quietly giving a nice boost to the economy. It's two ways; it's not only that
Americans are finally coming back to Canada, and we expect about a $1-billion to
$2-billion boost in American spending in Canada relative to 2014 levels over the
next year, so that's playing though, but we also know Canadians are visiting the
U.S. less, and some of that money will be redeployed in Canada, and that I think
will provide an even bigger boost. The numbers of Canadians going to the States
is declining a lot quicker in terms of the sheer size of spending volumes
relative to Americans coming up to Canada. It's just a very much bigger
magnitude. Together that double benefit is probably going to deliver a boost to
the Canadian economy in the order of $4 billion to $5 billion. It doesn't
completely change the picture, but it will provide a nice boost to the economy
where growth is sorely needed.
I will wrap it up there. I look forward to your questions. I am happy we're
not into this discussion of whether to fix our exchange rate to the United
States, because I just don't think, given the different economic structures,
that it would benefit us. I will stop there. Thank you.
The Chair: It's not that we haven't had that discussion before.
Mr. Burleton: You may have had it, but it's not in the media
The Chair: That's right.
We have a great panel here, senators, and we have until 12:30. Let's try to
elicit as much information and allow as many of them to speak as possible. So
keep your questions short and crisp and let them talk to us.
I'll start with the first speaker I have on the list, Senator Bellemare.
Senator Bellemare: Thank you, Mr. Chair. My question is brief and is
addressed to all of you. You all discussed this in your own words, but I am very
concerned by how the Canadian economy will adapt to the new reality of the under
par value of the Canadian dollar.
Your message was quite clear with regard to the fact that the value of the
Canadian dollar will increase, but we should not expect it to be higher in value
than the American dollar or at par over the next few years. Governor Poloz has
even told us that we are going to have to restructure our economy.
When we examine that reality from one province to the other, we see that
despite the fact that Quebec is in a good position, the maritime provinces,
according to data from 1999, have current account imbalances and export more
than they import, which gives rise to negative growth in terms of exports.
Yesterday at the committee, representatives from the Bank of Canada and
Export and Development Canada also alluded to adjustment problems. Mr. Hall,
vice-president and chief economist at Export and Development Canada, told us
some interesting things when he answered a question from Senator Tannas, such as
the fact that the adjustment was complicated.
Everyone said that with the lower Canadian dollar, people would be able to
buy machinery, but 60 percent of machinery is imported. And when the Canadian
dollar was high, businesses did not buy machinery, but built up liquidity.
I am going to read Mr. Hall's reply in order to make my question more
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 ....
So, this is my question: Do you believe that the financialization of the
economy has allowed the real economy to adapt in Canada, or has it prevented it
from doing so? We note that things are not going too badly, but that they could
be much better, in particular in certain provinces. Economic development is not
even, and it seems that the real economy is having trouble increasing
productivity and adjusting to international competition. As financial
institutions, what is your role in this issue?
Mr. Mendes: There were a few good questions there, and I'll answer two
of them and then pass it on to my colleagues here.
With regard to hedging activity, I agree it could delay some of the positive
effects and some of the positive rebalancing that is going on in Canada, but the
idea of hedging gives companies more certainty with regard to their revenue
streams and their costs, which actually allows them to operate in a more
efficient way. I think that it would be appropriate to say that in this case it
was maybe a negative, but overall, if you look at the long term, it is a net
positive for companies.
On your other question or comment with regard to machinery and the purchasing
of machinery, and how, when the Canadian dollar loses value, it costs more to
purchase machinery, I will make one comment that I think could be helpful. When
companies need to purchase machinery in U.S. dollars and they are exporters to
the U.S. and they're competing with U.S. firms, they're competing with firms
that need to purchase that same machinery and have the same revenue stream in
U.S. dollars. So actually it's not necessarily a huge negative in their
competitiveness because the U.S. firm is getting their revenue in U.S. dollars
and has to buy the machinery, and the Canadian firm is getting their revenue in
U.S. dollars and has to buy that same machinery. So it's not actually as bad as
maybe you might think at first blush.
Mr. Jean: My thoughts are similar to what Mr. Mendes has just
explained regarding the cost of investment. In fact, if we are exposed abroad,
at this time we will experience a positive inflation in income. I am talking
here about inflation in the cost of capital because of the currency, but if that
same inflation acts on the income, then you would have perfect coverage in a
perfect world, and the impact would be minimal.
We are competitive on the American market, and that is not really a negative
factor. Everything is not perfect, however. Clearly, certain businesses have
capital costs abroad, and are subject to that inflation and do not see it in
their income. This means that there are businesses that will target the domestic
In that case, there will of course be a very negative impact. How can this be
remedied? There is one way of doing so, and that is to generate that inflation,
that is to say to simply increase prices. In certain sectors, we see businesses
passing on these higher costs in higher prices, but not all sectors have the
capacity to do that.
In fact, certain sectors have very little capacity to increase prices in
order to offset higher costs. In the case of investment, this has the effect of
a tax on capital that may curb investment.
We cannot put all Canadian businesses in the same basket. Some businesses
will feel a very positive impact, others will not. In the work we did for
Quebec, we determined that a large number of businesses benefit from this
depreciation at this time, and at a certain point, we should see capital being
Mr. Perrault: I would have a few additional comments. Clearly, hedging
activities, as some of you have explained, interfere with adjustment. We must
not forget that that is an insurance policy. Although it may have some negative
effects, seen from a certain angle at this time, this also has a positive
impact, as some of you have mentioned, as it guarantees a payment flow at a
certain proportion of the currency. When that insurance was acquired, it
protected against downward or upward fluctuations. So the business had an
important advantage. Businesses do that, because it gives them an advantage. In
this case some of them lost a little, but basically, this is a positive factor
What we also see, at least in my area, is that businesses protect themselves
or purchase coverage at the current rate. Since we anticipate an increase in the
value of the Canadian dollar, these businesses were able to purchase coverage
from 68 cents to 72 cents, which will allow them to make more money if the
Adjustment is a complex process, as some of you mentioned. The governor of
the Bank of Canada referred to this often. This is an even more complex process
because of the global economic situation. We know that financing costs are very
low for businesses. They generally have a lot of money and are profitable. They
have a lot of money in the bank but they do not invest all that much. It is not
necessarily that financial costs are inhibiting investment. It is simply that
they are concerned about the economic perspectives, both in Canada and abroad.
We see this on a global scale; there are surplus savings as compared to
investment, because businesses are conservative. They are worried about the
global outlook, and that is constraining investment internationally. Canada had
a slight advantage as compared to other countries, to the extent that investment
was stronger here than elsewhere. In the provinces that will have to make
considerable structural adjustments, such as the maritime provinces, these
factors weigh even more heavily.
That is a partial reply, but it is important to have some perspective and
take global conditions into account.
Senator Massicotte: My question will be very brief, and I would ask
you for a very brief answer, which would allow me to ask several questions. You
are all in agreement that this is the wrong time to suggest that we freeze our
dollar as compared to the American dollar. That is out of the question. You are
all in agreement on that? Nobody disagrees? Very well.
When you do forecasts, it is easy to talk about the past. You talk about the
past with certainty, as does a sports analyst or a stock analyst. When you talk
about the future, it is always more difficult. Several of you made projections —
Ms. Desjardins, in particular — regarding the price of oil, as did Mr. Porter.
How would you quantify your projections in percentage terms? Are you 90 percent
sure? Or 50 percent sure? I would like to obtain a figure from each of you. Mr.
Mr. Porter: I would say about 30 percent sure. A little bit more
seriously, it does depend so critically on what you assume about oil prices,
and, quite frankly —
Senator Massicotte: So what is your percentage?
Senator Ringuette: He said 30 percent.
Senator Massicotte: No, 30 percent was —
Mr. Porter: Thirtypercent; I'm not kidding.
Mr. Mendes: I would say I'd be very certain. If you could tell me
where oil prices are, I could tell you where the loonie would be. With greater
than 50 percent odds, I would say that the oil prices end the year higher than
they are today and that the loonie ends the year stronger than it was.
Senator Massicotte: So 50 percent.
Mr. Jean: I would say that, at the same time last year, we were 75
percent confident that the price of oil would be sitting at $60 today.
Senator Massicotte: That was in the past.
Mr. Jean: I say that to draw a parallel. Today, the price of oil is
just above $30, so we're telling you that it will hit $46. But can we have the
same level of confidence? Can we be 75 percent confident in that projection, as
we were last year? Of course not, because the situation has obviously been
Senator Massicotte: What is your percentage?
Mr. Jean: If I had to give a percentage, I would probably say 40
percent. But I do think the lower the price of oil, the greater our opportunity
to bounce back.
Senator Massicotte: Ms. Desjardins?
Ms. Desjardins: I have to say, I think I'm reasonably confident that
oil prices will rise, so I would say 50 percent.
Senator Massicotte: Mr. Perrault?
Mr. Perrault: I would peg the probability of correctly predicting that
the price of oil will rise within a year and a half at somewhere around 50
Mr. Burleton: I'm on the same page. There are a lot of uncertainties
Senator Massicotte: What's your percentage?
Mr. Burleton: Oh, okay. I'd say 50.
Senator Massicotte: I'd like to make a comment, if I may. You're in
Ottawa; you're accustomed to not answering questions, having learned well from
our politicians. When you say 50 percent, you are working with a major bank or
financial institution. You have capital market departments engaged in the
management and speculation of billions of dollars every day. Do your capital
market departments listen to you? Are the risks they take in line with your
presumptions of certainty, or are those presumptions simply for public
consumption and discussion?
Mr. Porter, are the investments made by your capital market department in
line with your expectations? It's a simple question, and I'd like a simple
Mr. Porter: My own, no; they take that as one voice. I'm certainly
part of the consensus view out there. On financial markets, I believe that
economists are wrong as often as they are right. On other economic variables,
like the unemployment rate or growth or inflation, economists have a much better
track record, but, essentially, financial markets have all current information
priced into them already. So, pretty much by definition, anything from here on
out is a surprise.
Mr. Mendes: I would agree with Mr. Porter; he took the words out of my
mouth. By definition, financial markets are pricing everything that we know at
this current point, so, if we had great certainty, it would almost be rigged. So
it's most fair this way.
Senator Massicotte: Mr. Jean?
Mr. Jean: Whether it's the media or our clients, people are always
looking to us to talk and hear our views on the value of the dollar and
financial variables. If our opinion didn't carry any weight, we wouldn't be so
sought after. What matters is not so much being right, but more so, and above
all, making projections based on appropriate reasoning and being able to
articulate the various dynamics at play. I will tell you that our views are used
and they are important.
Senator Massicotte: Ms. Desjardins?
Ms. Desjardins: I agree with Jimmy inasmuch as we build a view based
on our best assessment of what we believe are the underpinnings of a movement in
the Canadian dollar. So, to that extent, I think it does add value because we do
have differing opinions, as you can hear, and differing opinions vis-à-vis the
I think, all in all, it does add value. Certainly, if you see developments
evolving as we anticipate, you have that same intuition based on economic
fundamentals, then I think it does certainly add value to our clients.
Senator Massicotte: Mr. Perrault?
Mr. Perrault: Our projections, in terms of both the dollar and
commodities, are used for tax and financial planning purposes.
Senator Massicotte: Mr. Burleton?
Mr. Burleton: If futures markets are any indication, they are a little
bit less optimistic than the mainstream forecasters, and it's the same thing
with a lot of variables these days — U.S. Federal Reserve Fed funds rate.
There's certainly caution in the markets relative to some of the pundits, but
that doesn't mean they'll be right and we'll be wrong, for sure.
Senator Ringuette: I have a simple question, but the answer may be
complex. It's for all of you.
For a number of years now, not a week has gone by when we haven't heard about
Canadians' level of household debt in the news. What impact do you think the
value of the loonie will have on household debt in the short and medium terms?
Mr. Porter: There's not necessarily a direct impact immediately. I
think in fact at the margin, one thing that's happened over the last year is
because of the weakness in oil prices, the weakness in the Canadian economy,
we've actually seen the Bank of Canada cut interest rates twice, we've seen
long-term interest rates fall to all-time lows in recent weeks, and if anything,
that has actually made it more affordable to manage the debt levels we do have.
When we look ahead, I think how this ultimately will be resolved or will
affect the economy — and this is part of the adjustment process when we talk
about the lower Canadian dollar — I think we will see a shift in emphasis of
growth in the Canadian economy away from consumer spending, away from housing
and more towards exports in particular, and the weaker Canadian dollar will help
us make that shift.
I've always tried to push back against the doomsday scenario about household
debt, seeing it as a clear and present danger to the economy. The one thing I
always like to point out is that Canada's household debt levels are not out of
the ordinary when we look around the world. There are a number of very
successful economies that have higher household debt levels than we do, such as
Switzerland, Norway, Netherlands or Denmark. Sweden is very similar to us. The
U.K. is very similar to us. Australia is also very similar. Yes, we are higher
than the U.S., but the U.S. consumer has reformed. It found religion during the
financial crisis and brought its debt down to much more manageable levels. So
Canada is not that unusual when we look around the world.
The way I look at our record levels of household debt is that we really can't
count on the consumer to continue to drive the economy in the years ahead, but I
don't see it as a near-term danger to the economy.
The Chair: Anybody else?
Mr. Mendes: I have just one comment on that. I think what we
understand is that the weaker Canadian dollar is going to affect consumers by
increasing inflation, but inflation is still very low and contained in this
What it will also do is support the labour market, which is more important,
so that people can still service that high level of household debt. I think the
Bank of Canada's cutting of interest rates as well will support the labour
market, and that's where we see support will come from for that debt.
Mr. Burleton: I think that's an important point. We often directly
link a lower Canadian dollar with reduced purchasing power of consumers, and all
things being equal, that's a negative for the household balance sheet.
The important distinction is not the decline in the dollar; it's what's
happening underlying inflation, so you need to look at a broader picture.
Inflation is the key from a purchasing power perspective when you look at the
Canadian household. By that, you're getting the offset from lower gas prices to
some extent. Most feel that the pass-through of the lower loonie to the general
consumer prices tends to be a short-term impact rather than something
Senator Ringuette: And the uptake on the job market will enable
Canadians to reduce that debt load?
Mr. Burleton: Absolutely. To the extent that the lower dollar helps
the job market grow, we get growth in these sectors — some of them I spoke of —
and that is really the key when it comes back to the consumer.
That's the thing. It's not the Canadian dollar; it's what it's implying about
the underlying economy. To the extent that the falling dollar is due to the
Canadian economy really weakening, then that doesn't bode well from a household
debt, household financial perspective.
Senator Tannas: Thank you all for being here. Yesterday — Senator
Bellemare referred to it a little bit — we tried to have a discussion with the
Bank of Canada around sentiment and how, when you add it onto speculation, the
short- selling of the dollar, hedging activities by nervous exporters or
importers to try to protect themselves, which further plays into sentiment, what
kind of an impact that has, and we got nowhere. It's obviously not something
they like to talk about.
You all did, or a number of you did. One of you mentioned some of the
evidence towards sentiment in your short sale of the Canadian dollar being four
times larger than in comparison with Australia, which leads me to believe from
your comments that we have been through a period of negative sentiment and that
the dollar has been oversold, and perhaps we are somewhere at the bottom or
maybe starting to move up as sentiment improves. If I'm wrong with that, maybe
you can correct me.
I guess what I'd like from you, being inspired by Senator Massicotte's way of
questioning, is could you from your models or from your experience give us a
number on neutral sentiment and what your model would drive out for a
Canadian-U.S. exchange rate today. We'll start with Mr. Porter.
Mr. Porter: It just so happens that we've been fine-tuning our model
recently, and what we're coming up with, based on today's commodity prices, is
actually not much different from Desjardins. We come up with 74 cents as a point
estimate. That's based on today's oil prices.
I'll give you a longer-term view quickly. I think when we try to look at what
is a fair value for the currency over the long sweep of history, something in
the low 80-cent range, based on more normal oil prices, is —
Senator Tannas: I get that, and we saw that in a number of years. I'm
just looking at the sentiment.
So 74 cents would be neutral. We're still at a discount. For all Canadians
watching who patriotically want to go out and short the American dollar today,
that's the number we're looking for: 74 cents is where we should be today based
on oil prices and all your other factors. Mr. Mendes?
Mr. Mendes: I have a few comments. I will give you the number. I would
say it's very close to Mr. Porter's number, 73 cents. But it's well known in the
economics profession that currencies often overshoot. I would say that this is a
classic case of that right here, what we saw in Canada recently.
The risk with the currency overshooting — and what I calculated was one of
the deepest and quickest depreciations of the Canadian dollar in its history
outside of the great recession and outside of a few other cases — is that when
it moves so far and so quick that it hits consumer confidence. Not even the
market's negative sentiment — it hits consumer confidence. That's where I would
I agree that the markets have been negative. There is that "short Canada''
mentality around the world. What I see in fixed income prices and bond prices is
that it's not very heavily priced in with regards to risk premiums.
So I would say that there is a negative sentiment towards Canada. The
currency did overshoot. We're moving back to more appropriate levels, and that's
a good thing, because if the move had been exacerbated, we would have risked
hitting consumer confidence.
Senator Tannas: Good point.
Mr. Jean: On the topic of confidence, I think confidence or market
sentiment has been downright toxic in January, not just in Canada but everything
in the whole realm of financial markets. It has obviously hit the Canadian
dollar significantly, but why? Because of oil prices. I think oil prices are
also oversold, given the fundamentals and what we see going forward.
I think what is really problematic right now is the speed of the decline and
the sense of instability that can be tracked to sentiment. When we crossed over
the 70-cent level, then the general press was alerted and the loonie was making
the prime-time news on a daily basis. That hurts how the average consumer and
business owner feels about the economy.
Yes, it does get into a period where it can be problematic. I think it's
important because the Bank of Canada on January 20 walked into the meeting with
the mindset that they should cut interest rates, but then the argument was made
that there's fiscal stimulus coming up and, secondly, cutting rates further
would exacerbate that instability in the currency. They ultimately chose to hold
back and wait a little bit so as not to have that counterproductive effect
happen. It is a fair point.
Today we're at 73 cents, so perhaps it acts the other way.
Senator Tannas: Are you 73 in your model, or are you saying—
Mr. Jean: No. I'm saying the currency right now is at 73 cents —
Senator Tannas: What is your number? What is your neutral number?
Mr. Jean: The value of currency is at 75.
Ms. Desjardins: We are at 76 in terms of what our model would say with
current economic conditions. I guess one of the factors that have played
significantly in this move of currency is of course oil prices but also the U.S.
dollar. The U.S. dollar has been powering along against everyone. There was a
sentiment that the Fed would be gradually raising interest rates while the rest
of the world is either cutting or holding still. We have to put that in the
context as well. Yes, we have some negative sentiment, but I think positive
sentiment to the U.S. dollar.
Mr. Perrault: We basically all use the same kinds of models for the
Canadian dollar. We may end up in a different spot, 74, 75 or 73 cents. We're at
73 cents right now, but that's heavily a function of what happens to commodity
Senator Tannas: You also mentioned that you are watching short
positions. You have a way of quantifying that. Are you seeing in the short term
an unwinding of those positions as a reflection that we've troughed out on
negative sentiment and that we're headed the other way?
Mr. Perrault: The data are weekly. The last data we have don't suggest
that. Clearly what's happened with the dollar over the last week suggests there
has been a sharp referral in positioning against it. I suspect that when the
next data are available, we will see some reversal in short positions.
As Mr. Mendes indicated, there clearly was negative sentiment. At the same
time, the way exchange markets work in general is that there needs to be some
degree of overshooting before markets reverse and investors start to say, "Okay,
this has gone down far enough; it's time to take a bet in the other direction.''
It looks like that's happening now for Canada. There's a large aspect of this
which is a kind of movement against the U.S. dollar. The U.S. dollar has been
strong for a long period of time. People are re-evaluating whether that strength
will be as long-lasting as they thought given what some of the Fed governors
have been saying. There is a move away from the U.S. dollar into other kinds of
currencies, including our own; but ours had been more aggressively sold than
others, so it is normal to expect that ours would pick up and rebound a little
more than others.
Mr. Burleton: My gut sense is that the Canadian dollar has oversold
but largely because the U.S. dollar has been overbought; and it probably will
Our models may be a little different. We're not far off where our models are
pointing. They are largely driven by interest rates as we find that to be a very
good indicator. Ten-year spreads between Canada and the U.S. are at historic
highs in terms of width; and five-year spreads aren't far off that. Unless that
changes dramatically, we see a bit of that narrowing going forward.
Senator Black: I have a question around exports. If it has been asked,
please tell me.
The Chair: Mr. Porter, next time you get nailed to go first, you can
defer to another witness.
Senator Black: I am very interested generally in whether Canada has
the ability to compete in manufacturing. That's the overarching question that I
have for you. I observe a falling dollar. I observe that our export numbers, as
you have really aligned today, haven't picked up perhaps as quickly as we would
have hoped. I would draw your attention to increasing free trade agreements,
which have taken me to a place where I'm a little bit worried about Canada's
ability to compete as an export nation. Maybe it's just on the products that
we're currently exporting, but I'm going to leave that to you. Would you be good
enough to comment on that, please?
Mr. Burleton: I guess I'm cautiously optimistic. One thing the
Canadian dollar falling to these levels has done is eliminate the gap in unit
labour costs between Canada and the United States that had really opened up.
That, of course, is an average statistic that really depends on the industries
as some are more competitive than others.
On the flip side, we're competitive against U.S. firms, while Mexico is still
a very big challenge within the North American market. We've seen our Canadian
dollar and the Mexican peso fall by almost the same amount. They've been almost
right on top of each other over the past year or two. That's a longer-term
challenge that we are continuing to adjust to — the idea being that our strength
will be in the higher-value end of the curve. It's taking time, but I think it
will happen, hence the focus on innovation. We're going to hear a lot about this
clearly in the upcoming federal budget and provincial budgets. That's really
going to be the trick.
Supply chains are something that Canadian producers will continue to have to
work on. We're late to the game in terms of adopting competitive supply chains.
I'm optimistic that we will have some success in penetrating other markets.
Mr. Perrault: One of the issues with our export performance,
obviously, as you appointment out, is whether our firms are competitive enough
to compete on a global scale. A weaker dollar helps to some extent as it reduces
our costs in foreign currency terms. As some of us have alluded to, it makes
investment a little more challenging and a little more expensive, which matters
a tremendous amount to the extent that productivity growth in Canada
historically has been weak compared to other G7 economies. There is a
fundamental issue with respect to the productivity of our firms, which has
affected manufacturing prospects.
That being said, as Mr. Jean indicated, we have seen in Ontario and to some
extent in B.C. a bit of a resurgence in manufacturing currently. That started
probably before the dollar started to go down most aggressively. There is reason
for optimism, but there is a fundamental challenge with productivity in the
country, which is partly related to something Mr. Burleton indicated: firms'
desires and interests in being innovative. You can come into the productivity
side with firms developing services, products or techniques for doing things
that differentiate themselves from others; and you kind of need both in order to
be able to do well in the global economy.
Ms. Desjardins: Yes, I agree with my colleagues in terms of how we
ensure that this actual rotation to the export side of the equation really
occurs. We are seeing investment that is very slow outside of the energy patch,
so we need to see that pick up to broaden the prospects that Canadian businesses
will be able to meet the demands. If we see a pickup in exports, and domestic
demand remains relatively resilient, then capacity will be stretched in many of
these industries. Certainly, we need to see willingness. Some uncertainty in the
environment, some of which stems from the decline in the Canadian dollar, is
holding these companies back.
Better days ahead certainly in terms of sentiment towards our currency and
our prospects for growth will underpin a pickup in investment and support all of
the anticipated increased demand for our exports.
Mr. Jean: You have two categories of business: those sensitive to the
currency of non-energy exports and those not sensitive to the currency. Within
the two categories, some are expected to be leaders going forward to carry
growth for exports, and there are some where you can't have that expectation.
For example, an export category that is sensitive to the currency and that
can be expected to carry growth forward includes aerospace products, aluminum
and pharmaceuticals. Research shows that those are the categories of exports.
Export performance in Quebec where those export categories are important in the
makeup of the total exports has increased by 25 percent in the first three
quarters of 2015 versus 2014. That's enormous. In aluminum, there's a 12 percent
increase. In pharmaceuticals, you have a 36.3 percent increase.
So to the question of whether we can compete, clearly for those categories I
think we can. To the question of whether we can compete, for example, in
clothing and paper, those industries that are perhaps sensitive to the currency
but subject to the long-term force of globalization, we can't really hold that
It's going to be a bit of a mix and match, but I think in a number of areas
we are able to compete.
Mr. Mendes: I broadly agree with what my colleagues have said. We lost
manufacturing capacity when the loonie was very highly valued.
I don't expect that we're going to see some sort of manufacturing revolution
with the weak Canadian dollar. I think as we've said, global competitiveness has
increased. Where I think Canada needs to focus is higher-value-added products,
but even then, the headwinds from weak global demand are still present. I think
that, appropriately so, central banks around the world are keeping interest
rates low to support demand, but it's not going to come back immediately.
As I mentioned in my opening remarks, I think services are a place Canada can
focus as well. Canada leads the world, leads the OECD countries, in tertiary
education, which places us in a very unique situation to take advantage of
Now, when we look at services exports versus goods exports, we see it as a
small component, but that's because it's difficult to measure services exports
sometimes. If we look at it on a different scale than what StatsCan actually
produces on a value-added scale, it's very close to the same level there.
We think that services exports will take a little more prominence in Canada.
I already have anecdotal evidence — I'm not going to name the specific
companies, but there is evidence that there are software and media companies
that are seeing significant increases in their revenues coming from the United
States. You can think of companies that would either move their head office or
keep their head office in Canada because they can pay their employees in
Canadian dollars but still operate largely in the U.S. or on a global basis.
Mr. Porter: I think we certainly can compete at this current exchange
rate, but I think there are four factors to believe that we're not going to get
the same kind of lift or torque as we would have in the past from this exchange
rate and this kind of growth that we are seeing in the U.S.
One is the lack of spare industrial capacity that others have spoken to. Just
to give you one little fact on that front or an example, last year we had record
auto sales in both Canada and the U.S., yet auto production in this country fell
by 5.5 percent last year. That's one factor.
The second factor, something that's different from the 1980s and 1990s, is
that we have much more competition from places like Mexico and the auto side in
China and almost everywhere else.
The third factor is certainly that the Canadian dollar has not been falling
by itself. We have fallen in line with almost every other major currency out
The fourth factor is some of the non-labour costs that have been rising, most
notably in Ontario, for things such as electricity, which has somewhat dampened
For all those factors, I don't think we can really expect the same kind of
lift in exports that we would have in the past.
Senator Black: Do I take, then, as a conclusion of the panel that you
are generally optimistic about Canada's ability to be an export nation and
rebalance the equation if we get our innovation and productivity right? Is that
Mr. Porter: Yes, but that's a big "if.''
Senator Black: I know. That's your next panel.
Senator Maltais: Since I had to step out for a few minutes, someone
else may have asked my question, so please set me straight, if that's the case.
The price of oil causes the loonie to fluctuate significantly. Currently,
production is outstripping demand. And we recently learned that Iran will be
bringing another one million barrels of oil to the market every day. Could that
cause the price of oil to drop yet again, or will prices remain stable? Could it
affect the Canadian dollar?
Mr. Mendes: I'll just mention that I think when you look at financial
markets, especially the oil market, once we know that Iran is going to come back
online, a lot of that gets priced into the market immediately. My expectation
would be that that's largely priced in.
Mr. Jean: I would say more or less the same thing. When you take, for
example, what the International Energy Agency said about oil, in other words,
that it would take quite a few more quarters before the current oil surplus
began to drop off. The agency put out that prediction last month. We've seen a
lot of volatility in the price of oil, but it hasn't been an additional factor.
We knew Iran's decision was coming. Financial markets have long taken into
account the idea that the current surplus is going to take much longer to be
absorbed than expected, but I don't have the sense that it can still bring down
the price of oil. The crucial thing to consider will be the supply adjustment.
What may have been the biggest surprise in 2015 was the fact that production,
particularly in North America, didn't drop as much as anticipated, in light of
what was happening with prices. Prices are now at levels that are jeopardizing
not only future projects, but also a certain number that are under way.
Production should slow down. Once the markets get that signal, we'll see oil
prices rebound somewhat.
Ms. Desjardins: Yes. I agree. I think the supply adjustment will come
likely more from the U.S. side of the equation. That's the area where we saw
significant growth. And now, as we go forward, many of these U.S. producers are
running into significant difficulties. They're running into difficulties because
they're not able to cover their costs. So for the current time, that's running
with a loss, but it also impedes the amount of capital that investors are
willing to give them for future production.
So I think when we look at the supply side of it, yes, you're going to have
new production from Iran coming to the market, but I think you're going to see a
commensurate decline in production from some of these U.S. producers. Therefore,
this will gradually lead to the oversupply coming down and a more balanced
market as we get through the end of 2016. It takes a while, but I think that's
the way it's going to play out.
Mr. Burleton: We talked a bit about financialization of the Canadian
dollar. From what I'm reading, something like 85 percent of oil in the U.S. is
unhedged this year, and that's a much lower level. A lot of companies had hedges
in place when oil was above $50 and $60, and they've allowed those to drop off.
I think many are counting on that to begin to accelerate the U.S. shale decline.
But don't underestimate the U.S. dollar as well. I think most models show a
pretty tight fit, at least recently, between the U.S. dollar changes and the
U.S. dollar oil prices. I think some of us are banking on the U.S. dollar to
lose some ground later this year, and that should be another precondition to set
Senator L. Smith: I asked a similar question yesterday, and I'll ask
it today. It's a crystal-ball question. I know you don't like making forecasts
and recommendations necessarily, but if you had to give three steps that would
be critical for the dollar and for our economy to rebound, what would they be?
If I could just ask you to help out.
We've talked about productivity, we've talked about manufacturing, but those
things have been talked about for the last 25 years. We've talked about
better-trained people in terms of we're well trained at the high end, but our
trades — Germany built its economy after World War II because they developed a
committed trade discipline with education.
I'm just wondering for Canada, what are the three things that would need to
happen from an economic perspective? I know we're talking about the dollar, but
it's tied to economics. Could you give us some insight? It would be helpful for
the people listening today, who would be able to understand in a more direct way
as opposed to the high-end way. We are televised, and a lot of people are
listening, and this is a very important focus that the Banking Committee has. I
think it's important for us to impart messages so that we can come to not only
discussion but some form of direction.
Mr. Burleton: Senator, I think some of my earlier comments in the
formal part were more relative to the 1990s. I do think the direct policy impact
on the falling loonie back then was much more important in terms of the fact
that we had very uncompetitive tax rates and our government's fiscal position
was in terrible shape. A lot of those issues have been addressed. I do think
there is more chatter now about the fact that the commodity sector has been a
key driver of growth in this economy, but now we're seeing a rotation away,
which I think if anything may put more emphasis on the need to take that
innovation file and further it.
I do know there is a lot of unfinished business in innovation. It's not maybe
so much in the tax rates but in some of the programs we have. And, again, maybe
we should have a separate hearing on innovation because it's a very complicated
issue. That's something we've got to hone in on more, and we lack data to
understand some of the elements there, so it will be key that we continue to
Senator L. Smith: Will that innovation be driven by business, or will
it be driven as a combination of business and government?
Mr. Burleton: A combination of business and government, absolutely.
And that's part of it, with good, strong relationships there. But I come back to
that I think a lot of the issues that will pull the Canadian dollar up aren't a
direct government purview. It comes down to differences in interest rates that
the U.S. is offering, different points in the cycle. Remember, the U.S. is
coming out of a very severe recession and has more upside to growth. We call it
the macho effect: the fact that they have more upside potential in growth. We're
coming off a period where we've had a very heavily taxed consumer, and we don't
just have that upside to growth. We're counting on this rotation, but it's
probably for a little while going to leave us at a weak growth rate. Governments
pick away and do things to help that, but it's a tough one on oil. There's very
little control over the oil price.
Mr. Mendes: I co-authored a paper recently with my colleague Benjamin
Tal. We found that about 50 percent of R&D spending comes from small and
medium-sized businesses. But one of the problems that small and medium-sized
businesses often have is that they lack access to proper funding. Getting access
to funding to these companies can help us increase innovation and productivity
in the country.
The second thing I would mention is an education mismatch. We have people in
Canada striving for a higher education, but we need them to go into the STEM
fields more. That will help our economy as well.
From a higher-level perspective, I would say that the federal government and
the Bank of Canada are on the right track. Easier monetary policy is one of the
key ingredients to helping our economy rebound. There are people who will take
hits at the Bank of Canada for lowering interest rates because of the risks
surrounding it, but I would say it's an absolute net benefit when it comes to
the labour market, promoting investment, things like that. Associated with that,
the federal government running a moderate fiscal deficit in a time like this,
and using it to fund infrastructure projects, seems appropriate as well.
Mr. Perrault: It's obviously a multi-faceted question. From a
shorter-term perspective, I think what you really have is an economy that
requires support. We are going through a very significant transition, very
significant negative shock that the Bank of Canada has up to this point been
accommodative with, so that has helped. Our view is that growth in the first
part of the year will be pretty low as investment and activity in the oil patch
continue to be affected by what's going on. To the extent there is uncertainty
about the outlook, that's clearly feeding weakness in the first part of the
year, but it's depressing household spending to some extent, and it's obviously
affecting investment. So a key factor in kind of a return to sustainable decent
growth is for those kinds of feelings of uncertainty to abate. And you can get
that to some extent by policy-makers making people feel better, and the bank
does a little bit when it moves interest rates. It's not just about the fact
that interest rates are going lower; it's about the fact that there's someone
out there trying to help. That has helped to some extent. I think you are likely
to see that, assuming the government puts forward some kind of stimulus package,
which will only come into effect in the second half of the year or early next
year. It depends on what they do.
I think clearly that will be of benefit, but those are shorter-term things.
There is a longer-term issue, which is that what we consider to be potential
output in Canada as the long-term growth rate of the economy has come down quite
a bit. Part of that is as a result of the fact that the oil patch is smaller now
and the energy sector is going to be smaller now than it was, so there is a
permanent loss in output resulting from that. But part of that is the fact that
the population is aging and productivity growth has been relatively low, so
there are some big adjustments required in the economy for potential growth to
come back to levels closer to where they've been.
It's probably impossible for that to happen. You're talking about things
relating to allowing the labour market to adjust, having the proper incentives
in the labour market for people to go from one industry to another, retraining
programs and those kinds of things. We have, as Mr. Mendes indicated, a fairly
high proportion of students coming out of the system in what we call the STEM
fields: science, technology, engineering and math. It's actually quite high
relative to the G7 standards. What is funny about the Canadian economy though is
that Canadian firms tend to use those less than other economies. Schools are
pumping out, by and large, people in the right fields, but for whatever reason
they're not being used as much in our firms as they are in other countries. I
don't know why that is. I'm sure people have done some research on that, but it
gets to some extent to an issue we were talking about earlier that related to
innovation and the desire and need for firms to be more innovative in their
approach. And in there it's easy to say the government has a responsibility and
there are things the government is doing that are kind of holding firms back. A
fair amount of the dynamic here is firms being more cautious.
Pardon me for going on at length here, but there is almost a cultural
dimension to this, which is that we're Canadians, we're kind of nicer and we're
a little more risk-averse; we're not like the killer Americans. And you see that
in the data. Productivity growth is a little lower, but firms don't see as
important a need to innovate in Canada as they would in our main competitor
economies. How do you change that? It's a kind of mindset. You can throw as much
money as you want at it from a federal government and provincial government
perspective, but at the end of the day, if a firm is just not interested in
innovating — but some are and a lot do — where do you go with that?
The Chair: Is it a cultural thing? Is it the schools? The schools are
producing business people and the innovators and the engineers and the
scientists, but they are less cautious. Is it partly the result of the schools,
risk-free schools sort of?
Mr. Perrault: Surveys have been done — I don't have the precise data
with me — that look at what we call the management acumen of firms in Canada.
And there are, generally speaking, fewer business folks running businesses in
Canada than in other countries and certainly relative to the U.S. We have fewer
MBAs that run businesses or are in management structures, and that goes to some
extent to the cultural aspect, which is that when you get an MBA you're
basically learning how to maximize profits in a firm.
I think there is a bit of a culture shift, and it's not necessarily that the
schools aren't producing these people, it's just that firms for whatever reason
have a different preference for the kind of people they want to hire, by and
large, relative to the Americans.
The Chair: Did you want to add something, Mr. Porter?
Mr. Porter: I was going to make a general overall comment to Senator
Smith's question. Keep in mind that as recently as a couple of years ago we were
widely seen as the toast of the town, one of the most successful economies in
the world, and I don't think the world has completely changed. What has changed
obviously is that we're dealing with a commodity price shock, and there will be
an adjustment. I think monetary and fiscal policy will play a role in that
adjustment, but I don't think low commodity prices always equal an unsuccessful
Canadian economy. Some of the best years of growth that we have had in recent
decades were in the late 1990s, admittedly during the height of the tech boom.
That was also a period of very low commodity prices. Low commodity prices do not
cast us into a period of low growth forever.
Senator Massicotte: We often interpret broad stock indexes, maybe the
S&P 500, as a reflection of how well the economy is doing. We think it's a
prediction of future economic growth or the contrary; yet when you look at the
news, and oil prices go down, if you notice the trend in the last couple of
years, the stock market goes down, particularly the S&P. The Canadian market you
can understand because we are perceived to be oil- or commodity-oriented.
If you look at the S&P 500 or the emerging world markets, if oil goes up that
seems to be good news and therefore the S&P goes up. As we all know, in some
countries it's the opposite effect. Does the S&P go up because oil and gas
companies form a significant factor in the calculation of that index? Or is it
really good? In other words, oil price goes up, S&P goes up, it must be good for
the world; the economy is doing great. Is that accurate?
Mr. Porter: This is something that has been bedevilling a lot of
people this year. On days when oil prices slump, you see the Japanese and
European markets dropping, and of course they are big oil importers; they should
benefit from lower oil prices. The best explanation I've seen for this tight
correlation between oil prices and global equity markets so far this year is
some concern that some of the large sovereign wealth funds in the oil producers
are now becoming forced sellers of financial assets as oil prices drop.
In other words, the Saudi Arabias and the UAEs of the world are reducing
their equity market holdings, or that's the perception, at least in the
financial markets. Whether that's happening or not is debatable. The view is
that as oil prices drop below $30, some of these the sovereign wealth funds are
going to have to sell equities because it doesn't make any economic sense.
Mr. Mendes: I have heard the same thing as Mr. Porter. But I question
why Japanese equities are sometimes underperforming other markets when they are
a huge oil importer.
I would propose a slightly different explanation. The global economy is
suffering from weak demand, and inflation in many countries is very close to
zero and near deflationary territory. There are two things at play there: Weaker
oil prices are going to depress headline inflation and push back against a lot
of the European Central Bank's work and the Bank of Japan's work, which is
working to increase inflation and expectations; it's working against that.
I would also mention something I'm sure you already know is risk sentiment.
Markets move broadly with risk sentiment, and on days when risk sentiment is
higher, oil and stock markets will be moving in that direction together.
Senator Bellemare: I have a comment I'd like to make before I get to
my question. My comment has to do with your answers in relation to the
adjustment process and productivity innovation. You talked about human
resources, and perhaps we should pay more attention to those human resources in
order to change the culture in our companies. That's what I took away from your
My question is fairly straightforward. International trade is hugely
important to Canada; it's a practice we will always be engaged in.
Interprovincial trade, however, also presents many opportunities. In the short
and medium terms, do you think we can do more to stimulate interprovincial trade
so as to restructure our economy and strengthen our companies, since we wouldn't
have to worry about the whole currency issue?
Mr. Jean: That's an excellent question, and it is one of the problems.
As for the inflexibility that hampers interprovincial trade, as we see in the
labour market, Canada is one of the worst-performing countries when it comes to
labour mobility, despite the east-west flow of workers resulting from the boom
in the energy sector. Internationally, we score very poorly in that regard.
Because of that inflexibility, our growth isn't as strong as it should be.
Interprovincial trade is another element that has long been defined as a
problem, given the tremendous growth potential it holds.
In the public sector, we are starting to see some partnerships, such as
between Quebec and Ontario in the area of hydroelectricity, and that's a step in
the right direction. But there's still much to do, especially for companies.
Earlier we talked about Canada's production potential, our growth potential.
These are the types of initiatives that will help us counter other factors that
negatively impact our growth potential. Yes, more and more, I think the dynamics
of interprovincial trade will be front and centre in the debate.
Senator Massicotte: I want to thank you very much for your
contribution to a very important debate for Canadians. I found it very
interesting, in spite of the fact that you only see a 30 percent probability of
your being right.
The Chair: I want to thank the witnesses. It has been a great session.
I want to thank your employers for letting you come here and participate. The
testimony is going to be very helpful to Canadians and to public policy-makers.
We didn't expect you to be fortune tellers or soothsayers, but you did a great
job as economists and business people.
(The committee adjourned.)