As much as the current account deficit is important, it’s just a symptom of a bigger underlying problem, i.e. an overvalued currency.
– National Bank, Weekly Economic Letter, March 19, 2012
Canada’s sterling reputation for stability has developed into a serious economic problem, as countries and businesses look to the Canadian dollar as a safe currency. The result has been an inflow of short-term financial investments that have pushed up the external value of the loonie. With a high dollar, Canadian exports, especially of manufactured goods, have deteriorated, and imports have soared. Canada’s international current account has moved from a surplus to a significant deficit.
A recent National Bank article posed the question of whether the Canadian dollar is overvalued, then set out a rather convincing argument that the answer is yes. The overvalued currency has contributed to the major deterioration in the current account position.
We not only agree but also suggest that Canada’s current account deficit outlook (which is related to our strong dollar) is far more serious than the fiscal problems facing the federal government. The reason for this is that Canadian policy-makers and the public in general have much more scope for tackling our fiscal problems than we have for tackling the current account and trade deficit problems.
The current account position in the balance of payments (the difference between exports and imports of all goods and services) is the broadest measure of trade between Canada and the rest of the world. It’s roughly the same as the trade balance figures used in the measure of GDP. In 2011, Canada recorded its third consecutive annual current account trade deficit after a decade of surpluses.
Historically, Canada has relied on exports (particularly manufacturing, forest products, minerals and energy) as the engine for economic growth. During most of the 40 years preceding the past decade, Canada recorded current account deficits. Then, with the dawn of the 21st century, the current account suddenly moved sharply into a surplus position.
The recent elevation in our dollar has shifted a decade-long manufacturing trade surplus into a substantial deficit – perhaps permanently.
Canada’s current account deficit was $48.30-billion in 2011, the second highest on record after 2010’s $50.86-billion. Last year’s current account deficit represented 2.8 per cent of GDP, as compared with 3.1 per cent in 2010.
The problem that a current account deficit poses is that it represents a leakage of output, jobs and incomes to other countries. So when Canada records a deficit running about 3 per cent of GDP, it implies that the domestic economy has to grow 3 per cent faster just to stand still.
Try to imagine the production and job gains potentially associated with an additional 3 per cent of GDP growth. If the $48-billion was added to the Canadian economy, it would represent an enormous number of new jobs across the country. In other words, the current account deficit represents a huge drain on the economy.
And as some politicians and economists have been stressing, a major reason for this loss of jobs and production to other countries was the escalation of the Canadian dollar to approximate parity with the U.S. dollar.
Although there’s no scientific way of determining what represents fair value for the loonie, most analysts would place it in the 80- to 90-cent U.S. range.
There’s little doubt that Canada’s high-flying currency has been heavily influenced by soaring resource and commodity prices, particularly that of oil. China and other emerging market economies that are rapidly industrializing play a key role in this complex story.
The overall effect on Canada has been a major shift from hefty goods trade surpluses from roughly $50-billion to $70-billion annually between 2000 and 2008 into approximate balance last year. At the same time, Canada’s services trade deficit has continued to widen over the past decade.
There’s no easy policy answer to an overpriced loonie. Much of the challenge will have to be met by business itself with strong increases in efficiency and productivity in the manufacturing sector to make Canada competitive. But Canada should also be sure that its tax policies don’t favour short-term financial investments that don’t result in real investments in plant, equipment and resources.
We can also learn from Germany’s success in supporting its export-oriented manufacturing firms. Its manufacturing sector has highly paid, skilled workers who make innovative products that provide value for customers as well as profits for its shareholders. Germany’s manufacturing industries also contribute to a healthier environment and to the country’s strong trade surplus.
Arthur Donner is a Toronto-based economic consultant who has been an adviser to federal and provincial governments. Doug Peters is a former chief economist of the Toronto-Dominion Bank and a former secretary of state (finance) in the Chrétien government.