The Bank of Canada dreams of world where everyone works together.
Countries with big trade deficits, such as the United States, will endeavour to get spending under control. Nations with big trade surpluses, such as China, will stop hogging export markets and generate more demand at home.
Timothy Lane, a deputy governor at the Bank of Canada, on Tuesday will try to win converts in a part of the world that has been most resistant to the central bank’s proselytizing: Southeast Asia.
For the Bank of Canada’s dream to come true, surplus countries must allow their real exchange rates – nominal exchange rates adjusted for inflation – to appreciate. This would narrow the competiveness gap between countries such as China and Britain. It’s not a zero-sum game. Britain might gain a little market share from China in goods markets, but that would strengthen the British economy, generating more opportunities than currently exist in Britain for Chinese companies. The difference between the “good” scenario of complementary policies and the “bad” scenario of essentially doing nothing is $6-trillion, according to Bank of Canada simulations.
For now, the world is drifting toward the “bad” scenario, according to slides Mr. Lane will present at a conference hosted by the Bank of Korea in Seoul. The main reason, he suggests, is the reluctance of surplus countries to allow their exchange rates to rise. China is the main culprit, but its neighbours are nearly as guilty.
Mr. Lane acknowledges that ultralow interest rates in Europe, Japan and the U.S. are putting upward pressure on currencies. However, he argues that this is better than the alternative: recessionary conditions in the world’s biggest economies.
“On balance,” he says in one slide, “exceptional easing in post-crisis economies is likely to be beneficial to other countries that were not at the centre of the crisis, since the favourable effects of stronger growth in the major post-crisis economies outweigh the adverse effects of currency appreciation.”
Australia, Brazil and Canada have endured considerable appreciation of their currencies in the post-crisis years. Southeast Asian nations have been less willing to accept that burden. Plenty of capital is rushing to their shores, seeking better yields than can be had in the U.S. and Japan. Yet they have opted to “sterilize” the effects by expanding their foreign currency reserves and then issuing bonds to mop up any excess supply of local money.
“If these inflows were unsterilized, they would result in higher inflation and thus real exchange rate appreciation,” Mr. Lane says. “In practice, this has taken place only to a limited degree. To some extent, inflows have been sterilized, accompanied by various restrictions on the financial system.” He adds: “From a global perspective, such sterilization partly offsets the effects of the monetary expansion in post-crisis countries.”
For graphic evidence of the former, Mr. Lane offers his own country as Exhibit A. Record-low interest rates spurred an economic recovery led by household spending. This growth strategy, however, has reached its limits. Household debt is 150 per cent of income, uncomfortably high, but probably a peak – credit growth now is contracting. But spending is contracting along with it, and Canada’s other engines of growth still are sputtering. Canada’s export recovery is the weakest of any business cycle in the postwar period.
“In the wake of the crisis, market forces have driven deficit countries toward deleveraging,” Mr. Lane says in his slides. “The surplus countries have felt less pressure to bring about a rotation of demand.”
It is unlikely prodding from a Canadian central banker will change many minds. But we can dream.