Briefing highlights
- On the cusp of a trade-currency war
- Canadian dollar at about 77-cent mark
- BCE boosts dividend as profit climbs
Beggar thy neighbour
“An international trading policy that utilizes currency devaluations and protective barriers to alleviate a nation’s economic difficulties at the expense of other countries.” Investopedia
Fears are mounting that the world is on the cusp of a trade-currency war.
Threats grow louder by the day as President Donald Trump and his team take on an increasing number of trade partners, from Mexico to Japan to Germany.
Among the biggest concerns is the potential for a so-called border-adjustment tax, which has been promoted by congressional Republicans and, though first deemed unlikely, now seen among observers is an ever-rising possibility.
Canada has largely been spared the wrath of the new U.S. administration, whose dislike of the North American free-trade agreement largely centres on Mexico.
For now.
Should a border-adjustment tax or other measures see the light of day, Canada and its currency will be swept up in a global battle.
“The importance of supply chains in the modern economy means that multinationals will strongly oppose such protectionist measures, so we suspect (and hope!) that an outbreak of protectionism on the scale seen in the 1930s will be avoided,” said Andrew Kenningham, the chief global economist at Capital Economics in London.
“Nonetheless, even if things don’t get as bad as they were in the Great Depression, the increased cost of trade and uncertainty about future trade policy will surely discourage firms from outsourcing and establishing or maintaining global supply chains,” he added in a report, referring to the border tax issue.
“The process of globalization has come to a halt in recent years. There is a growing risk that it could now go into reverse.”
The Trump team has made trade a key issue in its first two weeks, warning the U.S. dollar is too high, slamming Mexico, and trash-talking Germany and Japan on the currency front.
An all-out currency war could be sparked by a broader trade battle, said Bipan Rai, executive director of macro strategy at CIBC World Markets.
“If we see a broad trade war (even if Canada is not directly impacted) then the negative implications for global growth would likely weigh on the loonie,” he added.
Here’s a look at some of the issues and currencies:
Border-adjustment tax
This is part of a sweeping tax overhaul proposed by the GOP, and wouldn’t be an import tax as we think of it, though the impact would basically be the same.
“A centrepiece of the proposal is to scrap the current method of taxing global net income and replace it with a destination-based cash flow tax,” explained BMO Nesbitt Burns deputy chief economist Michael Gregory and senior economist Sal Guatieri.
“Revenue generated by domestic sales would be taxable, but revenue generated by foreign sales would not. Expenses incurred from domestic sources would be deductible, but expenses incurred from foreign sources would not,” they added.
“If the U.S. introduces an across-the-board tariff or border-adjustment tax, world trade would not come to a standstill,” said Mr. Kenningham.
“We suspect that other governments would tread carefully before ratcheting up a trade war, but that they would eventually retaliate in some form,” he said.
“The resulting increase in the cost of trade, and in uncertainty over future trade policy, would inevitably take a toll on global growth.”
Actions among various trading partners would surely differ, Mr. Kenningham said.
Some governments, including that of the European Union, would probably go to the World Trade Organization for relief. But that could take years to resolve, and America could well ignore what the WTO rules.
China and Mexico, though, would opt for bigger guns.
“Admittedly, a border-adjustment tax would be less provocative for China than a tariff which singled out just China and one or two other countries,” said Mr. Kenningham.
“But Chinese policy makers would still be likely to use regulatory changes to clamp down on imports of U.S. products such as cars, aircraft or iPhones.”
Mexico has already warned it would tax U.S. imports in response.
The U.S. dollar
Some observers believe the greenback is going to strengthen. CIBC’s Mr. Rai, however, suggests that’s something akin to an “alternative fact.”
Mr. Rai said in a recent report that he believes the U.S. is abandoning its long-held strong-dollar policy, though a border-adjustment tax could change things up.
“We find it unlikely that the Trump administration will continue to pursue this policy for several reasons,” he said.
“The most glaring reason - a stronger USD is not congruent with the administration’s goal of reducing the trade deficit,” he added, referring to the U.S. dollar by its symbol.
“Of course, this has important implications and we expect that grounds for sustained USD gains over the longer term are shaky. Certainly, there are risks to that view with the possibility of a border adjustment tax, and investors should take precaution to buy hedges when they are cheap.”
The border-adjustment tax, though, could drive the dollar up as U.S. exports surge.
Some say such a measure could boost the greenback by 25 per cent as exports surge, which, of course, would mute the impact. Mr. Kenningham, though, doesn’t believe it would appreciate quite so fast.
“Changes in the current account balance may be outweighed by capital flows and there are other complications, such as China’s managed exchange rate regime and the issue of how companies adjust their prices in response to currency movements,” he added.
“Also, Trump might try to limit any dollar appreciation, perhaps by influencing the Fed.”
The euro
This was the latest salvo from the Trump team, when one of the President’s key trade advisers, Peter Navarro, slammed Germany this week for using a “grossly undervalued” euro to its advantage.
Mr. Navarro is certainly correct that Germany is an export powerhouse. He’s somewhat off-base, though, as to the reasons why.
“Germany’s competitiveness has been achieved through years of unit labour costs restraint, not currency manipulation,” said Jennifer McKeown of Capital Economics.
“Policy makers there are understandably proud of Germany’s exporting prowess and keen to set an example to the euro zone’s indebted countries with a balanced budget policy,” she added.
“This position is supported by all of the main political parties, so will not change after September’s election.”
Germany’s current account surplus came in at 6 per cent of gross domestic product in 2016, and Ms. McKeown expects similar showings from here on in.
There’s also the fact that the European Central Bank is responsible for policy, and “with core inflation in the euro zone as a whole at just 0.9 per cent, the ECB’s ultra-loose policy seems justified.”
The yen and the yuan
The U.S. criticism here is a “little harder to fathom,” Bank of Nova Scotia currency strategists said in a report.
“Japan has not intervened directly in the markets in years while China’s recent efforts have been aimed at preventing the [yuan] from weakening,” they said.
“This remark may simply have been a comment on past, unwelcome practices rather than a specific criticism of current USD levels.”
Mr. Trump, remember, has threatened to label China a currency manipulator, which would only serve to heighten tensions.
Noting that the yen had the worst performance among major currencies in the fourth quarter, the Scotiabank strategists attributed this to “rising U.S. interest rates and wider U.S.-Japan rate differentials at the long end of the curve as well as [yen] underperformance in a generally pro-risk environment as U.S. equity markets rose following the election.”
As for the yuan, they expect pressure to continue this year.
“The People’s Bank of China will try and curb escalating one-way expectations of yuan depreciation on the one hand whilst preparing for future yuan depreciation on the other in the months ahead.”
The Canadian dollar
The loonie has now perked up to about 77 cents U.S. amid recent weakness in the greenback.
How it plays out depends on many factors, though most forecasters see it slipping to between 70 cents and 72 cents as the Bank of Canada stands firm on interest rates while the U.S. central bank raises its benchmark.
“The problem for the CAD is that the domestic economic outlook remains challenged by soft, non-commodity exports and weak business investment,” said the Scotiabank strategists.
“As Trump’s election campaign focused on trade and border issues, his win appears to have prompted a surge in Canadian worries about the economic (policy) outlook which hamper a recovery in either exports or capital spending.”
Much will depend on a border-adjustment tax, and how it might apply to Canada, and that’s a big unknown at this point.
“The Canadian dollar would need to weaken by 10 per cent to compensate for the impact of the U.S. border tax adjustment,” said Deutsche Bank senior currency strategist Sébastien Galy.
“To achieve this, the Bank of Canada needs to cut once and threaten [quantitative easing], while the rest of the move would theoretically come from the [U.S.] dollar.”
The peso
Mexico’s peso was seen as a proxy for Mr. Trump’s chances throughout the election campaign.
Now that the victory is his, and Mexico is his prime target so far, anything goes.
“Based on real effective exchange rate, the [peso] is now the weakest currency among the 24 emerging market currencies tracked by Bloomberg,” the Scotiabank strategists said.
“However, the uncertainty surrounding President Trump’s policies towards Mexico is not expected to dissipate before the summer, likely leaving the peso under pressure, or at least volatile.”
One last point where Mexico’s concerned, one that threatens to spoil Mr. Trump’s party.
Shareholders of big multinationals may want to take a look at what John Higgins, chief markets economist at Capital Economics, had to say about the fact that such companies have poured into Mexico since NAFTA.
“Mexico may run a large trade surplus with the U.S., but the idea that it has ‘taken advantage’ of its large neighbour - as Donald Trump provocatively tweeted on Friday - is surely wide of the mark,” Mr. Higgins said.
“Arguably, the opposite is true, which is why his policies pose a serious threat to the earnings of the companies that dominate the S&P 500.”
BCE boosts dividend
BCE Inc. is boosting its dividend amid stronger profit.
The telecommunications giant said it’s raising the dividend by about 5 per cent to $2.87 a year.
BCE profit rose to $669-million, or 75 cents a share, in the fourth quarter from $542-million or 58 cents a year earlier.
Revenue rose to $5.7-billion from $5.6-billion.
BCE also said it expects revenue to rise this year by between 1 and 2 per cent, and forecast adjusted earnings per share of $3.42 to $3.52, compared to 2016’s $3.46.