Stephen Poloz is special adviser at Osler, Hoskin and Harcourt and author of The Next Age of Uncertainty. He is a former Bank of Canada governor and sits on the boards of Enbridge Inc. and CGI Inc.
The U.S. and Canadian economies are in a similar situation and financial markets have given the federal government’s fall economic statement a passing grade. So why is the Canadian dollar trading in the low-70s against the U.S. dollar?
This is more than a matter of national pride. While weakness in the dollar may help boost exports, it has also contributed to our inflation problem. When the Canadian dollar slides from around 80 US cents to 73 to 74 cents, that boosts the prices of imports by 8 per cent to 9 per cent for anything from toys made in China, to lettuce grown in California, to Caribbean vacations, even without supply chain issues.
More importantly, the low-flying loonie is a symptom of wider issues. It points to continued weak business investment today, which will mean even weaker productivity and economic growth in the future. The federal government’s fall economic statement last week covers many problems in its 96 pages, but only this one is described as an “urgent priority.”
A microcosm of this issue can be seen in the dollar’s relation to the oil and gas sector. The dollar usually rises with higher oil prices because oil companies boost investment, and this extra activity attracts both domestic and foreign investors. New jobs are created, incomes go up and more wealth is built. The Canadian dollar appreciates along with rising national income and wealth, thereby improving Canadians’ global purchasing power – the prices of imported toys, lettuce and vacations fall – so all consumers benefit.
By that logic, the Canadian dollar should have reacted to the surge in commodity prices after the Russian invasion of Ukraine by rising to the 85-to-90-cent range, rather than falling. Had it risen, our inflation performance would have been far better.
But higher oil prices have led to only a modest increase in energy-sector investment, at least so far, and therefore our dollar has foundered. The fall economic statement highlights this investment shortfall and goes on to point out that it’s more than an oil-and-gas issue: Canadian business investment has been relatively weak in all sectors of the economy since 2015.
How has this happened? The observation that business investment has been weak since 2015 offers a clue as to the underlying reason: high and rising uncertainty about the future.
Consider: 2015 began with a collapse in world oil prices and a contraction in the Canadian economy, which of course led to lower rates of investment in all sectors. In contrast, oil-importing countries such as the United States continued to grow and their investment rates continued to rise.
Consider: In early 2016, presidential candidate Donald Trump began to talk about “tearing up NAFTA,” a risk that crystallized with his election that fall. The level playing field under NAFTA was fundamental to many Canadian companies, so the threat to the agreement meant investment remained weak. During the Trump presidency some companies even diverted investment spending from Canada to the U.S., so they could qualify for “Buy America” if NAFTA renegotiations failed. The signing of the USMCA in 2020 helped, but there were renewed tariff threats even after the signing of the new trade deal. The fraught geopolitical conditions we face today mean trade risks are on the rise yet again, an important headwind to new investment.
Consider: Since 2015, there has been, rightfully, growing emphasis of the goal of net-zero carbon emissions. All companies now need a net-zero plan because their customers, shareholders, employees, and their banks demand it. But there is much uncertainty about which path will be taken, how government policies might change along the way, and whether they will be consistent across countries or even provinces. For the energy sector the uncertainty is existential. While most paths to net zero would see the Canadian oil and gas sector remain important to Canada and to world energy security long into the future – after all, “net zero” is not the same as “zero” – some go so far as to advocate that Canada exit the business altogether. These uncertainties boil down to basic questions such as “Will this new investment still have value in 2050?” or “Can this new investment pass all regulatory hurdles, and in a reasonable time frame?” Uncertainty about the future of the business is why investment in the oil and gas sector has remained low since 2015 and has responded only modestly to the latest move to higher oil prices.
Uncertainty about the future is the main investment inhibitor, and I believe it will only get worse over the next 10 to 20 years. This is what the low loonie points toward.
Therefore, actively addressing uncertainty should be an urgent priority for governments: uncertainty about international trade; about regulations, both federal and provincial; about project permitting; about what net zero looks like. Giving companies more certainty about the future would be a fiscally prudent route to higher business investment, a stronger Canadian dollar, and lower inflation besides.