Adrian Wyld
Canada risks a "hollowing out" of its industrial base if the Bank of Canada does not intervene to bring down an overvalued dollar, Canadian Imperial Bank of Commerce warned in a report Tuesday.
"Plants that close because they are unprofitable at current exchange rates might permanently relocate elsewhere. They won't suddenly come back if the currency later cheapens," CIBC's chief economist Avery Shenfeld wrote in the report, issued just hours before Bank of Canada Governor Mark Carney was scheduled to appear before the House of Commons finance committee in Ottawa.
"We are hollowing out our industrial base by letting speculative foreign exchange market forces, in effect, dictate the mix of monetary conditions," Mr. Shenfeld said.
Mr. Shenfeld said the central bank has sent a clear message about the threat a persistently high dollar poses to Canada's fragile economic recovery, and has committed to keeping its benchmark interest rate at 0.25 per cent until well into next year to give "an offsetting boost" to output. This has helped the domestic economy.
"But in the real world, the mix of output also matters," Mr. Shenfeld said in calling for stronger measures to bring down the level of the loonie, which was pushing toward parity with the United States dollar last week.
"Putting people into larger houses because mortgage rates are lower … generates economic output in the construction industry and leaves the economy with a larger stock of housing. But if the loonie is overvalued for a few years, we may be sacrificing business plant and equipment on the altar of a strong currency," Mr. Shenfeld said.
Separately, Export Development Canada warned Tuesday that a dollar that persists around the 95-cent (U.S.) mark next year could slice as much as 3 per cent from the country's economic growth.
"A persistently high Canadian dollar through 2010, in the 95 cent plus range, could shave as much as 2 to 3 per cent from Canada's GDP," Peter Hall, chief economist at EDC, said in the agency's semi-annual forecast released Tuesday.
Bank of Canada officials have not ruled out intervention in foreign exchange markets to hold down the value of the loonie - a position that CIBC supports.
Mr. Shenfeld said the Bank of Canada's verbal intervention has worked to some extent in subduing the value of the loonie, which closed at 93.72 cents (U.S.) Monday after surpassing 97 cents earlier this month. And some might argue that it is safe "to wait and see" before intervening more forcefully, he said.
"Still, distaste for the U.S. dollar is likely to limit the scope for a weaker Canadian dollar," he wrote.
Barring intervention by the Bank of Canada, "that will leave the Canadian currency persistently overvalued relative to trade fundamentals, until commodity prices begin to close that gap in 2011 and beyond," Mr. Shefeld said.
By Mr. Hall's calculations based on fundamental drivers of the currency, the dollar should average around 86 cents through next year amid "modest" gains in crude oil and base metal prices.
"What we're seeing with the higher Canadian dollar right now is a strong speculative influence, not a fundamental shift," Mr. Hall said.
In Mr. Shenfeld's view, a Canadian dollar any higher than 90 cents is overvalued at this point.
"We have certainly been in an extreme circumstance in the last couple of months," Mr. Shenfeld said in an interview.
"In the here and now, maybe the currency is weakening on its own, so we might wait and see a little bit. But I think that when we were in the 95, 96, 97-cent range - and the Bank of Canada was clearly of the view that it [the dollar]was too strong for the economy's own good - that would have been an appropriate time to have dusted off the intervention tool and try to chase it back 5 or 6 cents," Mr. Shenfeld said.
If the dollar starts to approach parity again, the Bank of Canada should not hesitate to intervene, he said.
An effective approach would be to use Canadian dollars to buy up U.S. dollars, and build up the foreign exchange reserves, he said.
"You would go out there and sell Canadian dollars to buy U.S. dollars to try to weaken the Canadian dollar and hope that, if it is just speculative forces, that some of the speculators get nervous being up against the Bank of Canada and they also sell their Canadian dollars."
Export Development Canada expects the Canadian economy will contract by 2 per cent this year, before external demand and fiscal stimulus lift activity 1.9 per cent in 2010. That forecast is considerably slower than the Bank of Canada's projections, which expects the gross domestic product to expand 3 per cent next year.
Canada's exports are forecast to rise 6 per cent next year, EDC said.
But a number of challenges remain.
"If investors remain bullish on commodities like oil and copper, and commodity-currencies, this could drive the value of the loonie higher, with devastating effects not only to the Canadian exporter, but to the recovery itself," Mr. Hall said.
"There's an obvious sense of relief that world output is no longer in freefall, but there's a big difference between renewed growth and rock-solid recovery," Mr. Hall said.
These hurdles include rising unemployment, higher defaults at banks, protectionist "rhetoric" and inflation fears. And, a stubbornly strong currency.
Exports accounted for more than a third, or 36.8 per cent, of Canada's real GDP last year. A strong dollar makes Canadian goods more expensive, and hence less competitive, when sold abroad.
Exports plunged this year as a global recession sapped demand. This year's 24-per-cent drop is the largest single-year decline on record, the agency said.
Tavia Grant