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Canada’s blip of economic fortune has given way to a painful transition

As the loonie plunges and the economy falters, Bank of Canada governor Stephen Poloz says, “There is no simple policy response in this situation.”


It may sound cruel to ask this of you, but you need to flip back two years to fully appreciate Canada's jaw-dropping reversal of fortune, or, if you prefer the metaphor, the emperor's nakedness.

At the beginning of 2014, the Bank of Canada was predicting that our economy would be firing on all cylinders by now, as a modest decline in the value of the loonie fired up non-energy exports while a price of $90 (U.S.) a barrel for West Texas intermediate sustained Alberta's boom.

We wish. Gross domestic product growth for 2015 likely came in around 1 per cent, compared with the central bank's early 2014 forecast of 2.5 per cent. The bank's October forecast for 2-per-cent 2016 growth and the Canadian economy's return to full capacity by mid-2017 now seems giddy, considering this year's bleak start – oil testing decade-plus lows, China on the cusp of imploding and disappointing prospects for an export revival driven by the ever-sinking loonie.

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Speaking of our comatose currency, the term "northern peso" has re-entered the lexicon (thanks to an eerily compelling report this week from TD Securities) with Canada feeling all of the downsides of a weak loonie with little evidence of the upsides working their usual magic. The dollar has sunk more than a quarter against the greenback since 2013 with no end in sight.

The declining currency is rapidly eroding the purchasing power of already overextended Canadians (bought groceries lately?) without kick-starting exports as it did in the past. Massive structural changes and underinvestment in new capacity in the Canadian economy in the years since the loonie last flirted with 70 cents have muted the stimulus effect of devaluation.

"There is no simple policy response in this situation," Bank of Canada Governor Stephen Poloz warned Thursday. "The forces that have been set in motion simply must work themselves out. The economy's adjustment process can be difficult and painful for individuals, and there are policies that can help buffer those effects, but the adjustments must eventually happen."

What makes this transition even more painful, Mr. Poloz continued, is that "while Canada goes through its adjustment, some of its competitors are doing the same, and their currencies are depreciating along with Canada's. This will make the adjustment process more challenging compared with a case where Canada was the only country that had to adjust."

What not so long ago seemed hypothetical – that negative interest rates would cross the Atlantic – now looks increasingly probable as the Bank of Canada contemplates slashing its benchmark rate below zero. The only certain impact would be to ensure the dollar's continued depreciation.

This portends a full-on identity crisis for the Canadian economy. We were an economic wonder of the world during and after the Great Recession, basking in the glow of our gold-plated banks and commodities exporters. We bought and traded houses as if they were hockey cards.

With each passing day, it "looks more like a blip," former Bank of Canada chief David Dodge said recently. "So we're going to have to go back, having lost a decade on the technological side."

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It's not clear, however, that the technology picture was that much brighter back then. In 2002, yes, Nortel still had some life in it and Research In Motion was beginning its ascent. But Mr. Dodge was in the saddle when the loonie hit its record low – 61.76 cents in 2002 – which did not exactly provide Canadian businesses (outside the commodities sector, for reasons unrelated to the currency) with an incentive to invest in the future and move into advanced manufacturing. Nor did they take advantage of a strong dollar to invest in imported technology and modern processes.

As a recent C.D. Howe Institute study noted, business investment per worker declined at an annual rate of 1 per cent in Ontario after 2006, to hit $8,000 a worker in 2014. It grew by 3.9 per cent a year in Alberta to reach $42,500 in 2014, compared with a U.S. average of $19,000.

One of the reasons for the disparity is that foreign auto makers and domestic manufacturers expanded factories in Mexico and elsewhere instead of here. The result is that Canadian manufacturers have lost precious market share in the United States to Mexican and Chinese competitors.

It will take more than an underwater loonie to reverse that trend, and it's not clear it's even desirable. Our future does not lie in winning back U.S. market share in low-value-added exports.

This brings us inevitably to the innovation conundrum that has dogged provincial and federal governments of all stripes, to little avail. Shopify and Hootsuite are neat tech companies, if not takeover targets, but they're no substitute for Nortel or RIM/BlackBerry and the serious innovating that betters lives and economies.

It's cold out there. And Canada's economy begins 2016 looking awfully naked.

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