A Stronger Loonie Would Boost Living Standards, but Needs Initiative, Policy Changes to Happen

Commentary, Economy, Ian Madsen

The standard of living of Canada’s population is not growing as quickly as per capita Gross Domestic Product (GDP). The reason for that is our dollar has been declining in relative terms against the currency of our biggest trading partner, the United States. While some of that is the result of the greenback rising against most currencies around the world, including ours, a lot of it is because of things we have done to ourselves. According to The Economist, Canada’s GDP per capita is about US$47,640, 74.5% of that of our American cousins, at US$64,070. Remarkably, that is currently the exchange rate.

The last time the loonie traded at par with the US dollar was February 8th, 2013. It is tempting to blame the subsequent decline on the price of oil, Canada’s major export commodity. However, while the price of oil, as noted by West Texas Intermediate, the US commodity market benchmark, hit $108.64 per barrel on September 3rd of that year, it was only about $97 in February, and the big drop in the price of oil did not start until later in June of the following year, 2014. Since then, it has been a rocky slide for the loonie. If oil is not the sole reason for the loonie’s swoon, then some other factors must be at play.

The price of a currency, like all prices, is set by supply and demand. There are a number of constituents of demand: exports of our products and services, including tourism and other foreign visitors; short-term interest in our securities, including money market and other interest-rate sensitive securities; and longer-term interest in investing in our stocks, bonds, real estate, mortgages, loans, businesses and other assets. Our current account, including net exports and investment income, has been negative since 2014. The capital account (longer-term flows) and the exchange rate have to balance this.

We can increase demand for exports by developing new and attractive products and services, lowering prices of existing ones, or producing more and selling more of them into more markets. Unfortunately, Canada has not been good at this. There are few entirely new products being produced, and more of oil sands bitumen and natural gas have been produced, substitutes for which are already being crowded out by new production in the main market of the United States, as the shale revolution explodes.  

When the loonie was last at par, we were selling all the oil and bitumen we could produce to the US, and at much higher prices. Those higher prices may not ever come back. The volumes sold could increase, but there is not the pipeline capacity to sell into markets in the central and eastern United States, or eastern Canada (which imports from the Middle East, Africa, and Latin America).  

The Keystone XL Express pipeline, which would move 510,000 barrels per day, ‘bbl/d’, from Alberta through North Dakota to central markets and thence Gulf Coast refineries awaits final court decisions in the US. The TransMountain pipeline, now owned by the Canadian federal government, is near a decision to triple capacity and sell an extra 590,000 bbl/d into US, local and overseas markets. Ottawa is hoping that its enhanced First Nations consultations and coastal environmental assessment and risk mitigation measures will meet court scrutiny that scuppered the earlier expansion plan.  

Enbridge’s replacement of Line 3 from Alberta to Wisconsin will add another 370,000 bbl/d. Only Line 3 looks near-certain; by year-end. However, relieving capacity constraints on Canadian production may not raise prices for Western Canadian Select by much, or add much to Canada’s total export volumes: about $6 billion per year, just .3% of GDP, at US$45/barrel, if Line 3 is done. Canada needs to do more.

The loonie is also weak because there is little interest in investing in the country. The biggest companies are in energy, mining and banking. As there is more than enough energy, that sector is not attractive. Canadian mining companies have to compete for money with others around the world, where getting projects approved, permitted and developed to the commercial stage is faster and cheaper, if not always as safe. Finally, banking is not as enticing as in days of yore, as interest rates are low and destined to remain so, because Canada’s economic growth is weak, and, recently commercial and mortgage loan growth has stalled, even as consumer debt has escalated to risky levels.

Canadian investors are voting with their dollars: according to Global Affairs Canada, from 2013 to 2017, foreign investment in Canada grew by about $135 billion, an average of about $27 billion per year, whereas investment abroad by Canada-based investors grew by a whopping $343 billion, or about $69 billion per year, a more than two-to-one ratio. For 2018, the trend continued, as foreign investment flowed in at $51.3 billion, and outward at $65.4 billion. If capital accounts are negative, and short-term accounts are negative, with lower interest rates here than in the United States, and a negligible or often negative trade balance, then there will continue to be downward pressure on the loonie.

Foremost, local, national, and foreign investors have to believe that rates of return for investing in a country are, if not robust currently, will become so in the near future, and have a high probability of being sustainably high. While Canada’s population growth rate is good, at over 1% per year, which is quite high for a developed nation, its productivity growth rate is meagre, at less than 1% per person per annum. From this, increased profits and improved wages and living standards are nearly impossible.

Add to that regulations that increase costs and lengthen times to start or expand businesses and projects, increasing opposition from environmental and Indigenous groups and landowners to resource, industrial or real estate projects, and high corporate taxes versus our major trading partner, the US, and it does not look like a US-Canada currency parity is imminent. As an example, capital is pouring into Texas’s Permian basin and oil and gas production is soaring and improving US trade balances.

One significant thing that Ottawa could do to improve Canada’s tax competitiveness at comparatively little harm to the federal deficit, would be to expand on the re-orientation of the corporate tax basis from net income to taxing net free cash flow; i.e., after complete, immediate expensing of capital expenditures, as the United States has done. This would boost capital spending, and productivity.  

It could also start a long-term reduction in corporate tax rates from 15%, down by, say, 0.5% per year for the next ten years – a gradual approach that Quebec has done for several years, now. With more business-friendly governments now in power in most of Canada’s provinces, they might be agreeable to chiming in on it, and that would make the total average rate in the nation even lower. Lower rates, and boosting capital investment are crucial to increasing productivity, wages, and living standards.  

Reducing or eliminating the cost-boosting carbon tax would help even more. There could be other inducements to entice business and consumers to increase energy efficiency and encourage them to substitute clean, cheap, lower-CO2-emitting natural gas instead. Nobody has to invest in Canada, including Canadians, so it is wise, in the short and long term, to find ways to make it more alluring.