Over inflated Canadian dollar risks hollowing out the country's manufacturing base
The report argues that by not intervening in the foreign exchange market when speculators are pushing the dollar to heights it does not believe are fundamentally sound, the Bank risks a hollowing out of the country's industrial base.
"Anyone who has watched the Canadian dollar's performance in the last 15 years would have a tough time arguing that foreign exchange markets are the perfectly rational, calculating machines that the textbooks suggest," says
One of the concerns in not intervening in the rapid appreciation of the Canadian dollar is that the Canadian economy is made up of many different sectors that react very differently to changes in currency values and interest rates. "If one thinks of GDP as simply an undifferentiated lump of output, then foreign exchange bubbles would not seem to be too consequential for
"In the current context, the drag on overall growth and inflation could be largely offset by the Bank of Canada's decision to keep rates on hold for an extended period. This month's interest rate announcement sent a clear message that to the extent that the Canadian dollar will delay re-attaining the two per cent inflation target, it will help keep rates low for longer, giving an offsetting boost to output."
While this may keep the country's GDP numbers on an upward slope, it's the composition of growth that concerns
"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. Plants that close because they are unprofitable at current exchange rates might permanently relocate elsewhere. They won't suddenly come back if currency later cheapens. We are hollowing out our industrial base by letting speculative foreign exchange market forces, in effect, dictate the mix of monetary conditions."
Given this, he believes it may be time for the Bank to shift policy gears and intervene in foreign exchange markets when it believes the loonie is overvalued. "To those who say intervention never works,
What he doesn't want to see is a fixed exchange rate, "which forever hands over our interest rate policy to the (U.S.) Federal Reserve (Board), and fails to allow any adjustment to longer swings in commodity prices."
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/soct09.pdf.
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