Bank of Canada Governor: Commodities ‘Unambigiously Good’ For Canada

Spruce Meadows, south of Calgary, where Bank of Canada Governor Mark Carney was a marquee speaker for the annual Spruce Meadows Changing Fortunes Round Table

Wading into a national debate that was ignited by a controversial claim by Thomas Mulcair, leader of Canada’s left-leaning National Democratic Party (NDP), that Canada’s booming resource sectors harm the overall Canadian economy- the so-called ‘Dutch Disease’ hypothesis, Bank of Canada Governor Mark Carney on Friday strongly rejected the notion and endorsed the view that high commodity prices are a net benefit to the Canadian economy.

The Dutch Disease argument Mulcair first put forth in April is that higher revenues from Western Canadian oil exports have increased the value of the dollar, which has made Canadian manufacturing less competitive in international markets, and that in the long-run, the contribution made by the resource sectors to the Canadian economy does not make up for the resultant decline in manufacturing.

In a presentation given to the annual Spruce Meadows Changing Fortunes Round Table near Calgary, an event that attracts business leaders from across Canada, Carney roundly dismissed the argument, saying “the [Dutch Disease] diagnosis is overly simplistic and, in the end, wrong.” He added that “Canada’s economy is much more diverse and much better integrated than the Dutch Disease caricature”, and that much of the decline in manufacturing is not related to the rising value of the dollar.

Carney provided the following chart to demonstrate that the decline in Canadian manufacturing’s share of GDP “is part of a broad, secular trend across the advanced world” as opposed to a Canadian peculiarity owing to the country’s natural resource wealth:

Carney said that an analysis done by the Bank of Canada using its Terms-of-Trade Economic Model (ToTEM) projects that the economic effect of a 20 percent increase in oil prices would be positive for Canada under all three scenarios modelled:

Stronger demand from the U.S. would contribute to a 3 percent increase in GDP over five years. Stronger demand from Asia, as is the case now, would boost GDP by 1 percent over the same time frame, and a short term supply shock would increase GDP by 0.2 percent in the first year.

Maximizing Returns

Carney said that to increase the benefit that Canada derives from high commodity prices, the country should shift “export markets toward fast-growing emerging markets”, in particular in the Asia Pacific region, as U.S. growth had slowed and would likely stay muted for the foreseeable future.

He also prescribed that the country build “new energy infrastructure—pipelines and refineries” to bring Western Canadian oil to Eastern Canadian consumers, who are now importing oil and paying an average premium of $35 over the price in Western Canada. The infrastructure would bring “more of the benefits of the commodity boom to more of the country”.

Other recommendations Carney made were:

  • Improving interprovincial mobility through changes like standardizing occupational licensing across provinces, to help bring more skilled labour from other regions of the country to where it’s needed in Western Canada,
  • Increasing skills of labour force by encouraging more graduates in the sciences, technology, engineering and math (STEM) and focusing “on skills upgrading and (re)training for existing workers”
  • Increasing business investment in light of sufficient “precautionary cash balances” and “the scale of the resource opportunity”

Building on Canada’s Strengths

Carney concluded the talk by saying that the strength of Canada’s resource sectors should be recognized as “a reflection of success, not a harbinger of failure.”

He said that attempting to reverse the effects of Canada’s energy exports on the value of the dollar “requires that we undo our successes in order to depreciate our currency. Taken to its natural conclusion, this logic dictates that we shut down the oil sands, abandon our resource wealth, have high and variable inflation, run large fiscal deficits and diminish our financial sector.”

“Such actions would surely weaken the Canadian dollar, but they would also weaken Canada,” he added.

“In a world of elevated commodity prices, it is better to have them,” he concluded. “Rather than debate their utility, we should focus on how we can minimise the pain of the inevitable adjustment and maximise the benefits of our resource economy for all Canadians.”

Canadians Now Wealthier Than Americans, Mostly Due to Housing Prices

Condo construction in Canada. The crash in the US housing market was the main cause of the average net worth of households in Canada surpassing the net worth of households in the US (Raysonho)

A report that first surfaced on Canada Day stating that Canada now has higher average household net worth than the US set the news media on both sides of the border buzzing. Advocates of robust government intervention in the economy pointed to this development as vindication of their faith in their economic ideology, while Republicans blamed the news on Obama’s term in office.

The real cause of the switch in household net worth standings is much more mundane: a drop in housing prices in the US. As the National Post’s Andrew Coyne notes, home prices declined by nearly one-third in the US from 2006, when the US was ahead in household net worth, to 2011, when the wealth comparison used in the report was done, while they remained steady in Canada, and this accounts for almost all of the drop in the average household net worth in the US relative to that in Canada. A commodity boom driving up the value of the Canadian dollar also helped Canada’s relative position.

The key policy decision in the US that caused the divergence in the wealth of American and Canadian households was the goal the American political establishment set in the early 2000s to purposefully encourage a boom in the housing market using the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, and low interest rates from the Federal Reserve as the tools.

As far back as 2001, popular American pundit Paul Krugman, in classic Keynesian economic fashion, trumpeted the benefits a housing bubble could provide for the US economy and proposed the means of creating it:

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

The Federal Reserve obliged and sharply lowered interest rates and kept them there for the next three years.

The GSEs did their part and expanded their volume of purchases of privately issued mortgage backed securities from $20 billion in 2000 to over $150 billion at the height of the housing bubble, in 2006.

In contrast, the Canada Mortgage and Housing Corporation (CMHC), a crown corporation which has a role somewhat similar to that of the GSEs in the US, remained conservative in the type of mortgages it insured, while the Bank of Canada kept its overnight lending rate a full two percentage points higher than the Fed’s, and consequently, no bubble formed in Canada’s housing market.

Whether the US economy would have been spared a housing bubble in the absence of the expansion of GSE subsidies and lowering of the Fed’s lending rate is a matter of much scholarly debate. At the very least, the decision by the American political establishment and Federal Reserve authorities to expand government mortgage subsidies and keep interest rates low for three years, respectively, did nothing to prevent a bubble from forming, and made the one that did form worse than it otherwise would have been.

The real story that emerges in Canada overtaking the US in average household net worth is the superiority of a more prudent approach to economic intervention that emphasizes sustainable economic development over one that focuses on boosting GDP in the short term at any price.

Inflation Drops to 1.2% in May, Reducing Likelihood of Rate Hike

The decline in inflation in May is bullish for short-term housing prices. Housing prices in Canada's major cities have increased significantly over the last five years, which anecdotal evidence suggests is partly due to greater investment in the market by foreign and immigrant investors.

Prices increased 1.2 percent in the 12 months leading up to May, a drop of 0.8 percent from the annual inflation rate in April, according to a report released by Statistics Canada today, a development that could keep interest rates low and help shore up housing prices in the near term.

The slowdown in inflation was due primarily to declines in natural gas and oil prices, smaller price increases for passenger vehicles, and a small decline in women’s clothing prices.

The inflation news could help boost short term housing prices, or forestall what some see as a coming correction in housing prices that are at bubble levels, as it reduces the likelihood that the Bank of Canada will increase interest rates.

The likely repercussions for the housing market are tempered by Finance Minister Jim Flaherty’s announcement yesterday that the federal government would tighten mortgage rules to reduce what his department sees as housing demand driven by speculation and funded by too much borrowing.

He said that the Canada Mortgage and Housing Corporation (CMHC), a government owned home mortgage guaranteer that insures 49 percent of Canadian home mortgages, would reduce the maximum term of mortgages it will insure from 30 years to 25 years and no longer insure mortgages for homes worth more than $1 million.