The Central Bank of Canada effectively devalued the Canadian Loonie last week, and that has some good and bad consequences. The bad news is that I paid $7 Canadian for an American cup of coffee. The good news is that I bought Canadian money at an insanely cheap American price.
The real question now is: why the Bank of Canada is so afraid of deflation that it cut its key interest rate by ¼ of a percent, when there’s little sign of deflation, even with bottoming oil prices – even when other advanced, independent economies are talking about raising key interest rates?
In a closed economy, cutting interest rates isn’t going to mean much to every day folks inside Canada; the price of things aren’t going to change by much, and it becomes cheaper to borrow money. It does have some negative impacts. For example, Canadian sovereign debt bonds will be priced higher, thwarting public revenue from domestic investment. This, ironically, is the same problem that the Eurozone is facing with its new QE program, and that the U.S. has faced after their QE program was in full swing.
So are there signs of deflation in Canada? Not really. Canada has been in much worse shape as far as deflation goes in the past, and is pretty much on par with the United States, and the U.S. wants to raise key interest rates to spur inflation.
Food and gas prices create volatility in inflation for Canada. But it does that for all advanced economies, which is why real economists rarely gauge food and gas in inflation. They are commodities (not stocks), and all commodities are subject to volatility because they are “natural resources.” Even with the volatility of food and gas prices factored in, there are no deflationary alarm sirens blasting. It’s certainly not the Eurozone.
Canada was doing so well too. While they had a short, minor recession in 2009, it was nothing that hit the U.S. or the global economy. No bank has ever failed…EVER in the history of Canada. While their unemployment rate has been stagnant, and real wages just keeping up with inflation, they had (and continue to have) a stronger social safety net with serious bank regulations (Note: there are no poor bankers or doctors in Canada). The Loonie rose while American banks collapsed and the U.S. Dollar turned into “mattress-filler.”
Will the drop in oil prices force people to hang around for cheaper prices on everything else? There’s no evidence of that. Oil makes up about 5.8% of Canadian GDP. In 2009, oil took a major hit in Canada, but they had nothing resembling the recession that hit the rest of the world, mostly because of government transfers à-la-Keynes.
Maybe it’s the Eurozone. Canada’s second largest net export is the Eurozone, and they’ve been in a full-blown depression for 6 years. But this only accounts for .01% of Canada’s GDP, with a $2 Billion net export surplus with the EU.
So there’s no real or rational reason for the Bank of Canada to lower interest rates, devaluing its currency on the global exchange market. However, one thing to note is that even with the increase in Canadian Sovereign debt bond prices, it will still only cost about $86 U.S. Dollars for $100 par on Canadian bonds. So perhaps Canada is looking for more Greenbacks. More Greenbacks however, is not what Canada needs, just like the U.S. doesn’t need China buying more U.S. Treasuries. In Canada, as in the U.S., more domestic investment, be it from the Toronto Stock Exchange or government transfers is needed. This is what the Federal Reserve in the States attempted with it’s QE bond buying program – domestic investment when people just wanted to stuff money under their mattresses. Of course the U.S. QE program didn’t work out so well, and had massive structural consequences for the labor force, but the intention was clear (and somewhat good): domestic investment.
With Canada cutting interest rates, and effectively devaluing the Loonie on the world market, the only thing the Canadian central bank has done is hang a “Help Wanted” sign out to foreign investors. GDP is calculated WITHOUT factoring foreign investors, which means that foreign investment will NOT boost GDP, which means that Canada, like the U.S. may face secular stagnation without the benefit (if there is one) of a QE program. Lack of domestic investment will, like the U.S., spur growing-on-steroids income inequality and permanent labor force destruction.