How the high Canadian Dollar and Alberta oil really impacts Canada

By Kunal Jaggi
(Sources of Info: Bloomberg, www.norway.org.uk)

The shopping trips apart, what does the recent US Canadian Dollar parity really mean for the Canadian economy. I listened to an extremely insightful podcast today by Bloomberg with the Chief Economist of TD Canada Trust Bank - Don Drummond on the line.

• The last parity was in 1976 when Canada had strong growth following its integration with the world economy in the post WW II era of 50's and 60's.

• The most worrisome fact for Canada is that at present productivity levels in Canada are 75 % that of the US. This figure was at its highest (90%) in 1976 and has gone down drastically since then.

• In 1976, Canada was ranked as having 3rd highest level of productivity in the OECD (out of around 20 at the time). At present they are 17th. France and Denmark are much higher , and France makes up for fewer working hours through increased productivity.

• One of the reasons for this is capital in-adequacies. Drummond states that Canadian workers have a lot less capital intensive machines / equipment to work with. Two-third the figure for per hour of labour work in the US. Canadian companies should use the high dollar to beef up on high-tech equipment, but Drummond says they are not doing so.

Oil - the Dutch disease ?

The term 'Dutch disease' was coined in 1977 to describe the decline of the manufacturing sector in the Netherlands after the discovery of natural gas in the 1960s (source Wikipedia). Essentially, the theory implies that a huge increase in revenues from natural resources will de-industrialise a nation's economy by raising the exchange rate, which makes the manufacturing sector less competitive.
Drummond mentions that

• Alberta is totally skewing national averages. AB, with its oil boom is growing at about 5 %, rest of Canada at about 2 %. AB wages growing at 6% , rest of Canada at 2.5 %. With a weight of 10-12% the Alberta boom growth skews national figures of growth, i.e makes it seem that the whole country is doing better than it actually is, since most of the growth is coming from a small region. This will still make the Central Bank hike interest rates since they can't treat Alberta as a separate country, monetary policy is national, not provincial.

• Provincial spending by Alberta has been growing by 12% to meet all the infrastructure and other demands of the oil boom.

• Second largest proven oil reserve after Saudi Arabia
  $ 30-40 break even cost in 2002
  $ 50 - 60 break even cost in 2007

• Drummond mentions that Alberta, which has a surplus of around $ 40 Billion from the oil currently has not invested any of the money outside the province. This is extremely risky since the surplus can decrease very fast as the price of oil decreases.

• As a comparison, Norway has around $200 Billion from their oil exports (they have about 50 percent of Western Europe's oil and gas reserves). In order to prevent the 'Dutch disease' affect on the economy, the Norwegian Parliament established the Norwegian Govt petroleum Fund in 1990, which it hedges in other investments (source: http://norway.org.uk). It would be advisable for Alberta to do something similar.

The value of a nation's currency is not always an indication of how well the overall economy is doing. For a resource rich country like Canada, commodity prices (like oil) are the major reason for fluctuations in the currency. In other words, as the price of oil per barrel increases, the Canadian currency becomes more expensive for countries importing from Canada. For more on how commodity prices effect currencies, click here.

Another point to note would be that the manufacturing sector (which is concentrated in Ontario) will suffer heavily from

• The increase in Canadian dollar vis-a-vis the US dollar
• Lower rate of productivity in Canada as reported
• Increase in Chinese imports. Previously, North America didn't import auto parts from China. Now they account for 5 %.
• US Southern states pay 12 - 15 $ hourly wages in manufacturing plants, Ontario has historically paid 35-40 $.
• Until about 5 years ago, 86 % of Canadian trade was with the US. Now, Canada has been attempting to diversify its trading partners. The result has been more emerging economies importing Canadian natural resources.

We can expect the Canadian Dollar to rise even further

• Even higher prices per barrel of oil
• The US Federal Reserve might cut interest rates again, whereas in all probability, the Canadian central bank will hike interest rates (the AB growth effect skewing the actual economy growth) providing further short-term momentum towards the Canadian Dollar.
  

According to Drummond, Canadians are not focussed much on this problem. The Government and economists have not done a good job explaining the situation. He says that a lot of Canadians don't want things to be exactly like the US, i.e have dense cities with high crime rates. He says - " You don't get citizens embracing a concept unless there is a crisis. There isn't a crisis right now in standard of living. Things are going sideways kinda like Japan - the incomes are still high ".

Well, at least those American basketball players will be cheaper to buy now.