The inevitable demise of the loonie

December 7, 2001
Sherry Cooper
National Post

Now that the loonie has rebounded to a whopping 63.5 cents, the talk of dollarization has dissipated. We have breathed a sigh of relief; our currency has rebounded again from yet another record low. But I won't drop the clarion call for dollarization for, in my case, it was never based on a single week's level of the loonie, but its inexorable, long-term downtrend.

Just as before, the currency will not retrace its full loss, and the next global financial crisis will drive it to new lows. The fact is, globalization spells the demise of peripheral currencies like the Canadian dollar. It is not a matter of if, but when, we will acknowledge the synchronicity of the Canadian and U.S. economies, the blurring of national economic borders and the ever-growing free flow of goods and services across our borders. The harmonization of security and immigration policies will accelerate the process.

This is not just a North American phenomenon but a global one. Over the past decade, the growth in world trade has far surpassed the growth in world GDP. This is why a slowdown in the world's largest economy, the United States, has been felt so acutely everywhere in the world: nowhere more so than in Canada. Of all the major industrialized countries, Canada is the most dependent on foreign trade and, particularly, the most dependent on foreign trade with the United States. Exports represent 44% of our economy, compared to a third for Germany and the Britain and 11% for Japan -- and 85% of our exports go to the United States, a far greater proportion than any other G-10 country.

That is not a bad thing; we certainly enjoyed the ramifications of our trade dependency on the U.S. when the American economy was booming, as it was for a decade until last March. And we will enjoy it once again when the rebound inevitably comes next spring or summer. But what it also means is that our businesses and financial markets will increasingly be transacting in the world's only reserve currency, the U.S. dollar. Even now, although Americans have suffered the loss of thousands of civilians on domestic soil, the currency remains strong. Following a knee-jerk appreciation in gold, the Swiss franc, the euro and the yen in the immediate aftermath of the Sept. 11, the U.S. dollar has retraced much of its loss. The greenback is seen anew as the global safe-haven currency with the deepest and most liquid financial markets. Canadians themselves have sent record volumes of their own investment dollars into the United States with each liberalization of the foreign content limits for RRSPs. Canadians recognize that the currency has fallen 36% in the past 30 years and we want to protect our precious retirement savings from any further decline. And foreigners do not need to buy Canadian dollars to invest in the largest and most liquid of our companies; they are all inter-listed on the New York Stock Exchange. Never before have global stock market movements been more synchronous, because all stock indexes are dominated by the large, multi-national corporations which are impacted by the same set of economic factors regardless of head-office location.

There are those who suggest that discarding the loonie would impair our ability to compete, raise our cost of living and diminish our sovereignty. The Conference Board has recently asserted the gap between the greenback and the loonie reflects primarily the long-term widening gap in productivity between Canadian and U.S. industry. They point to a second factor, the long-term decline in real commodity prices. (Yet, when energy prices surged last year, the loonie barely budged.) All these factors are beyond our control, and so is the attractiveness of U.S. investments and financial markets as a 'magnet for capital'.

With all of this, I agree. Yet our conclusions are so different. The Conference Board somehow believes we can control our domestic productivity growth by a magical set of government policies. If only our tax rates were lower or our subsidies for research and education were higher, then our productivity growth would outperform and our dollar would soar. As long as we continue to devote so much of our economy to declining industries -- a reality encouraged by the false veil of continual devaluation making our export businesses seem more competitive than they are -- we will not be forced to make the adjustments necessary to be truly competitive. We will not devote sufficient capital, human and financial, to the high-growth, high-productivity sectors of the economy. If a country could devalue its way to prosperity, then Russia, Indonesia and Japan would be booming.

The supporters of a flexible Canadian dollar exchange rate suggest it is an adjustment mechanism -- a shock absorber needed to cushion us from the blows of commodity price volatility. That would be fine if the loonie fluctuated, even widely, around a relatively flat trendline. The truth is, the loonie does not fluctuate, it sinks, and we all know it. At the rate we are going, the loonie will be at 50 cents within the next eight years, and we might not even notice it. We have been anaesthetized to the downward drift.
With each new low we congratulate ourselves on our sovereignty, and our independent monetary policy. This is a fiction. The currency's decline is beyond our control until, and unless, we dollarize. The adoption of a common North American currency, likely the greenback, would force the adjustments necessary to assure a rise in Canadian productivity and living standards. The initial shock of the adjustments could be painful, to be sure; some businesses will fail and others will be forced to restructure. But an ever-falling loonie is also painful in a corrosive, less obvious manner, and with no long-run payoff. The ultimate shift is inevitable -- it is only a matter of when and at what level?

Sherry Cooper is global economic strategist and executive vice-president, Bank of Montreal Group of Companies

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