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Soaring Loonie

In the 1960s, the Netherlands experienced a vast increase in its wealth after discovering large natural gas deposits in the North Sea. What was seen initially as a positive development, turned out to have serious repercussions on important segments of the country’s economy. As the Dutch guilder became stronger as a result of the gas discovery, the Netherlands’ “non-oil exports” struggled under the high value of the guilder. This syndrome has become known as “Dutch Disease.”

Dutch Disease is an economic concept that tries to explain the relationship between the exploitation of natural resources and a decline in the manufacturing sector.

In the Netherlands, when the gas industry naturally leveled out, there was a “hollowing out” of the economy due to heavy losses in the manufacturing industry.

Some analysts theorize that Canada has succumbed to this economic illness. While the similarities are apparent, others feel Canada’s current economic situation is more complicated and affected by a wide variety of factors.

Canada’s dollar, also becoming known as the “petroloonie,” has increased as much as 25% in the last year alone, and more than 60% in the last five years. The value of the dollar seems to fluctuate with the international price of oil.

And the price of oil is likely to stay high for years, according to the International Energy Agency. Canada’s many other commodity exports, such as copper, also encourage the dollar higher.

The economic advantages of a 60 cent dollar are merely a memory now. The manufacturing sector has lost 280,000 jobs since 2002 — with 32,000 of these losses from the forest sector.

In 2007 alone, Canadian mills announced more than 50 capacity closures resulting in 6,500 lost jobs, according to the Forest Products Association of Canada (FPAC).

While a lowering of interest rates has had a dampening effect on the dollar value in the past, the recent rate reduction by the Bank of Canada will more likely translate into inflation, according to a commentary in the National Post by Robin Banerjee, a policy analyst at the CD Howe Institute. “If the bank tries to react by, say, cutting the interest rate, then instead of being absorbed by the exchange rate, these changes would be wholly absorbed into higher domestic prices, increasing inflation.

“Manufacturers are now entering an era when the currency is likely to remain strong,” Banerjee continues. “Whereas in the past the low dollar might have provided some protection for less-productive companies, Canadian companies are now exposed to greater competitive forces. The bottom line is that to survive they must adapt and improve productivity.”

According to a paper prepared by the Micro-economics Division of Statistics Canada, Canada’s situation stems not from the rise of commodity prices, but from the integration of emerging nations, symbolized by China, into the global economy.

“The integration of China had the effect of a large productivity increase in the global manufacturing sector. The integration, of China and other emerging nations, has simultaneously lowered prices of consumer goods and raised resource prices,” writes the author Ryan MacDonald.

“The adjustment of the manufacturing industry has garnered the greatest attention because it has borne the brunt of job losses. However, the adjustment of the manufacturing industry has not been straightforward. Rather, a complex reallocation has taken place within manufacturing that has been predominantly due to the integration of emerging nations into the global economy,” states the report.

This report concludes that “China Syndrome,” and not Dutch Disease is the leading cause of changes in the economic landscape.

This does not give manufacturers who have been hard-hit by the dollar any comfort.

“I remember when it was said: ‘What is going to happen when the dollar hits 70 cents, then 80 cents?'” says Seth Kursman, vice-president of communications and government affairs for Abitibi-Bowater in Montreal. “It’s amazing how resilient [the industry] has been considering the speed at which the dollar has increased in value.” He adds: “It has a drastic effect on long-term contracts. How do you adjust to that?”

Stu Dornbierer, Communications Director of Daishowa-Marubeni, headquartered in Vancouver, says “The devastating impact of the Canadian dollar eliminates and mitigates all the cost-reductions already made to keep the company in a good economic position.” The high dollar “swiftly and dramatically eliminates those efforts.

“Every cent has an impact on our company,” adds Dornbierer. “Transportation costs, wood costs, labour costs are all climbing. The lower currency was the only thing giving us a break. I think we need a longer time to manage parity with the US dollar.”

More time to adjust to a high Canadian dollar is not in the cards, according to Banerjee. “There will be no return to the low dollar of a decade ago.”

If a high dollar is here to stay, how can the manufacturing sector benefit from it?

Director of Fiscal Studies at the Fraser Institute, Niels Veldhuis, says the high Canadian dollar can in fact benefit manufacturers in terms of spending power. Imports and capital expenditures from the US seem like a bargain, after all.

Veldhuis also points to the dramatic reduction in corporate taxes over the next five years, announced in the last Federal budget. It is this sort of policy that “creates a level playing field for all sectors. This is the natural course of an economy.”

Paper and forest products analyst Paul Quinn at Salman Partners in Vancouver spells out this “natural course” for pulp and paper: “There are large numbers in this industry that will not survive this shift. There will be a lot of pain in the meantime. Plants will close and there will be a lot of restructuring.”

FPAC is trying to stave off some of this “pain.” It is calling for the government to look at ways to control the dollar value regardless what factors have caused its climb.

“In Canada, we have seen our trade-weighted exchange rate increase by over 40% with little discussion or debate about what it means for our economic future,” says FPAC President and CEO Avrim Lazar.

“Some argue that a strong currency will prove to be good for Canada in the long run because it will ultimately drive us toward the economists’ holy grail of faster productivity growth, says Lazar. “Whatever the textbook merits of this argument, the textbooks clearly weren’t written with the current situation of the Canadian economy in mind: our currency has appreciated by 64% in over five years and by 22% this year alone against that of an economy that buys 30% of our GDP. It doesn’t add up.”

According to FPAC, the evidence so far paints a very different picture and has been anything but positive for productivity in Canada. Canada’s forestry industry has had a very strong productivity record in relation to its US counterpart and the Canadian economy as a whole.

FPAC points to the wood products sector as an example, stating that it has led all Canadian industrial sectors in labour productivity growth over the last six years, recording a rate of growth more than double that of its US counterpart. This has not been enough to counter the appreciation of the Canadian dollar.

While FPAC acknowledges the value of the Canadian dollar is influenced by factors beyond the control of the government or monetary authorities, it is asking the government to take a closer and more far-reaching look at the impact of such a high dollar.

“We don’t expect the government to make everything right for us,” continues Lazar. “We do expect, though, that they think carefully about what the long-term implications of a dollar at parity and beyond are for our economy, and show some leadership in working with affected industries and regions.”

What can the government do, after all? According to Banerjee, “If Canadian politicians want to help manufacturing in this country, they must move the idea into policy. I
mpediments like high taxes on capital investment need to keep coming down. Provincial governments have a job here; they too need to aggressively pursue policies to increase productivity.”

Adds Kursman, “Government can do a lot at the federal and provincial levels. Tax policy, fibre policy and energy policy all affect [this industry].”

In a world of emerging economies as large as China and India, a Canadian dollar more closely tied to commodity prices than ever before, and a US economy showing signs of possible recession, the power of our politicians inspires an image of a small boat in a stormy sea.

Quite ironic really: A resource-rich country such as Canada suffering under the weight of its newfound wealth. Even if this wealth is permanent, the change is still worrisome, according to Christine Ebrahim-zadeh writing for Finance and Development, a newsletter published by the International Monetary Fund.

“When capital and labour shift from one sector to another, industries are forced to shut down and workers have to find new jobs,” she says. “This transition — no matter how brief — is painful, both economically and politically.

“In countries whose newfound wealth is likely to be permanent,” she adds, “policymakers need to manage the inevitable structural changes in the economy to ensure economic stability.”

A Silver Lining for Forestry

There is a silver lining to the high Canadian dollar for some of eastern Canada’s key forestry companies, a study by PricewaterhouseCoopers indicates.

In the third quarter, the soaring loonie eased the debt load of forestry companies financed with US dollars, the report said.

The gain on the transition of foreign currencies on long-term debt for eastern Canada’s six largest public forestry companies in the last quarter was $300 million, compared with $7 million in the corresponding quarter of 2006.

But that “paper gain” does not fully counteract the cash losses companies are experiencing when they sell their products in US dollars, said Libarid Guluzian, the firm’s Canadian forestry tax leader.

“Where you have an advantage is where you have a company that has financed its debt in US dollars,” he said.

Abitibi-Consolidated (which merged with Bowater at the end of October), Domtar, Fraser Papers, Tembec, Cascades and Norbord reported aggregate net earnings of $155 million, an improvement for the corresponding quarter of 2006.

Higher prices for pulp and paper throughout the quarter were partly offset by increased fibre and wood chip costs and the strong Canadian dollar, the report said.

Source: The Montreal Gazette