From the December 7, 2007 American Online
December 7, 2007
by Christopher Sands
When I was a kid growing up in Detroit, my mother once said that she loved to visit Canada, right across the river, because "everything there is on sale." It certainly seemed that way when the Canadian dollar traded at a fraction of the value of the U.S. dollar.
Today, of course, the situation is reversed: the U.S. dollar has been declining against major currencies, while the Canadian dollar has been rising. Over time, this could transform the largest bilateral trading relationship in the world and bring major changes to the Canadian economy. It will also affect the United States, since supply chains in virtually every sector of the American economy cross the 49th parallel.
For decades, Canadian firms have relied on a low Canadian dollar to cover the gap in labor productivity with U.S. companies (who invest more heavily and often in automation) and to attract U.S. investment. The low Canadian dollar has helped Canadian commercial service firms to compete in the U.S. market and has lured millions of American tourists and convention visitors. But now, in sectors ranging from manufacturing to services, Canadian exporters are finding that the high dollar makes them more expensive for U.S. customers.
This is why Canada's finance minister, Jim Flaherty, has been talking up the virtues of monetary and exchange rate stability and dismissing those Canadians who view it as a symbol of national pride to have a currency that is "stronger" than the American dollar. Flaherty has also signaled that Canada will be vigilant and punish speculators who try to bid up the Canadian dollar in order to make a quick profit at Canadians' expense.
Not everyone in Canada is suffering. The main reason the Canadian dollar has been rising in value is world commodity prices. Canada is a natural resources superpower, wealthy in minerals as well as energy resources, and a major agricultural and forestry producer. It also is the biggest foreign source of U.S. energy imports, supplying oil, natural gas, electricity, and uranium for nuclear power plants. Growing economies in the developing world, particularly resource-poor China and India, are demanding more commodities on world markets and are thereby pushing up prices. Although high commodity prices and the exchange rate gap will soften U.S. demand for Canadian resources, continued strong demand elsewhere will keep upward pressure on the Canadian dollar.
This may lead to a permanent restructuring of bilateral trade, which is worth around $1.46 billion (in U.S. dollars) every day. Two-thirds of U.S.-Canada trade is generated by two sectors: the automotive sector and the energy and natural resources sector. Even before the recent surge of the Canadian dollar, Canadian automotive exports to the United States had begun to decline. Now Canadian plants will appear even less attractive to the major U.S. and Japanese assemblers. When an auto plant wins new work from an assembler, the results show up in trade figures for as long as a decade; so even if the relatively high Canadian dollar proves to be a temporary phenomenon, its impact on investment decisions in the auto industry could linger for several years.
The shift in the U.S.-Canada exchange rate will push Canadian manufacturers—in the automotive industry but also in other businesses—to make new investments in automation to close the productivity gap. (A relatively low Canadian dollar provided little incentive for making such investments in the past.) As a result, manufacturing output will remain steady or even grow, but manufacturing employment will fall. In Canada, where labor unions have been stronger and more militant than their counterparts to the south, this will invariably become a political concern.
Meanwhile, in the United States, the weak U.S. dollar is actually providing a boost to manufacturing employment by making American products cheaper overseas. During the 1990s, high labor costs and a strong U.S. dollar triggered a flood of imports, including many from Canada. Now, after the dollar's plunge, U.S. manufacturers are seeing export growth for the first time in decades: in the third quarter of 2007, U.S. exports were up by 16.2 percent over the same period last year.
As American manufacturing industries provide fewer jobs to Canada, will the Canadian service sector pick up the slack? The strong Canadian dollar may benefit certain firms that provide domestic services. Ultimately, however, Canada will need a lower Canadian dollar to remain competitive in services traded to the United States. The vast majority of contracts between U.S. and Canadian firms require payment in U.S. dollars; but Canadian companies obviously must pay their domestic workers in Canadian dollars. With unemployment at record lows across Canada, and with severe labor shortages for certain skilled-labor and professional categories in Alberta and British Columbia, Canadian employers cannot afford to cut salaries for fear of losing talented staff. Over the short term, at least, they will see lower profits.
Tourism is a particular concern, since many Americans travel to Canada by car and will be discouraged by high gas prices. Worse, the new U.S. passport requirements for travel to Canada have created confusion. The United States, meanwhile, is already benefiting from a flood of Canadians crossing the border to do their holiday shopping. The two neighbors have traded places: America is now the country where "everything is on sale."
Christopher Sands is a Senior Fellow at Hudson Institute.
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