CIBC calls for loonie intervention
'Go pick on some other currency,' CIBC economist Shenfeld says
Last Updated: Tuesday, October 27, 2009 | 4:47 PM ET
CBC News
A high-profile Canadian economist has called on the Bank of Canada to use its reserves to defend the Canadian dollar against speculation in extreme cases.
In a report released Tuesday, Avery Shenfeld of CIBC World Markets said the central bank should intervene to keep the exchange rate stable and to protect Canadian manufacturers.
A CIBC report calls for the Bank of Canada to defend the Canadian dollar in times of extreme speculation. (CBC) "Canada could consider what might be called a bounded float," Shenfeld said.
He recommended the central bank buy U.S. dollars during times when speculation is causing a sharp rise in the loonie's value.
"By intervening only at extremes, the central bank could help chase away speculative flows that take the currency, in its considered judgment, beyond fundamentally driven levels."
Shenfeld told the CBC's The Lang and O'Leary Exchange, that essentially, the central bank should step into the market to sell Canadian dollars in exchange for U.S. dollars to try to weaken the loonie by a few cents.
"Nothing stops them [from doing that] other than it's a policy tool they've left gathering dust in the Bank of Canada's garage," he said.
There is a risk that Canada's trading partners would dislike such a blatant intervention in the free markets, Shenfeld said, but as long as it's a tool used only in extreme cases such as the current climate, it's unlikely Canada would be lumped in with countries perceived to be currency manipulators.
"We just think [the loonie has] done enough appreciating against the U.S. dollar for now," he said. "So go pick on some other currency."
Interest rates a blunt instrument
Shenfeld said the bank's tendency since 1988 not to intervene directly and instead rely on interest-rate levels means rates might stay low longer than would otherwise be the case. He said relying on interest rates alone creates problems.
"In the real world, the mix of output also matters," Shenfeld wrote. "Putting people into larger houses because mortgage rates are lower than otherwise generates economic output in the construction industry and leaves the economy with a larger stock of housing. But if the loonie is overvalued for a few years, we may be sacrificing business plants and equipment on the altar of a strong currency."
Plants that close because they are unprofitable at current exchange rates might permanently relocate elsewhere.
'We are hollowing out our industrial base.'— Avery Shenfeld, CIBC economist
"They won't suddenly come back if currency later cheapens," Shenfeld said. "We are hollowing out our industrial base by letting speculative foreign exchange market forces, in effect, dictate the mix of monetary conditions."
Other economists have disagreed. Scotiabank economist Derek Holt has said a higher currency forces manufacturers to invest in technology and find other ways to become more competitive globally. He has pointed out that it also gives them the purchasing power to buy that technology if it comes from the U.S.
Mark Carney, the Bank of Canada governor, told the Commons finance committee Tuesday that central bank intervention in currency markets seldom works unless accompanied by other policy measures.
Although the Canadian dollar closed up 0.08 of a cent Tuesday to 93.80 cents US, the loonie on Friday and Monday retreated from its recent highs. The drop came in part because of Carney's past insistence he will stick to his low-interest-rate policy and might intervene in currency markets directly.
The currency had closed as high as 97.55 cents on Oct. 14.
Strong dollar afflicts exporters
According to Canadian Manufacturers and Exporters, a lobby group, Canadian firms that sell to other countries lose about $2 billion in sales with each one per cent rise in the loonie's value.
Export Development Canada, the Crown corporation that assists exporters, has calculated that a 97-cent dollar could cost Canada between two and three percentage points in the overall gross domestic product next year.
"Anyone who has watched the Canadian dollar's performance in the last 15 years would have a tough time arguing that foreign exchange markets are the perfectly rational, calculating machines that the textbooks suggest," Shenfeld said in his report.
"Clearly, it's not simply trade flows and commodity prices but also wildly fluctuating expectations and the hot money flows they generate that set the tone for currency movements. The Bank of Canada admits as much when it points out the dangers of recent Canadian dollar appreciation."
Shenfeld argued that intervention is practical and has worked for China and Switzerland.
