Rather than worrying about the impact of a strengthening loonie, now creeping back toward 77 cents US, it may be time for Canada to weigh in on a more pressing problem: helping the world avoid a potentially devastating global currency war.
After U.S. President Donald Trump’s first week in power, the world’s free traders had begun to adjust to the idea that the U.S. administration would be protectionist.
But last week they got a new shock. Financial headlines expressed dismay that Trump had opened a new front in his battle to protect domestic jobs.
“Trump devaluation claims raise fears of global currency war,” blared the London Financial Times. “Trump’s currency war against Germany could destroy the EU,” said Foreign Policy.
U.S. concern about currency manipulation is nothing new. What’s new is that the outspoken president and his unconventional trade adviser Peter Navarro have broken a diplomatic taboo and made the accusations aloud.
‘Like a bunch of dummies’
“They play the money market, they play the devaluation market, while we sit here like a bunch of dummies,” said Trump in an off-the-cuff remark while meeting with pharmaceutical bosses last week.
In spite of the horror at the remarks, Trump’s frank comments contained truth. Countries can benefit and have benefited from using financial tools to hold down the value of their money.
The economic literature of protectionism includes currency devaluation as a recognized barrier to trade.
Just imagine, for instance, that a country suddenly cuts the value of its currency in half. That means everything it sells becomes a bargain to the country’s trade partners. Everything its trade partners sell suddenly becomes twice as expensive.
In trade terms, such a move would be indistinguishable from a 50 per cent “border tax” on imports. In the absence of retaliation, exports from the devaluing country would shoot up. Sales by its trade partners would collapse.
In a world where nearly everyone, including the United States, has been cutting interest rates and buying bonds to make money cheap, one question is whether currency moves are intentional manipulation or a byproduct of stimulating the world economy.
According to David Laidler, professor emeritus at Western University and the first outside special adviser to the governor of the Bank of Canada back in the 1990s, the worrying implication of comments by Navarro and Trump were that the U.S. was going to respond to a “grossly undervalued” euro and a manipulated Japanese yen by forcing down its own currency.
“It really does frighten me because I think you’ve got an economically illiterate administration in there as far as trade policy and international monetary matters go,” says Laidler. “I think we’ve got to be worried because these lunatics seem to believe in currency manipulation.”
Despite fears in some quarters of a rising loonie, he says that Canada must be a leader in showing that it is doing nothing to manipulate its own currency. That is, doing nothing beyond adjusting interest rates to hit the Bank of Canada’s inflation target.
“Trump is almost certain to come after us, but I think it would be much healthier for Canada if it was seen that the initiative came from America rather than was provoked by Canada,” says Laidler. “Not poking a stick in his eye is probably a good idea.”
A true currency war of the type seen in the 1930s Great Depression is something worth avoiding, and it would be far more devastating than a small rise in the Canadian dollar, says monetary policy expert Scott Aquanno.
“What characterizes a war versus a manipulation is the ongoing response to the others’ actions,” says Aquanno, a senior associate at the Munk School of Global Affairs and a professor at the University of Ontario Institute of Technology.
Competitive devaluation and collapse
“So the U.S. devalues, then Mexico devalues, then the U.S. devalues and Europe devalues, and you have this ongoing devaluation which will eventually lead to a collapse of global trade,” he says.
If the loonie climbs a bit, Aquanno says, Canadians should accept it graciously as a vote of confidence in the country’s relative economic and political stability. While oil has given the currency a boost, he says there is little fear of it driving the loonie back up to levels where it will once again damage Canada’s manufacturing sector.
And as to currency war rhetoric from Trump and Navarro, Aquanno is convinced that cooler heads will prevail. A strong greenback that acts as a de facto global currency offers many advantages to the country that controls it, and the majority of Trump’s financial advisers know that. It is in Canada’s interest to support that view.
Increasing demand for oil has not been the only reason for the loonie’s rise. Economic growth figures rose last week, spurred by factory orders. Employment has been trending higher. We will get new Canadian jobs figures on Friday.
Economic growth is always positive, says Aquanno. “If the [Canadian] economy grows through export-oriented development and the currency appreciates, that’s very good.”
For Canada, for the United States and for the rest of the world, a currency war would be very bad.