Thursday, November 08, 2007

Interest Rates and the Canadian Dollar

Canada's capacity to be a value-added manufacturing country is being disassembled.

Monday October 22, 2007 UAW local 222 circulated a green letter informing their members of another round of significant and permanent layoffs. Twenty-five years ago Oshawa was home to the largest single car plant in the world. Dimensionally speaking, Oshawa's GM plant is still the largest under-one-roof autoplex in the world. Nevertheless, today it is close to sitting idle. By the end of next year only about 5,000 employees will remain of the 10,000 from a year ago, and down from 20,000 of just a couple of decades ago.

Oshawa's manufacturing force is down 50% over two years and 80% over twenty-five years.

Paralleling Oshawa's story, Canada's manufacturing sector eliminated 400,000 jobs over the last three years. The cause of the manufacturing collapse is not our workers, nor the want of resources or capital, nor the ability to find customers (see note below).

National economic strategy is the cause of the collapse.

The Canadian dollar has risen nearly 80% in about six years. In the last three years the dollar has risen sharply, increasing more than 20% in the last year alone. Consequently, the Canadian cost of production - relative to U.S. customers - has inflated nearly 80% in just six years.

Management of the relative value of the Canadian dollar has demonstratively failed. Whether you are a radical socialist who believes in complete central management of the dollar or an absolute laissez-faire capitalist, the loss of quality manufacturing tells you economic planning in Canada is seriously flawed.

U.S. customers can no longer afford Canadian manufactured products.

After the 9/11 tragedy, the Bank of Canada (BoC) kept its interest rate more than 100% higher than the U.S.; today Canadian interest rates remain high in comparison to the American rate. Our money supply has likewise remained relatively restricted. The raw value of a Canadian central bank bond versus a U.S. central bank bond was kept high by the
Bank of Canada.

The Bank of Canada is significantly contributing to the demand for the Canadian dollar and its rise against the U.S. dollar.

Hindsight's lesson of our near collapse in Canadian manufacturing from
the rise of the dollar tells us that the Central Bank's policy is a mistake. The question going forward is how to set interest rates appropriately so as to reflect the true value of the Canadian dollar.

The Canadian dollar should be a reflection of the internal value of the Canadian economy (fair traded value), the value of externally traded goods (free trade value), and the future value of economic activity (interest value).

The calculation of the value at which to set the Canadian dollar is not necessarily as nebulous as it sounds and neither does it have to be so radically in error as in Canada for the last six years. For example, we can look at the calculated value the European Union or the United States places its dollar. Canadian interest rates can be set within the average of those major economies.

Canadian Central Bank Rate = (US Interest Rate + EU Interest Rate)/2 +/- 1%

Flexibility needs to exist to account for year-by-year variation and changes in economic value (which affects future value). Naturally, all central banks adjust the face value of its currency by changing interest rates and the amount of currency in circulation. There is a good faith goal to reflect value as demonstrated by the economy. owever, given the gross error of the BoC over the last 3 years, the BoC should no longer be allowed unlimited latitude to set interest rates.

More than a 1% variance should be justified to the Minister of Finance
and require written temporary permission.

The working class of Canada, particularly the manufacturing sector, is paying dearly for ivory tower mistakes at the BoC. The mistakes are needless as we can find sound company in the world's two largest currencies. We can chart our own course with some latitude (+/- 1%) but must remain grounded in economic realities as demonstrated by our own economy, the U.S. economy, and the European Union. Canadians deserve a stable economic playing field.
Footnote: The cause of the manufacturing collapse is not our workers, not the want of resources and capital, nor an inability to find customers. As recently as three years ago, Oshawa's plant was the world's most profitable autoplex with the highest quality and customer satisfaction ratings. Oshawa's truck plant won Best in Class. The car plant won the Harbour and JD Powers awards. The Buick Allure built in Oshawa tied the Lexes for top quality. Accordingly, billions of dollars have regularly gone into upgrading the complex. Surrounding the plant are world class suppliers like Magna Corp, Lear Siegler, Lasco steel (now in foreign hands), and hyrdo-power as cheap and reliable as is humanly feasible. Our manufacturers are not the cause of their own demise. Of course, employment remains statistically strong as quality manufacturing jobs are being rapidly replaced by lower paying service industry work or the selling raw resources to the US. Notably, the demand for oil is temporarily offsetting the loss of manufacturing jobs. Regardless, the loss of over 15,000 GM jobs in Oshawa directly translates to over 150,000 manufacturing jobs in Ontario. We are giving up manufacturing capacity in favour of selling raw resources.

(c) 2007 Victoria BC


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