Plain talk about the dollar from Macklem

Stephen Poloz was supposed to be the Bank of Canada governor who cared about the dollar, not Tiff Macklem, his successor.

Poloz's PhD dissertation was about exchange rates and he was a longtime leader at Export Development Canada, the Crown lender that caters to a group of companies that have a reputation for using a weak dollar as a “crutch,” as former Liberal cabinet minister John Manley described it in 2002.

In the end, the dollar played only a minor role in the Poloz story. He devoted a speech to the subject in 2014, but the currency rarely featured in interest-rate discussions. In his final interview as governor last May, Poloz said he thought that he had been unfairly tagged as being “soft on the dollar,” when all he was doing was trying to keep deflationary forces at bay.

Macklem came to his current job with less direct exposure to the real economy than Poloz, who boasted of having spoken to more than 70 Canadian executives in his final year at EDC, by which time he was chief executive. Macklem's career to the same point had been spent entirely in policy and academics, giving him an aura of detachment.

Maybe that's why he's willing to talk about the dollar like a normal person, instead of worrying that someone will misconstrue something he said to stoke a phoney “currency war,” or overthinking how traders on Bay Street and Wall Street might attempt to profit off his remarks.

“We don't target the value of the Canadian dollar. We don't have an objective for the Canadian dollar. We have an objective for the inflation rate,” Macklem said during an exclusive year-end interview on Dec. 16. “But the exchange rate is a very important relative price in our economy and it affects the competitiveness of our exports. It also affects the competitiveness of other countries' exports into Canada.”

That means the currency can be a tailwind, which, all things equal, would put upward pressure on inflation. It can also be a headwind, especially when the dollar's strength has little to do with economic fundamentals, as has been the case lately.

The dollar has climbed to about 78 cents U.S. from about 75 cents at the end of September, even though oil prices were generally stagnant until very recently.

There is usually a tighter link. The Bank of Canada attributes the currency's rise to broad selling of the U.S. dollar, probably because the arrival of vaccines has broadly improved the economic outlook, meaning investors no longer feel they need a haven from the COVID-19 crisis.

There's nothing Macklem can do to offset forces like that, and he doesn't intend to try. But he can speak clearly about how he and his deputies will confront an important change in the weather.

“When our currency changes for reasons that are unrelated to Canada, in that case, it's not acting as a shock absorber,” he said. “It's becoming a force in its own right. It's not offsetting something else; it's becoming a force in the economy.”

If, say, oil prices rose, and the exchange rate stayed the same, the dollar would probably fade as a threat to the economic outlook. That's because oil is Canada's biggest export and we generally sell as much as transportation networks can handle. The windfall from a higher crude price would offset lost sales of other goods and services that were uncompetitive at a higher exchange rate. It's unfortunate for those uncompetitive exporters, but the numbers even out from where the Bank of Canada sits.

But if oil prices don't come back, or other commodities falter, then a stronger dollar is a negative variable that could impede the recovery. Macklem acknowledged on Tuesday in a speech to the Greater Vancouver Board of Trade that an elevated exchange rate was partly responsible for the unexpected export weakness that followed the Great Recession. When Poloz took over as governor in the summer of 2013, he said an export-led recovery was imminent, but it didn't happen until much later in his term. The lesson is that policy-makers can't take an export rebound for granted.

The dollar is “becoming its own source of drag,” Macklem said in the interview. “As we make our projections of the Canadian economy, it's beginning to become a material factor. It's on our radar screen. In our press releases, we highlight things that are material, that are on our radar screen, and that's why you've seen it in the last couple of press releases.”

Canada's exports of goods have climbed most of the way back to where they were before the pandemic, but services exports, which are dominated by revenue from tourism and tuition from international students, continue to languish. Macklem told the Greater Vancouver Board of Trade that the accelerating shift to a digital economy could offset some of the weakness, provided Canadian companies take advantage of surging global demand for everything from cybersecurity solutions to medical advice via video link.

That could make the Canadian recovery even more sensitive to the exchange rate. Experienced exporters of manufactured goods have learned how to exploit futures contracts to hedge against currency risk, and a stronger dollar lowers the cost of imported inputs. But for software developers and other digital technology companies, a weaker exchange rate is pure profit because their costs are fixed, and vice versa.

Macklem said he didn't know if the growing importance of exporters of services had made the currency an even bigger factor, but you get the feeling he'll be doing the math.

“Some of these services companies are struggling right now,” he said. “Hopefully, they can get to the other side of this and be ready to take advantage of opportunities as vaccines become widely available.