Currency and Inflation Risk: KB Faculty Weighs In
EXPERT OPINION: KNOWLEDGE BUREAU FACULTY
Knowledge Bureau asked three of its Distinguished Faculty members about their views on these latest developments and specifically, resulting currency issues. Here is what they say:
I believe that the Canadian dollar will reach par and then likely move above par in time. I think the question for the Bank of Canada (BoC) is not whether it will move higher, but the speed at which it moves higher. Of note is Prime Minister Harper's answer to a question about the Canadian dollar poised by a reporter. Mr. Harper - who is an economist by trade - said (and I am paraphrasing) that he felt a rapidly rising Canadian dollar would dampen the pace of the recovery and then went on to say that he had full confidence that Mr. Carney at the BoC was handling the Canadian dollar in an appropriate fashion.
The key point is the rapidly rising comment. There is very little any government can do to manage their currency against the momentum of currency traders. You can talk down the dollar temporarily as the BoC did recently. But over time, it will move back to its base case driven by momentum, and that points to a stronger Canadian dollar - much stronger.
The fundamental principle underpinning this has to do with a simple proposition as put forward by Dennis Gartman, editor of the Gartman Letter. Canada has things (commodities, oil, precious metals) that the world wants and Canada is willing to sell those things at very high prices - all of which translates into a stronger dollar.
I think it should be obvious to everyone at this point that trying to predict currency movements is like trying to catch the wind. If the global recovery gathers momentum in 2010, then we should see upward pressure on the Canadian dollar. The extent to which the Bank of Canada is willing to back up its words with actions will determine how fast and how far it will rise. But if we slip back into recession and commodity prices weaken, especially oil, then the loonie will fall back to perhaps as low as 80-85 cents. The bottom line is that the fate of the loonie is closely tied to the health of the international economy.
My take on this is that the US dollar is now the currency of choice for the carry trade, whereby you borrow in the low cost market and invest in higher returning assets abroad. As long as this continues, there will be downward pressure on the US dollar. A counter argument could be made if there were a significant movement back to risk aversion, as this would drive the US dollar higher, much as it did a year ago.
Once the Federal government starts to tighten monetary policy, I expect a sharp upward movement in the US dollar, as the carry trades are unwound and the dollar loans are repaid. Of course, if this occurs after other Central Banks have started their monetary tightening cycles, this effect would be significantly weakened.
A rapidly rising US dollar could also have a large dampening effect on asset prices, much as the unwinding of the yen carry trade a year ago caused major disruptions in both currency and asset markets. It now appears that we have a rapidly inflating global asset price bubble starting to form, while deflation remains the predominate force in both goods and labor markets. Asset price inflation is being driven by extremely loose monetary policies in all major economies, while goods and labor market prices are being driven lower by high and rising unemployment in most Western economies.
Moving to the Canadian dollar, it still appears to be closely tied to the price of oil. At the time of writing this article, oil had weakened somewhat over the past few days, as had the Canadian dollar. It will be very interesting to see what happens to oil prices when US interest rates start to move higher, as there will be two competing forces at play. On the one hand, that should signal that US economic growth is returning, tending to push prices higher. This will be offset by a strengthening US dollar, which will tend to push the price of oil down. I have no data to suggest which force will predominate.
Does anybody else care to either agree or disagree with me? I would appreciate hearing your views.
Good question, Robert. Please send your thoughts by clicking on the Add Your Thoughts button below:
Evelyn Jacks is Founder and President of The Knowledge Bureau and Program Director for the Distinguished Advisor Conference, which will be covering these global issues of concern November 8-11 with top advisors from Canada and the US in Tucson, AZ.
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