A debate has been raging in the City of Toronto about building a casino. Opponents say that a casino brings a guaranteed net loss for society. If the city gets some extra tax revenue, it will come at the expense of people who are unlucky enough to lose their money. Much of it will get skimmed off for overhead and the profits of the international casino operating company.
The public has some say in whether to build that casino, but nobody asks Canadians if they want to participate in the much larger casino of the global currency market. You are in whether you like it or not. If you are unemployed, you are likely one of the losers from this giant virtual casino of international currency trading.
The total value of trading in foreign exchange markets in 2010 was $4 trillion per day. That's four with 12 zeroes after it. It increased by 90 per cent between 2004 and 2010, driven by hedge funds and algorithmic trading.
If the annual amount of trading was converted into $1,000 dollar bills, they would be enough to stretch the 93 million miles from the Earth to the sun. More to the point, the volume of foreign exchange trading is more than 50 times as large as the whole world's value of exports of goods and services.
This market is not doing what it is supposed to do for the economy. The foreign exchange market is supposed to balance supply and demand in international trade. Instead, currency trading is driven by speculative fads. It is the plaything of people who are professional gamblers in the currency markets. People who depend for their living on actually making goods and services and selling them to other countries often end up as roadkill on this highway.
The Canadian dollar has been one of the worst victims. The uncertainty and volatility are particularly harmful, as noted by Jayson Myers, President of the Canadian Manufacturers and Exporters Association:
"If you go back to 2007, the dollar rose from 95 cents to $1.10, then it fell to 78 cents, and then went back up to parity. Those swings are really difficult to manage. It hurts on the way up and it hurts on the way down. That variability is very difficult, particularly for a small company that simply doesn't have a lot of financial expertise it can call on for hedging."
There is a debate between people who worship unregulated markets, and those who think they don't always work perfectly. The voice of reason on this matter comes from Joseph Stiglitz, a Nobel laureate in economics. In his recent book Freefall, he wrote that ,"I believe that markets lie at the heart of every successful economy but that markets do not work well on their own. Government needs to play a role."
Winston Churchill famously quipped that democracy is the worst system of government, except for all the others. Likewise, the market economy is the worst economic system, except for all the others. We know that democracy is improved by various forms of regulation, such as the secret ballot and constitutions guaranteeing individual human rights.
In the same way, markets can benefit from a guiding hand, especially markets that are overly volatile and prone to fads. Nobody who has observed world financial markets through history can claim that they are entirely rational. Even the Swiss, those paragons of capitalism, have launched a policy of putting a cap on the value of their currency.
In the case of the Canadian dollar, volatile trading and speculation have driven its value up by 60 per cent over a short span of years. It has recently been waning somewhat, as the reality of weak growth and a large trade deficit sinks in. The fundamentals do eventually have an influence, but it takes too long. In the meantime, trade and jobs are lost.
The OECD estimates that the fair value of the Canadian dollar to balance supply and demand for Canada's exports is just over 80 U.S. cents. The overvaluation has had a devastating effect on many parts of the Canadian economy. It has impacted not just manufacturing, but services trade. Back home office jobs in high tech are regularly being outsourced to lower cost countries.
Nowhere has the effect been worse than in the province of Ontario, which is more dependent on trade than any other part of Canada. I documented this in a recent paper that I wrote for the Mowat Centre. Ontario has seen a large loss in its share of the U.S. market. Auto sales are on a strong upswing in North America, but Ontario is getting much less than its traditional share of jobs and investment.
Critics argue that Canadians need to become more productive in order to compete. As I document in this paper, these critics have it backwards. It's the overvalued dollar that has discouraged investment and led to losses in economies of scale. That has caused productivity to be lower.
The last several years of global turmoil have made Canada's financial sector seem glamorous in a gloomy world. Either through luck or prudence, none of our major financial institutions collapsed. Canadian bankers who in the past were condemned as cautious old fogies are now the toast of the world.
Hot money looking for a safe haven has flooded into Canada, driving up the value of the dollar. It has gone into money market paper, not productive long-term investments. Ironically, foreign lenders can force us to borrow from them. Here is how it works: the dollar goes up, Canadian exports fall, and incomes and government revenue drop. Suddenly, Canadians need to go into debt, for no good reason.
Canada is a small country on the world scale, and it does not take much to drive the value of our currency off the rails. When speculation is pushing the dollar up, the Bank of Canada is quite potent, as it can produce as many Canadian dollars as the world demands, and more. It does not take much effort to knock the dollar down, and scare the speculators away.
The Bank of Canada can, and should, take a more active role in guiding the currency. It should put speculators on notice that the Canadian dollar is not a ball that anybody can just pick up and bounce around.