The Americas: In Canada, a Fat Government Means a Thin Dollar
Harry Johnson, one of the top Canadian economists of this century, used to say that most things about economics are simple; the problem is to recognize simplicity when you see it. This principle needs to be applied in explaining why the Canadian dollar has been dropping like a rock.</br></br>The mystery here is that the Bank of Canada seems to be doing everything right, producing exemplary consumer price performance. But the loonie -- named for the loon on the face of the dollar coin -- hovers at $1.50 to the U.S. dollar instead of the $1.25 to the U.S. dollar that a consumer price-based measure of Purchasing Power Parity (PPP), or the relative purchasing power of the two currencies, would suggest. The reward for monetary discipline should have been a strong Canadian dollar. Instead the legacy of inflation fighting by former central bank governor John Crow is a currency that seems to have no bottom.</br></br>But while the Bank of Canada sticks to a strict anti-inflation diet, the Canadian government continues to consume a large share of the fruits of the country's productive capacity through a punishingly high tax rate. And this explains much of the loonie's loss of value.</br></br>Some have argued that it is incorrect to measure PPP using the different changes in consumer prices between the U.S. and Canada. Producer prices are the main reflectors of international competitiveness, and if that measure of inflation is used the Canadian dollar's plight is slightly less puzzling.</br></br>However, another argument has been advanced by WorldInvest International of London and Vancouver. It argues the PPP based on unit labor costs in manufacturing should be used to discover the Canadian dollar's theoretical value. WorldInvest notes that during the last 20 years unit labor costs have risen 109% in Canada versus 57% in the U.S. Correspondingly, the unit labor cost PPP of the U.S. dollar has moved from C$1.08 to C$1.40.