Weekly Market Insight

February 15, 2008

NORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS

Should We Mourn the Loss of the Trade Surplus?

A surprise report of job gains in Canada’s factory sector in January seemed to offer a glimmer of hope, but that was extinguished after the disastrous readings for December exports and manufacturing shipments. They were, in a word, ugly.

Some of this is cyclical and obviously not good news; Canadian factory GDP has dropped in every US recession or slowdown in the last five decades. And the recent dive will contribute to an economy that will slow to barely 1% growth in the near term. That said, a favourable cyclical signpost is that real imports were still growing in Q4, in contrast to a drop for US real imports — a signal of better activity by Canadian consumers and business equipment buyers.

Beyond the cyclical story, given the spate of recent permanent plant closure announcements, it’s likely that a more lasting dent has been left in Canada’s trade surplus by the loonie’s five year ascent. The loss of some high skill, well paid factory jobs is obviously a harsh reality for some workers and their communities. But in and

of itself, should we be mourning the end of massive monthly trade surpluses?

The mercantalists of centuries past would have thought so, as running a trade surplus, and accumulating a hoard of gold in the process, was seen as a road to riches. But living standards are based on what you can buy, not what you sell. The happiest economy would be one in which, by some magic formula, the residents were able to consume huge volumes of imports without working or exporting anything.

After stripping out the temporary hit from what might be a US recession, what we are also seeing in Canada’s trade numbers is a reflection not of failure, but of success. By selling resources to the rest of the world at ever higher prices, Canadians got richer in the process. The economy can live with a stronger currency (if not necessarily much beyond where we are now) because each barrel of oil, each ton of nickel, each ounce of

gold, and lately each cubic metre of natural gas, reaps more US dollars.

At the new, stronger exchange rate, Canadians can afford to do more shopping abroad, at cheaper prices. We’re cashing in, in effect, on our resource bounty. Exchange rates have only done what they’re supposed to do, eliminating large imbalances in trade and focusing a country’s economy on what it does best.

Equity investors should be doing the same — underweighting Canadian sectors where at these exchange rates, lasting damage will be done. In a typical slowdown, there can be great buys among manufacturers whose equity prices have slumped. But if resource prices and the C$ continue to be elevated by secular trends in global growth, this time around, what looks cheap in manufacturing stocks might only get cheaper.

Avery Shenfeld

Senior Economist