Blame Canada! Contemplating Economic Outperformance North of the Border

Conclusion: While we have no position, we have a bullish stance on the Canadian Loonie versus the U.S. Dollar based a number of economic metrics.  The first nation of hockey is good at more than hockey it seems.


In 1995, the Wall Street Journal wrote that Canada was “an honorary member of the Third World in the unmanageability of its debt problem.”  Not surprisingly, Canada’s currency reflected this out of control debt and deficit issue and was commonly known as the Northern Peso, due to its weakness vis-à-vis other first world currencies.  In fact, the Wall Street Journal bottom ticked the Canadian Dollar, which is outlined in the chart below, as Canada slowly but surely got its fiscal house in order and its currency reacted accordingly.

At its zenith, Canadian debt-to-GDP was 120%, of which 70% being federal and 50% being provincial.  As a result, Canada’s credit rating was downgraded to AA, and its currency, the eponymous Loonie, could not catch a bid.   In 1995, enter Finance Minister Paul Martin of the Liberal party and some dramatic reforms and the currency was off the races and a steady climb to parity with the U.S. Dollar. (For the second time in the last 30-years, the Canadian Dollar is now worth more than the U.S. Dollar, and was last trading at 1.027 U.S. Dollars per Canadian Dollar.) 

Blame Canada! Contemplating Economic Outperformance North of the Border - 2

Finance Minister Paul Martin had clearly not been reading his New York Times, as he took a path of austerity instead of implementing additional government stimulus.  The key measures that Martin put in place to right the Canadian financial ship, were as follows:

• Federal government employment was reduced by 14%;

• Federal grants to the provinces were reduced by 14%;

• Spending cuts were 4 ½ times tax hikes.

• Canada’s welfare system was dramatically modified;

• Corporate taxes were cut by almost a third; and

• The General Services Tax (GST) was instituted to pay for the tax cuts described above.

In essence, Canada cut spending and improved the corporate tax environment, which narrowed the deficit and reduced government borrowings.  The result of these measures, much to the chagrin of Keynesians, is that Canadian has dramatically outgrown its industrialized peers from 1995 onwards.

We continue have a positive view Canada’s economy for a number of key reasons, which as are as follows:

1. Commodities – The natural derivative of a declining U.S. dollar is inflation, especially an inflation of those commodities priced in U.S. dollars.  In the case of Canada, this means oil.  Canada’s oil reserves, particular due to its vast Alberta Oil Sands, are virtually incomparable globally.  In fact, when utilizing the reserves in Alberta’s Oil Sands, Canada has almost 180BN barrels of reserves, which is second only to Saudi Arabia.  As the U.S. dollar declines, the asset side of Canada’s balance sheet inflates via its oil reserves.

2. Free marketers in power – Alberta native and current Canadian Prime Minister Stephen Harper is in his second term with a minority government, but his Conservative party won an increased share of parliamentary seats the second time around and has popular momentum.  One of the key economic accomplishments of Harper’s term was to finalize free trade negotiations with European Free Trade Association.  Recently, Harper also appointed my former colleague from Onex Corporation, Nigel Wright, as his Chief of Staff.  Wright is a long time partner at Onex, Canada’s largest private equity firm, and is solidly pro-business and in favor of free markets.  As the Prime Minister’s Chief of Staff is oft called the second most powerful position in Canada, Wright will have influence, which should be positive for the Canadian economy and continue the small government policies of Harper.

3. Unemployment – While the Canadian economy is not yet firing on all cylinders, it is also not going down the Road of Economic Perdition as is currently being followed by the United States.  Canada’s banks did not over leverage themselves in the housing market and are considered some of the healthiest in the world.  As a result, capital has continued to flow naturally, versus artificial infusion via quantitative easing, and therefore Canada has seen a gradual improvement in its unemployment rate, which we have charted below.  For the first time in almost 30-years, Canada’s unemployment is below that ofthe United States’, and by almost a full 2%. 

Blame Canada! Contemplating Economic Outperformance North of the Border - 1

On the negative ledger, the most negative factor facing Canada may well be the fact that its largest trading partner is the United States.  As of 2009, 73% of Canada’s exports were sent to the United States and 63% of Canada’s import came from the U.S.  Canada cannot hide from an economic slowdown in the United States.  Nonetheless, we’ll take Canadian on the relative trade (and in the next Olympic hockey final).

We would also advise U.S. policy makers to set aside their Krugman Krpytonite and take a look at Canada’s fiscal turnaround in the mid 1990s.  She’s a better case study than Japan, to be sure.

Daryl G. Jones

Managing Director