Ever higher resource prices not necessarily good for Canada, CIBC says

Jun 1, 2011

TORONTO, June 1, 2011 /CNW/ - A new world economic order means rising commodity prices no longer have the same strongly positive benefits for Canada that they once did, according to a report from CIBC World Markets Inc.

"Canada's natural resource bounty is, no doubt, a blessing in an era in which commodities are getting expensive, while manufactured goods from clothing to high tech, seem to get ever cheaper," said Avery Shenfeld, chief economist at CIBC. "But an upward run in commodity prices is less likely to boost growth and get Canada to full employment as it might have been in the past."

In fact, a CIBC analysis of the relationship between Canada's commodity prices and U.S. and Canadian Gross Domestic Product shows an upward shock in the basket of resource prices has tended to slightly lower the level of Canadian GDP since 1995 versus a one per cent positive impact that occurred previously.

CIBC's research uncovered a number of factors that explain this change.

For example, when resource prices were on a demand-driven upswing in the past, a booming U.S. economy was part of that story, which meant good times for other non-resource Canadian exporters.

"Not so today. Prices for copper, cotton, oil, gold, and other globally traded resources all reached multi-year highs despite America's economy sporting a five per cent output gap," Mr. Shenfeld said. "Rather than booming, the U.S. is being held back by the mess in its housing market, and to some extent, by high oil prices that have acted as a tax on American consumers."

Those high oil prices have had the same effect in Canada, eating up a higher share of incomes and retail sales. And because oil's share of Canada's commodity basket has grown, these increases are having a greater effect on consumer spending than in the past.

"Historically, Canada's commodity basket was well diversified, and included heavy weights for items like forest products that don't feature prominently in the CPI basket," Mr. Shenfeld said. "In recent decades, the energy, and particularly oil's share of the basket has grown, meaning that a rising Bank of Canada commodity price index has weighed more heavily on real consumer spending power than it might have in the past when industrial commodities had a greater weight."

A further twist in the commodities-growth debate is that the value of the Canadian dollar has become much more closely tied to commodity prices since 1995. Recent resource price rallies have seen a greater contribution from investor flows into vehicles like exchange traded funds, buying "hard assets" in response to fears of a U.S. dollar devaluation. Those same fears create investor flows into the Canadian dollar as another U.S. dollar alternative.

While Canadian dollar appreciation does provide greater purchasing power for Canadians with jobs, it also exerts a drag on non-resource exporters, resulting in a "Dutch disease" effect that makes it harder to achieve full employment, Mr. Shenfeld said.

"The impact of the Dutch disease on Canada's factory sector has meant that what were once trade surpluses in auto parts, rail equipment and other manufactured goods are now deficits, leaving commodities as the sole source of Canada's trade surplus by the end of the last expansion, and making the currency even more tied to commodities."

The net effect is that the boost to growth from higher capital spending in the resource sector is partially dulled by the impact of the Canadian dollar on other exports, as evidenced by the fact that Canada has given up about a quarter of its former share of nominal U.S. imports, with Mexico picking up share over the same period.

"The result of all of these forces is that commodity booms in prior decades were associated with less Canadian dollar appreciation, more U.S. growth, a healthier Canadian factory sector and even more response in our resource export volumes than the two booms since 2000," Mr. Shenfeld concluded.

"We're blessed by our resource base, but when it comes to commodity price rallies, it's not clear that the more the merrier holds true for Canada these days."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijun11.pdf.

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.

For further information:

Avery Shenfeld, Chief Economist, CIBC World Markets Inc. at (416) 594-7356, avery.shenfeld@cibc.ca; or Kevin Dove, Communications and Public Affairs at 416-980-8835, kevin.dove@cibc.ca


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