Canada is paying a heavy price for China’s intransigence in moving to a flexible currency that better reflects its growing importance on the global economic stage, Bank of Canada governor Mark Carney says.
In a lengthy speech that barely mentions China by name, but is devoted almost exclusively to the country’s massive surplus in foreign reserves, Carney said all countries need to accept responsibility for the global system.
“All countries should accept their responsibilities for promoting an open, flexible and resilient international monetary system,” he told the Foreign Policy Association in New York.
“Responsibility means recognizing the spillover effects between economies and financial systems and working to mitigate those that could amplify adverse dynamics.”
But despite the scale of China’s economic miracle, Carney said the country, which pegs its currency, the yuan has not appreciated in real terms since 1990.
That has contributed to the massive build-up in the country’s current account in terms of trade and finances, with the accompanying deficit in the U.S.
And other countries, like Canada, Japan and the Euro countries, have borne the brunt of the adjustment in rapidly appreciating currencies.
“The net result could be a sub-optimal global recovery,” he said.
As he as repeatedly stressed, Carney said the soaring loonie versus the U.S. greenback — the global reserve currency — is working to both subdue inflation in Canada and subdue the recovery.
“We do see a risk that a stronger-than-assumed Canadian dollar, driven by global portfolio movements out of U.S.-dollar assets, could act as a significant drag on growth,” he said.
Speaking to reporters after the speech, Carney said all systemically important countries should move to market-based exchange rates.
“I think there are gradations in that and starting positions matter and history matters and so obviously the end point would be fully flexible exchange rates, but there are paths along that road,” Carney said.
“But part of the adjustment process that needs to happen is that major surplus countries - and it is obvious in many respects who those countries are - should move toward market-based exchange rates.
“That said it is part of a package of other measures that need to be taken by major economies and that’s why we look forward to the G20 discussions.”
Last month, Carney estimated that the loonie’s surge had wiped out all the better-than-anticipated economic advances that had occurred since July. And he downgraded growth in 2011 by three-tenths of a point to 3.3 per cent, solely because of the loonie.
While he said the central bank retains weapons to depress the Canadian currency if necessary, including printing more loonies, Carney’s likely preferred route would be to keep interest rates as low as possible for a longer period.
In a report released earlier in the day, the Organization for Economic Co-operation and Development (OECD) advised Carney to keep the policy rate at the practical low of 0.25 per cent until at least June — the Bank of Canada’s own suggested date — and possibly beyond.
Recent talk that the U.S. dollar might be replaced as the global currency is impractical in the near term — and even if it occurs down the road — won’t restore the needed balance, Carney says.
He said gold represents only about 10 per cent of the world’s reserves, which is too small, and the Chinese currency is not convertible in open markets, hence the question is “moot.”
“Over the longer term, it is possible to envision a system with other reserve currencies in addition to the U.S. dollar,” he added, but that would still not address the current problem of global imbalances.
History has shown it is the “adjustment mechanism, not the choice of reserve asset, that ultimately matters,” he concluded.
Carney’s overall preferred response is for China and other countries with massive current account surpluses to allow their currencies to reflect their economic might.
“While surplus countries can delay adjustment, in the end, all nationals suffer when the system breaks down,” he warned.