Canada is likely in a technical recession, after the economy shrank for the first five months of the year. It’s heavily dependent on commodities. The oil bust and the broader commodity rout have been blamed liberally. The theory goes that the problem is contained. The oil patch may be wallowing in the mire. But no problem, the rest of Canada is fine.
The swoon of the Canadian dollar against the US dollar has caused a bout of false hope that this would make Canadian exports of manufactured goods more attractive to buyers in the US and elsewhere, and that the economy could thus export its way out of trouble. This theory has now run aground.
Because the threat to manufacturing in Canada comes from Mexico.
“I think Mexico’s just a cheaper place to produce, and you have enough human capital and engineering skills to produce almost everything you can produce in Canada and do it a lot cheaper,” Steven Englander, Citibank’s global head of G-10 currency strategy, told Bloomberg.
And the multi-year swoon of the Canadian dollar against the US dollar isn’t going to help. Over the last three years, the loonie has lost 25% against the US dollar, the peso 21%. Over the past 12 months, the loonie lost 16% against the dollar, but practically in lockstep with the peso.
This chart shows the move of the two currencies against the dollar as a percentage change from three years ago. It’s like a downhill tango:
So devaluing the loonie sounds like a good old central bank solution. But it hasn’t boosted exports of manufactured goods:
The US dollar value of non-oil exports from Canada to the US reached $32 billion during the peak month in 2008, crashed during the Financial Crisis, and recovered, but by 2012 started petering out at $30 billion a month, has since lost ground, and remains below where it had been before the financial crisis.
But exports from Mexico to the US rose from the $20-billion-a-month range in 2008, after a dip during the Financial Crisis, to the $30-billion-a-month range. It has recently exceeded Canada’s stagnating exports to the US (chart).
Exhibit A is the auto manufacturing industry. CBC News reported that Mexico now manufactures “twice as many cars as it did a decade ago, and has leapfrogged Canada in the process.”
Magna, Canada’s crown jewel in the automotive component sector, has heard the siren call. It now has 30 plants in Mexico with 24,000 employees. And it’s no longer just cheap labor.
“At the beginning, we were just doing assembly,” said Diba Iluna, head of Magna’s powertrain plant in Ramos. “Now we do assembly and machining of components. We do some very complex components here that seven years ago we thought we would never [do].”
CBC News on the Mexican threat to Canada:
Employment is up 35% in Mexico’s auto sector in the past eight years, as international companies have poured $7 billion worth of investment into the country. Contrast that with Canada, which is struggling to find commitments to replace expiring assembly lines at GM, Toyota, and others.
Companies are rushing to set up shop in part because of labor costs as much as 10 times less than those in Canada, but also because the country’s workforce is being trained to do more and more. Productivity at plants there is skyrocketing….
And quality is no longer a problem.
“There was a time when Mexico had a reputation of building shoddy product,” said Bill Hammond of Hammond Power, which has been making electrical transformers in Guelph, Ontario, but now has three plants in Mexico. “We’re finding now that global manufacturers are more than willing to accept products coming out of Mexico because the quality levels are as good as they are out of the United States or Canada.”
And Mexico has other advantages for Canadian manufacturers:
Thanks to more than 44 free trade deals with countries around the world, automakers can save up to 10% per vehicle when shipping a car from there to various export markets. Contrast that with Canada, where businesses lament the red tape involved in even shipping goods between provinces.
Mexico may not be exactly an industrial paradise, beset as it is with horrific violence and entrenched corruption. But Canadian manufacturers are increasingly doing what their US counterparts have discovered many years ago.
This is a structural issue. It won’t just disappear, unlike the commodity rout. Prices of oil and other commodities might recover in a year or two to levels that Canadian producers can live with. But Canada can’t win a currency war with an emerging market like Mexico.
And this debacle of non-oil exports, Citibank’s Englander says, is the bigger issue for the Canadian economy. “CADMXN, the relationship between the Canadian dollar and Mexican dollar, is dead flat the last three years,” he explained. “So the Canadian dollar depreciation hasn’t gained them any competitive advantage. They’re, you know, getting clocked, both oil and non-oil.”
At first, there was hope that only Canada’s oil patch would be headed into a recession. Now the oil patch is already there. Despite months of assurances that the oil bust and the broader commodities rout won’t spread into the rest of the Canadian economy, they’re now beautifully spreading into it. Read… It Gets Ugly in Canada
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Another reason why manufacturing is not recovering despite the declining dollar is the Ontario government’s green energy mandate which have drastically increased energy costs for manufacturers. That, and increased provincial and local taxes have made Ontario a much less friendly place. Normally the Big 3 would be moving more production to Ontario with a weak Canadian dollar but the energy costs and taxes have made Mexico a more attractive jurisdiction.
Wolf sez:
“Prices of oil and other commodities might recover in a year or two to levels that Canadian producers can live with. But Canada can’t win a currency war with an emerging market like Mexico.”
How can prices recover when jobs are flowing from US and Canada (and elsewhere) to low wage Mexico (and elsewhere)? Where is the bid going to come from?
Exports from Mexico are not exactly cheap for the American end-user. What is left over after paying the Mexican workers is retained by the financiers. So is the lion’s share of the credit needed to re-establish the various factories. In the end there are massively indebted companies and no customers.
This dynamic — indebted suppliers and bankrupt customers — is behind the +50% crash in oil prices. Exporting jobs to low-wage countries amplifies the dynamic further.
When producers run out of money to produce below the cost of production, they stop producing because they’re going out of business. Once production drops enough, shortages crop up, and guess what? Prices rise.
In commodities (except gold and silver), it’s always the same thing. Only this time, it takes longer because of new money keeps propping up these companies (thanks to ZIRP that has done a job on investors).
Natural gas drillers are already cratering. The natural gas bust has been going on for a lot longer than the oil bust. So they’re ahead. But it will eventually happen with oil.
Or do you think that the economy can function without oil? Naw, I knew you don’t think that.
In the long term, sure, but with China’s SOE s, some have been running at a loss for years. (although that may be in the process of change)
Ann Stevenson- Yang in a presentation given in Feb. 2015 said that the aluminum industry in China, with 2 trillion US invested, was drowning in overcapacity. But a bank had forced a shuttered plant to reopen so it wouldn’t have to report a bad loan. Who knows, the bank might have lent it more.
Apparently even China is starting to run out of the peasant labor that is happy to live in a company dorm and make 10-20 a day, which constricts the ability of a sweat shop to run a ‘profit”
Watch out for a deal between North Korea and China, where NK supplies a new (and maybe the world’s last) ultra cheap labor that will work for food, a roof, and a few bucks walking around money.
This would be the ultimate corrupt act by the supposedly socialist CCP but ya gotta do what ya gotta do.
In a world of highly leveraged producers (like the current shale oil boom financed by junk bonds) it it impossible to simply cut back production in the face of low prices as they have a huge monthly nut to crack… the only option is to produce more (at lower prices) until bankruptcy and fire sale of the remaining assets…. hence the continued glut of oil.
Pray for Global Warming, and Canada will be exporting’ tomatoes soon!!!…PJS
So, let them eat tomatoes – when the wheat harvest fails? :)
What puzzles me is that the managers who “off-shore” their operations expect to be able to ship home and sell to the very people they’ve fired. They don’t seem to understand that a former employee who no longer has money to spend won’t be buying their goods no matter how cheap.
Jim,
it amazes me that economist don’t seem to understand that basic dynamic, when all the good jobs are gone and most (which is already the reality) make less than $12 an hour who’s going to buy the products. I read constantly about the “lack of demand” in first world economies….well DUH!! all the jobs are gone and now being done for pennies on the dollar in the 3rd world so even they don’t make enough to buy the products they produce. You’d think that this would be obvious to those who should know better.
I’ve been in manufacturing my whole career and it’s been tough, I’ve not been able to raise prices for my services for over 25 years, meanwhile the price of housing as tripled in the same time frame.
the “solution” that economists point to is more debt, to me that isn’t a solution, that is slavery
Interesting,
CEO’s don’t care about who they are going to sell their products to in 5 years when they off-shore operations, they only have their eye on how huge their bonus is going to be and how much they can make from their share options.
They know that they will be long gone before the repercussions arrive.
One of my majors was Economics, the other Applied Mathematics. The reason Economists don’t see the correlation between offshoring and lower demand is because they are taught models where only one variable at a time changes. They are not taught to extrapolate those changes thru an entire model or economy. The only changes they see from offshoring is lower costs, which to them equals higher sales. Also, most economists only have to take one year of calculus for their major. At my college the calculus course taught to the business school was referred to as “calculus for poets” by the chairman of the math department.
To somewhat bend a quote sometimes ascribed to Napoleon: “Never ascribe to malice that which can adequately be explained by stupidity.” It can, of course, be reversed as well. The stupidity here being the western neo-liberal religion which is going to meet the fate of other religions. The worshipers have it so good, they cannot imagine why it would be a con.
Canadian economy is getting hit from all angles. Oil, mining and agriculture dropping like stone and this is bred and butter for majority of provinces. Once construction and auto sector slow down we are DONE, and the way I see it won’t be for too long before it happens.
Excellent rebuttal Steve, but even the likes of WR haven’t got the fundamental systemic problems figured out. EVERYONE out there in the blogosphere are a dime short and a day late in their analysis. It’s always about the symptoms, never the causes. WR would do himself some real good and his readers, if he took the time to visit the Economic Undertow site where you predicted to the quarter, when the wheels would fall off the credit markets and why.
It’s amazing how many otherwise bright individuals just don’t get the role energy plays in the economic and financial equations. Rarely, if ever, any mention of energy return on energy invested. In fact, I doubt Wolf is well versed in the concept. That said, as a Canadian, I appreciate the fact that at least this site reports on matters pertaining to Canada. I just wish the commentary was more causal than symptomatic.
Bill, clearly you haven’t read a thing I wrote over the past several years about energy (particularly fracking) and debt. I wrote long before the oil price plunged that fracking is tearing up the balance sheets of oil drillers. I wrote this 3 years ago in a number of articles about natural gas drillers. This is now happening. It’s also clearly a lot easier to open your mouth than it is to read my articles.
Touche Wolf!!
Wolf I have recently discovered your site and find it to be refreshing in both content and timing. Your information you present is informative and well thought out with a touch of humor that bites the backsides of many that deserve it.
Cheers,
Rich
It doesn’t surprise me that the CBC would say ‘labor costs as much as ten times less’- the ‘network’ is pretty much innumerate- you can watch CBC TV business/ economic new for years without seeing one lonely graph.
Anyway, I think what they’re trying to say is that labor in Mexico is one- tenth the cost.
Oh- and just a reminder that the CBC”s Patrick Brown stole my comparison (of the Chinese inept market to Mickey Mouse as the sorcerers apprentice in Fantasia)
My comment posted here on July 6 on Wolf Richter’s piece: Central Banks Scramble…
Used as lead by Brown on July 10
I am a fond of Toyota Corollas. Very reliable. I have had several over my lifetime and have recommended them to others. They are moving production from Canada to Mexico. I will not be buying any more.
Good comment, Michael.
I have been trying to do that with Chinese products for some time.
Yes, Canada is hurting in manufacturing right now. Long term, where would you rather live, in a faltering commodity exporting nation like Canada, or US, Mexico, China, Brazil, Austraila, EU, wherever?
I thought so.
Oh so true. Was just watching a US piece about all the gunfire in the US national parks- some pretty much a shooting range.
Hurry! Round up all the financiers and air lift them to the gun fire areas and never let them walk out! Problems solved.
Reset……those greedy freaks are the real problem and the real under tow.
regards the exhaustion of resources through “fiat capitalism”, i invite you to visit http://www.peterjoseph.info/….very informative also.
Are you kidding me. lol. More delusional people who don’t get economic cycles.
I’m sorry but Socialism and Communism do not work and are equally as corrupt as any other ideology on this planet, if not more so, to say otherwise is sheer rubbish.
Anybody that talks about exhaustion of resources doesn’t have a clue what resources are or where they come from but given that you’re pimping the Zeitgeist Movement that comes as no surprise.
i have a Canadian customer who is crying the blues over the exchange rate, i feel sorry for the guy but i have to make a living.
I don’t know why everyone is acting like all of this is new and different. It’s called economic cycles. They tend to happen every now and then. Canada goes up, Canada goes down.. etc. etc. etc.. I’m almost afraid to see the reaction when the housing bubble finally explodes and contactors are all sitting at home on welfare drinking beer and eating popcorn like they were in the 1990’s.
The loonie will sink back down to 68 Cents. The housing bubble will pop causing massive defaults all across the country and the Federal Gov’t will be forced to lay off workers just like Jean Chretien did in the 1990’s.
They are already trying to pawn the CHMC off on some foreign sucker. Once it gets sold off, expect the housing crash. I really feel sorry for the next PM of Canada. I surely do not want that job. It will be bad for a good long time before it gets better again.
The Canadian Economy got it in 1992, right after free trade. It has never recovered. The standard of living is about a quarter of what it was in 1979… and falls a little more each year.
The real truth is robots could out compete humans at any price 30 years ago. The work that left Canada then will never return. It will not leave now – because there is none left to leave.
Since wealth is no longer being distributed by wages, or at least not like it once was, then the only balancing option is either give money so spending can occur – or allow competition to resume – driving down prices and profits until prices equal wages – in other words – liquidation of all non competitive assets.
This is not rocket science, it’s economics. Humanity has reached the point where we simply no longer require massive human labour in order to provide – we let the robots do that – it is the distribution system that requires fixing – before the free hand of the market does it for us.
Look at Detroit – there are severe penalties on the horizon for those who fail to fix this… and the biggest losers will be those with the most to lose. Civilization has already ended in Detroit. It is now no-mans land. Government no longer rules there… and grandmothers are packing heat.
It is time for you to wake up and see the disaster unfolding.
Great blog. Behold, Harper’s failed policy of relying to heavily on commodities and not adequately investing (modernizing) in Canada’s manufacturing base. And with RIM blown to oblivion, no one talks about tech there as well. When Canadians wake up and find that they can’t export themselves out of this mess the reality will set in, the housing bubbles will collapse and the ‘dumb’ ethnic vote in Toronto will probably reelect Harper for another 4 to 5 years in office.
These trends are not nascent to Harper’s term but nice try
And what is it, exactly, that the other parties would have done to make Canada more competitive in this same period of time? In particular, how would digging a bigger deficit through social spending be the solution to these long term secular headwinds?
Just a reminder… Harper inherited a budget surplus and turned it into a multi year ongoing deficit … while incentivising the housing and consumer debt bubble, all the while discouraging savings. voila: a public, private and personal debt problem as we stare into the abyss of higher unemployment, low return on pensions, rising costs and foreign capital flight…..
One comparison of Canada to Mexico the piece didn’t mention: sovereign or country risk. The sad fact is that a majority of Mexico’s population might actually benefit from a REAL revolution- maybe even a communist revolution, and please not that PRI nonsense (Party of Revolutionary Institutions- that was the ruling party for about a century)
And believe me I’m not a Marxist- maybe no other creed has done as much damage- and it’s still taking out countries- Venezuela, Greece, etc. (The former Greek minister of finance is an actual self-proclaimed Marxist- which is like having a witch doctor for minister of health. )
But the situation of most of Mexico’s population makes revolution tempting.
I am a Canuck. Second generation wood manufacturing. I have just closed down the business. Reasons – lots. Red tape, government (all levels), border issues, currency swings, freight costs, taxes, compliance (all types), and finally competition with cheaper countries. Some things I can accept as “economic cycles“ but government red tape and taxation are two things that drove me nuts of recent. They just keep increasing both and all the while your take home gets smaller and smaller. Canada is going to have some tuff times ahead. Why anyone would want to open a business here right now is beyond me and until that changes —- do the math.
The government of Ontario, which was the leading province for manufacturing, has systematically destroyed the economy of the province for many years now and their insatiable demand for more cash to waste on harebrained schemes and corruption which has exploded the debt, increased taxes and driven out business.
We used to have a thriving branch-plant and primary manufacturing economy but that’s been gone for many years now, shipped to other countries – even the USA, where costs are lower. We are now a ‘service’ economy perched on a property bubble financed at near-zero interest.
Ontario spends multibillions in capital cost on windmills purchased from foreign firms (without competitive bids!) to generate power at 10 times the normal cost so they can ship excess power to the States basically for the cost of transmission while alienating rural property owners and destroying the value of their property by erecting these useless behemoths nearby. We also have a line item on out Hydro bill to pay off the debt of the previously bankrupt Ontario Hydro, to make the bondholders whole (who were these bondholders, anyway, and what happened to the concept of risk?)
Ontario is now proposing their own ‘Pension Plan’, to supplement the federal Canadian Pension Plan and the federal Old Age Pension. This Ontario Pension Plan is nothing but a tax grab on business and a forced savings plan on workers to steal cash flow which the government can spend buying more votes while driving away even more business. Instead of paying higher interest on 300 billion of escalating downgraded debt, why not just steal the money? Huge numbers of people won’t be retiring for years from now anyway, and later they can just blame someone else or raise the retirement age.
The voting public here is so stupid that (after the Premier of the province resigned and ran away to the States to temporarily ‘teach’ at Harvard), after corruption, after wasteful stupidity, after criminal behavior by the government is exposed the voters return the incumbents and new Premier with a majority in parliament. We have websites here that monitor the price of gasoline hour-by-hour for tenths-of-a-cent fluctuations because the greedy oil companies are charging too much, but not a peep from anybody when the price of gas is raised overnight by 13% in new taxes.
The federal government is not exempt, claiming that oil at 40 dollars is no problem, even though the cost of production is 50 or 60, massive cutbacks in the industry are taking place, and the property market in Alberta, private and commercial, is collapsing. We’ll just lower national interest rates – until the election’s over, anyway. Which of course begs the question: shouldn’t interest rates in ANY economy be regional, according to local conditions, not national?
On the macro, for gold and silver bugs, there is a bright side. Having your currency depreciate by 40% means that your gold’s still worth almost 1500/oz instead of less than 1100 -in nominal dollars anyway, and if you don’t spend the money on imported goods which now cost 40% more … or spend it on inflated housing …
Sigh …
Wolf , I think your analysis is bang on, the Great White North’s economy is on the ropes and will falter further as the world economy grinds slower and slower. This brings myself ( a Canuck) to wonder, ” will our ‘Loonie’ continue to fall against the almighty dollar, given many prognosticators predict the dollar will be devalued in the currency war gaining steam?”
Having our currency taken a shit-kicking in the past 3 years, a lot of us are trying to prevent even greater shrinkage by having the ole nest egg ( apart from some tied up in PMs) in the cleaner shirt amidst a dirty laundry bag. What say ye?
Everything goes in cycles. The dollar isn’t “almighty.” The Fed is dedicated to crushing it more or less slowly. So the US dollar’s turn to shrink will come. Short-term the loonie might be in for some more pain. But the US economy isn’t doing so hot either….