Will a Smaller Global Commodities Appetite Benefit Canada?

Popular opinion suggests any slowdown in resource demand from China, which is becoming more desperate in its attempts to revive its flagging economy, will be especially bad for a commodity-dependent economy such as Canada's.
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Popular opinion suggests any slowdown in resource demand from China, which is becoming more desperate in its attempts to revive its flagging economy, will be especially bad for a commodity-dependent economy such as Canada's. That may well be the case, but it does overlook at least one key silver lining. Sharply lower commodity prices are now offering Canada an opportunity to push the reset button on an economy that's become distorted by an over-dependence on resource markets.

Whether you're talking about oil, coal, or copper, it seems as if all roads have led to China for going on 20 years. With the sun now appearing to set on China's track record of robust economic growth, questions are now being asked about whether the country might follow the example of Japan's economy, which set the world on fire decades earlier before sliding into a protracted period of stagnation that it's still struggling to shake off.

Whether stimulus spending, rate cuts or a recent devaluation of the yuan, Beijing's attempts to prod China's once seemingly unstoppable manufacturing sector back to its former heights continue to fall short. As the country's leaders are finding out, the transition towards a service economy oriented towards servicing more than a billion consumers is a different beast than what they've come to know. It's a shift that global resource players, which have come to depend on steadily increasing demand from China, are also now grappling with as well.

Where does a smaller appetite for commodities leave a country like Canada? In the present moment, the answer is certainly worse off. In the longer run, though, the country could well be in better shape for the changes that will be induced.

A slowdown in China's economic growth and, by extension, much tamer global commodity demand, presents Canada with both a challenge and an opportunity. The hard part, of course, is preventing a contraction in the oil patch from dragging down the entire economy. On the other side of the ledger, however, lower commodity prices are also helping to take the wind out of the sails of the Canadian dollar, which offers a potentially game-changing opportunity to sectors that have long suffered in the shadow of the resource boom.

While the loonie has always moved to the rhythms of commodity price cycles, in recent years it's become even more tethered to the price of oil, largely due to the massive growth in oil sands production. Riding on the coattails of triple-digit oil prices, the loonie experienced a meteoric rise to parity and beyond against the US dollar. In the process, though, the petro-charged currency also wreaked havoc on a manufacturing sector that shed more than half a million jobs.

China is often rightly cited as the culprit for the loss of domestic factory jobs, but frequently it's for the wrong reason. By and large, those jobs didn't migrate across the Pacific, but instead crossed the border south to the US, as the loonie's soaring value made Canadian labour costs uncompetitive.

Just as China's insatiable resource appetite helped push the loonie to heights that spurred an exodus of jobs in the export sector, it works the other way as well. Indeed, a slowdown in that demand is already having profound implications for the loonie, which is now at its lowest point against the greenback in a decade, having fallen nearly 25 percent in the last few years. Throw in a Bank of Canada that appears more than willing to keep cutting interest rates to support economic growth and a move into the 70-cent range looks ever more probable.

Fortunately for Canada, big swings in a currency, such as the loonie is now experiencing, can be just as powerful at attracting footloose manufacturing jobs as they are in sending them away. Although the Canadian dollar's march to parity may have killed hundreds of thousands of factory jobs, a move towards 70 cents will bring other jobs back. What's more, the investments in new plants and equipment spurred by a falling loonie will boost the falling productivity of Canada's neglected factory sector, creating a virtuous cycle.

No doubt a downshifting in China's economic growth will bring short-term pain for Canada, but it also sets the stage for a fundamental reshaping of the country's economy. Not since the early days of the fur trade has Canada's economy been as dependent on a single product as it has in its recent petro-dominated incarnation.

The idea of economic diversification is often positioned as something that's nice in theory, but difficult to achieve in practice. As lower commodity prices and a falling exchange rate breathe new life into a beaten up manufacturing sector, Canadians may actually get to enjoy the merits of a diversified economy, one that ultimately will be much more sustainable than the resource-dependent one that today serves them so poorly.

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