Yearning for a 85 Cent Loonie: But Interest Rates Are Key

mark-carneyOver the last few days I have seen Canada’s finance minister, Jim Flaherty talk about how fragile the world economy is.  He is obviously worried because of the tenuous debt situation in Europe is making everybody nervous.  Thankfully, Canada does not seem to be even close to that.  Our economy and debt levels are much healthier than our European cousins.  Needless to say, Bank of Canada Gov. Mark Carney will announce this week what he is doing with overnight interest rates.  Keeping that inflation dragon at bay is always job one.

Interest rates are going up but not necessarily this week.  If you have read this column for the last 10 years, you’ll know that my dream job is as the Bank of Canada Gov. It is one thing to write about the economic levers that affect our greater society.  However, I’d love to be in Mark Carney’s position.  Having my hands on those levers, even for a day would be entirely satisfying.

I believe interest rates are going up in the long-term for two reasons.  Firstly, we are at such anemic low levels there is not much room underneath us.  So it’s obvious that interest rates only have one direction to go and that’s up.  And the other reason I believe interest rates will head north is because I believe our American friends will eventually have to raise rates.   US Federal Reserve chairman, Ben Bernanke will eventually get the US economy in a spot where they will need to cool inflation.  Their problem continues to be a moribund housing market and an economy that can do much better.  Eventually I believe they will stop printing money, which should create an inflation event.  In the meantime, Mr. Bernanke will need to raise rates incrementally, avoiding inflation, but being careful not to destroy employment gains.

Interest rates are important because they represent the cost of credit, which is the lubrication of the greater economy.  It may be true that economists like musing about interest rates.   However, it is easy to fall into the trap that we may be looking at interest rate hikes like we had in the 1980s when consumers were paying over 20% interest.  In fact I might be a captive of that time, as I paid those rates once and it always remains in the back of my mind.  Is that fair?  Or are interest rates over 20% or even above 10% completely preposterous in the 2011 economy?

I think so.  Under the present monetary policy of the Bank of Canada and the cost-cutting coming up via both federal and provincial governments, it would seem that high inflation is not on the horizon.  I think the younger generation that cannot remember the 1980s at least for the moment should rest easy.  Higher rates are coming but maybe not double-digit for quite some time.

The reasons for higher interest rates have to do with many things the Bank of Canada monitors.  Canadian economic growth is running at a red-hot 3.9% on an annualized basis for the first quarter of 2011.  This has inflation written all over it.  The problem lies in the fact that many Canadian households have a debt to income ratio of over 150%.  Add higher interest rates to that jumbled mix and grandma probably won’t be very happy.

Then of course there is the Canadian loonie, which have been comfortably in the 1.02 US level for quite some time now.  Any significant rise in interest rates would only make the loonie go higher.  This will hurt the competitiveness of Canadian exporters and with Ben Bernanke holding still on interest rate increases in the US it wouldn’t be good here.   Oh, how I yearn for a $.85 loonie.  It seems so retro now.

Key of course to any future interest-rate movement is the unknown factor about what governments, consumers and economies around the world will do in the next few months.  For instance if you have massive government protests in places like Greece, Spain and Italy this summer, the European Union may come unglued as Germany may be unwilling to foot the bill for restructuring.  This would fracture many small economies sending jitters through central banks.  Add another rogue war into the mix, such as Libya and you get a monetary environment coming unglued.

That would mean higher interest rates and if you are a saver, it’ll be time for rejoicing.  However, I would not hold your breath.  Sure, the global economy is still jittery.  Just ask Canadian finance Minister Jim Flaherty.  However, for the immediate future, look for the Bank of Canada to raise those rates this fall.  You got the summer to get ready.