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THE SURGE IN THE LOONIE:. Canadian Dollar Strength or U.S. Dollar Weakness?. Dr. Kenneth Matziorinis Department of History, Economics & Political Science. THE VALUE OF THE CANADIAN LOONIE AGAINST THE GREENBACK: 1971 - 2007. Canadian Dollar Floats in May 1970 (May 1962 - May 1970 = Parity).

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The surge in the loonie

THE SURGE IN THE LOONIE:

Canadian Dollar Strength or

U.S. Dollar Weakness?

Dr. Kenneth MatziorinisDepartment of History, Economics & Political Science


The value of the canadian loonie against the greenback 1971 2007

THE VALUE OF THE CANADIAN LOONIE AGAINST THE GREENBACK: 1971 - 2007

Canadian Dollar Floats in May 1970 (May 1962 - May 1970 = Parity)

CAD/USD Exchange Rate

1.2

1.1

1

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

0

1

2

3

4

5

6

7

8

CAD/USD

Canbek Economic Consultants Inc.


Currencies that have gained the most this year year to date 2007

CURRENCIES THAT HAVE GAINED THE MOST THIS YEAR: Year-To-Date: 2007

Appreciation Against the U.S. Dollar

20

15

10

5

0

-5

-10

Euro

India

Brazil

China

Japan

Russia

Mexico

Taiwan

Norway

Sweden

Thailand

Australia

Malaysia

Denmark

CANADA

Singapore

Switzerland

South Africa

South Korea

New Zealand

United Kingdom

T-W Broad Index

T-W Major Currency Index

Canbek Economic Consultants Inc.


Why has the loonie appreciated

Why Has the Loonie Appreciated?

Improvements in Underlying Fundamentals

  • The introduction of inflation control targeting framework in Canada since 1991: The target for inflation: 2%

  • Elimination of public sector deficits and their transformation to sustainable surpluses: from a deficit of 9% of GDP in 1992 to surpluses of 1% of GDP

  • Increase in the national saving rate: from 13% of GDP in 1992 to 24% in 2006

  • Decrease in the country’s external debt: from 44.5% of GDP in 1993 to under 7%

  • Decrease in interest rates and the cost of capital: from 9% in 1992 to 4.2%

  • Increase in the rate of gross fixed capital formation: from 18% in 1993 to 22%

  • Up-turn in commodity cycle: rising commodity and energy prices including oil

  • Improvement in Canada’s terms of trade: higher export prices; lower import prices

  • Gains from free-trade with the United States and Mexico: NAFTA

  • Reduction in political uncertainty over Quebec separation

  • The ONLY NEGATIVE: Canada’s lagging productivity growth

Canbek Economic Consultants Inc.


Canada u s consumer price divergence

CANADA - U.S. CONSUMER PRICE DIVERGENCE

Since 1991, Canadian prices have risen by 10.8% less than U.S. prices on a cummulative basis. This adds 10.8% to the value of the loonie relative to the greenback. Average Inflation: Canada 1.9% vs. U.S.A. 2.6%

160

7

140

6

120

5

100

4

80

3

60

2

40

1

20

0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

CANADIAN CPI

CAN Inflation

U.S. CPI

USA Inflation

Canbek Economic Consultants Inc.


Canada s government budget balance 1992 2007

CANADA’S GOVERNMENT BUDGET BALANCE, 1992 - 2007

Canada’s public sector has shifted away from the largest deficits to the largest budget surplus in G-7

Surplus (Deficit) % of GDP

4

2

0

-2

-4

-6

-8

-10

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

All Levels of Government, % of GDP

Canbek Economic Consultants Inc.


National savings rates canada and the u s a 1961 2006

NATIONAL SAVINGS RATES, CANADA AND THE U.S.A: 1961-2006

The saving gap widens between the two NAFTA neighbors

Percent of GDP

30

30

25

25

20

20

15

15

10

10

5

5

0

0

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

02

04

06

CANADA

U.S.A

Canbek Economic Consultants Inc.


Canada s current account balance 1992 2007

CANADA’S CURRENT ACCOUNT BALANCE, 1992 - 2007

As Canada’s national saving rate recovered, Canada’s international trade balance has risen in recent years

Percent of GDP

3

2

1

0

-1

-2

-3

-4

-5

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Current Account Balance

Canbek Economics Consultants Inc.


Net international investment positions of canada and the u s a 1976 2006

NET INTERNATIONAL INVESTMENT POSITIONS OF CANADA AND THE U.S.A.: 1976 - 2006

A Tale of Two Countries: Canada’s foreign debt is falling while America’s is rising

Percent of GDP

20

10

0

-10

-20

-30

-40

-50

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

U.S.A.

CANADA

Canbek Economic Consultants Inc.


Long and short term interest rates in canada 1992 2007

LONG AND SHORT-TERM INTEREST RATES IN CANADA: 1992-2007

The cost of capital in Canada has declined benefiting producers and consumers

10

9

8

7

6

5

4

3

2

1

0

1992

1992

1992

1992

1992

1992

1993

1993

1993

1993

1993

1993

1994

1994

1994

1994

1994

1994

1995

1995

1995

1995

1995

1995

1996

1996

1996

1996

1996

1996

1997

1997

1997

1997

1997

1997

1998

1998

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1998

1998

1999

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1999

1999

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2000

2001

2001

2001

2001

2001

2001

2002

2002

2002

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2002

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2003

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2004

2004

2004

2005

2005

2005

2005

2005

2005

2006

2006

2006

2006

2006

2006

2007

2007

2007

2007

2007

2007

3-M Treasury Bills

Long-Term Gov. Bonds

Canbek Economic Consultants Inc.


Canada s terms of trade 1987 2007

CANADA’S TERMS OF TRADE, 1987 - 2007

Since 2002 our export prices have risen faster than our import prices, improving our terms of trade

Export & Import Price Indexes (2002 = 100 )

120

110

100

90

80

70

60

50

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Export Prices

Import Prices

Canbek Economic Consultants Inc.


Commodity price index 1982 90 100 u s dollar terms

COMMODITY PRICE INDEX, 1982-90 = 100, U.S. DOLLAR TERMS

Commodity prices have surged led by the price of energy

300

250

200

150

100

50

0

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Total

Total Excl Energy

Energy

Food

Industrial Materials

Canbek Economic Consultants Inc.


U s dollar percent depreciation against major benchmarks

U.S.DOLLAR PERCENT DEPRECIATION AGAINST MAJOR BENCHMARKS

The Loonie is not the only currency being lifted

January 2002 - November 2007

Year-to-Date

Trade-Weighted Broad Index

-7.5%

-23.0%

Trade-Weighted Major Currency

-10.4%

-35.4%

Gold

-21.1%

-64.8%

Canadian Dollar

-17.1%

-38.9%

E.U. Euro

-8.7%

-38.8%

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The value of the u s greenback against the loonie 1971 2007

THE VALUE OF THE U.S. GREENBACK AGAINST THE LOONIE: 1971 - 2007

In August 1971 President Nixon Suspends Convertibility of Gold to the U.S. Dollar, Beginning of the End for Gold Exchange Standard Set Up at Bretton Woods

USD/CAD Exchange Rate

1.8

1.6

1.4

1.2

1

0.8

0.6

0.4

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

0

1

2

3

4

5

6

7

8

USD/CAD


U s trade weighted exchange index broad basket of currencies

U.S.TRADE WEIGHTED EXCHANGE INDEX: Broad Basket of Currencies

Source: Board of Governors of the Federal Reserve System (1973 = 100.0)

140

130

120

110

100

90

80

70

60

50

40

30

20

10

0

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

0

1

2

3

4

5

6

7

8

Trade Weighted Exchange Index - Broad

Canbek Economic Consultants Inc.


U s trade weighted exchange index major currencies

U.S.TRADE WEIGHTED EXCHANGE INDEX: Major Currencies

Source: Board of Governors of the Federal Reserve System (1973 = 100.0)

160

150

140

130

120

110

100

90

80

70

60

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

0

1

2

3

4

5

6

7

8

Trade Weighted Major Currency Index

Canbek Economic Consultants Inc.


U s dollar depreciation since february 2002

U.S DOLLAR DEPRECIATION SINCE FEBRUARY 2002

Percent (%) Decline in the Value of the US Dollar Since Recent Peak

20

15

10

5

0

-5

-10

-15

-20

-25

-30

-35

-40

-45

-50

Euro

India

Brazil

China

Japan

Russia

Mexico

Taiwan

Norway

Sweden

Thailand

Australia

Malaysia

Denmark

CANADA

Singapore

Switzerland

South Africa

South Korea

New Zealand

United Kingdom

T- W Broad Index

T- W Major Currency

Canbek Economic Consultants Inc.


Gold price u s dollar per ounce london prn fix

GOLD PRICE, U.S. DOLLAR PER OUNCE (LONDON PRN FIX)

The U.S. Dollar price of gold has broken through its previous high of January, 1980, not a positive sign!

U.S. Dollar Price per Ounce

1000

900

800

700

600

500

400

300

200

100

0

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

0

1

2

3

4

5

6

7

U.S.Dollar

Source: World Gold Council Canbek Economic Consultants Inc.


U s current account deficit

U.S. CURRENT ACCOUNT DEFICIT

1960 - 2007

Current A/C Balance, Bil of USD

Current A/C Balance as % of GDP

200

2

100

1

0

0

-100

-1

-200

-2

-300

-3

-400

-4

-500

-5

-600

-6

-700

-7

-800

-8

-900

-9

-1000

-10

60

61

62

63

64

65

66

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68

69

70

71

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90

91

92

93

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95

96

97

98

99

0

1

2

3

4

5

6

7

Current Account Balance

Current Account Bal as % of GDP

Canbek Economic Consultants Inc.


U s net intermational investment position

U.S NET INTERMATIONAL INVESTMENT POSITION

1976 - 2006 Source: BEA, US Department of Commerce

Trillions of U.S. dollars

Percent of GDP

1500

15

1000

10

500

5

0

0

-500

-5

-1000

-10

-1500

-15

-2000

-20

-2500

-25

-3000

-30

76

78

80

82

84

86

88

90

92

94

96

98

0

2

4

6

8

Net Foreign Borrowing

Percent of GDP

Canbek Economic Consultants


U s national saving investment imbalance 1960 2006

U.S NATIONAL SAVING - INVESTMENT IMBALANCE: 1960 - 2006

Investment Needs Exceed Available Savings: Must Rely on Foreign Savings

Percent (%) of GDP

25

20

15

10

5

0

-5

-10

60

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

02

04

06

Saving Rate

Investment Rate

Foreign Borrowing

Canbek Economic Consultants Inc.


U s consumption and personal saving rates 1960 2006

U.S CONSUMPTION AND PERSONAL SAVING RATES: 1960 - 2006

Spend More and Save Less: Hakuna Matata!

Percent of GDP Consumption Left Scale

Percent of GDP Saving Right Scale

80

12

75

11

70

10

65

9

60

8

55

7

50

6

45

5

40

4

35

3

30

2

25

1

20

0

60

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

02

04

06

Consuption as Percent of GDP

Personal Saving Rate

Canbek Economic Consultants Inc.


U s trade balance and personal saving rate 1960 2006

U.S TRADE BALANCE AND PERSONAL SAVING RATE: 1960 - 2006

Coincidence? Correlation? or Causation?

LS: Personal Saving Rate

Current Account Balance :RS

12

4

10

2

8

0

6

-2

4

-4

2

-6

0

60

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

02

04

06

Personal Saving Rate

Trade Deficit as Percent of GDP

Canbek Economic Consultants Inc.


Price of crude oil brent bbl

PRICE OF CRUDE OIL BRENT $/BBL

Oil prices have risen again and they are transferring wealth from oil consuming to oil producing nations. This time, however, the energy intensity of the world economy is about half what it was in the 1970s

Average Annual Price in USD/BBL

100

90

80

70

60

50

40

30

20

10

0

61

63

65

67

69

71

73

75

77

79

81

83

85

87

89

91

93

95

97

99

01

03

05

07

Current Dollars

2006 Constant Dollars

Source: BP, Historical Data Canbek Economic Consultants Inc.


Central bank key policy interest rates 2001 2007

CENTRAL BANK KEY POLICY INTEREST RATES: 2001-2007

As the world’s major central banks raise rates, US is forced to cut, narrowing spreads and reducing the attractiveness of USD-denominated assets

Percent Rates (%)

7

6

5

4

3

2

1

0

2001

2001

2001

2001

2001

2001

2001

2001

2001

2001

2001

2001

2002

2002

2002

2002

2002

2002

2002

2002

2002

2002

2002

2002

2003

2003

2003

2003

2003

2003

2003

2003

2003

2003

2003

2003

2004

2004

2004

2004

2004

2004

2004

2004

2004

2004

2004

2004

2005

2005

2005

2005

2005

2005

2005

2005

2005

2005

2005

2005

2006

2006

2006

2006

2006

2006

2006

2006

2006

2006

2006

2006

2007

2007

2007

2007

2007

2007

2007

2007

2007

2007

2007

2007

CANADA

USA

EURO

JAPAN

Canbek Economic Consultants Inc.


Growth in central bank reserves 1999 2007

GROWTH IN CENTRAL BANK RESERVES: 1999 - 2007

Developing countries are accummulating unspent balances from export surpluses Source: IMF COFER

Billions

6000

5500

5000

4500

4000

3500

3000

2500

2000

1500

1000

500

0

1999

1999

1999

1999

2000

2000

2000

2000

2001

2001

2001

2001

2002

2002

2002

2002

2003

2003

2003

2003

2004

2004

2004

2004

2005

2005

2005

2005

2006

2006

2006

2006

2007

2007

Total Reserves

Industrial Countries

Developing Countries

Canbek Economics Consultants


Composition of global allocated central bank reserves 1999 2007

COMPOSITION OF GLOBAL ALLOCATED CENTRAL BANK RESERVES: 1999 & 2007

Not all central banks report the currency composition of their reserves: 64% are allocated Although the share of U.S. Dollars is falling, the growth in developing country central bank reserves is sufficient to finance U.S. trade deficit -for now Source: IMF COFER

U.S. Dollars

64.8%

U.S. Dollars

71.1%

Other

4.9%

Other

8.0%

GBP Sterling

4.7%

GBP Sterling

2.7%

E.U. Euros

18.1%

E.U. Euros

25.6%

Canbek Economic Consultants Inc.


Composition of canada s foreign exchange reserves october 2007

COMPOSITION OF CANADA’S FOREIGN EXCHANGE RESERVES: October, 2007

Does Canada’s composition of F/X reserves indicative of the direction that other central banks in the world are going to follow?

EURO 49.3%

YEN 1.5%

US DOLLARS 49.2%

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Why is the u s dollar depreciating

Why is the U.S.Dollar Depreciating?

Too many negative factors and mounting loss of confidence

  • Huge and unsustainable trade deficit, near 6% of GDP

  • Huge borrowing from the rest of the world amounting to $2 Billion per day

  • Deterioration in the U.S. net international investment position with the rest of the world: US net external indebtedness now over 20% of GDP

  • Loss of confidence in U.S. financial markets: From Enron & WorldCom to the Fiasco in the sub-prime mortgage and asset-backed securities market involving securities totalling $1 trillion dollars

  • Distressed housing market, rising foreclosures, falling housing prices and recession in housing construction and automobile industries

  • Cuts in policy interest rates: The fed funds rate cut by 75 basis points to 4.5%, while every other central bank in the world is raising policy rates

  • Deteriorating inflation-adjusted interest differentials with the rest of the world

  • The growing cost and burden on the U.S. A. of the war on terror and the Iraq War: estimated by CBO to exceed $1.7 trillion by 2017

  • Large dependence on increasingly unstable foreign oil: 66% of oil consumed in the U.S. is imported, most of it from the Middle East at a cost of over $30 billion a year

  • In August, foreigners sold more U.S. securities than they purchased, the sharpest drop in many years signaling a loss of appetite in U.S. securities by private foreign investors

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Implications for current future policy

Implications for Current & Future Policy

It is not the end of the world, but the world will change

  • Depreciating U.S. dollar will help restore international competitiveness of U.S exports and help reduce trade deficit, but it will take time

  • Will intensify global competition and increase the strain on the rest of the world's economies, including Canada’s

  • Will undermine confidence in the U.S. dollar as an international reserve currency and accelerate the movement away from the U.S. dollar and toward the Euro

  • Countries with their currencies pegged to the U.S. dollar will consider de-pegging and increase the probability that oil-exporting countries will start pricing their oil in non-U.S. currencies, further undermining the role of the U.S. dollar as the world’s currency

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Implications for current future policy1

Implications for Current & Future Policy

Tough choices: Between a Rock and a Hard Place!

  • U.S. policy makers will be forced to choose between: A) a strong dollar which implies higher interest rates and weaker growth for the economy and B) a weaker dollar which implies lower interest rates and avoidance of recession.

  • - Raising interest rates to shore the currency may push the U.S. economy to recession and place downward pressure on equity prices in the short-run, but will address the problem and set the U.S. on a course of lower interest rates and faster growth in the long-run.

  • - Lowering interest rates to shore up the economy will lead to further currency depreciation, international monetary instability and errosion of U.S. economic hegemony in the world and by postponing the problem, reduce future growth and risk higher inflation and higher interest rates down the road

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Implications for current future policy2

Implications for Current & Future Policy

Short-term Pain for Long-term Gain

  • A tighter monetary stance to defend the integrity of the U.S. dollar will facilitate the necessary domestic adjustment the U.S. needs to undergo in order to restore the saving rate, reduce senseless consumption, clean up the financial excesses, reward thrift and industry and punish excess and speculation. In short restore value and integrity in the U.S. financial system and the U.S. dollar

  • Recession is probably the better though not the most popular option for the U.S. now - The Federal Reserve has to make a stand: what is its main goal? price stability or economic growth?

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Implications for current future policy3

Implications for Current & Future Policy

Solutions are Available, Is there a Political Will to Act?

  • One credible and sound means to restore confidence to the U.S. dollar is to adopt an explicit inflation control target similar to the one adopted by Canada in 1991 and which the current Chairman of the Federal Reserve Ben Bernanke has already recommended that the U.S. central bank adopt

  • A second measure is the introduction of a gasoline tax. Such a tax can increase domestic saving, reduce imported oil, reduce oil dependence and reduce carbon emissions thus achieving three desirable goals in one strike: reduce trade deficit, enhance national security and reduce carbon emissions

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Implications for canada

Implications for Canada

Payback Time !!!

  • In the 1990s while going through its massive corporate and public finance restructuring Canada relied on a low dollar policy to keep its head above water

  • Now our American neighbours to our South are counting on us to do the same for them!

  • Currency re-allignments are exchange of favours. Now we are being called upon to repay.

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Implications for canada1

Implications for Canada

Good for consumers, bad for manufacturers a test for East-West federal-provincial relations

  • Stronger loonie will dampen exports and boost imports, reducing Canada’s trade surplus

  • Intense competition from U.S. imports will compress retail margins and the tourist industry

  • Canadian consumers will benefit from lower prices of tradeable goods

  • Consumer inflation will fall and will help keep interest rates lower than otherwise

  • Stronger loonie will accentuate the divide between resource-rich Western Canada and manufacturing-intensive Central Canada

  • Will complicate the application of national policies as two regions require different treatment

  • Possibility that Central Canada will go into recession as Western Canada continues to grow

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Implications for canada2

Implications for Canada

Moderating Factors: Strong Domestic Fundamentals

  • Moderating the negative effects of a stronger loonie are:

  • Strong fiscal balances at the federal and many provincial levels of government

  • Strong trade balance and concentration in resources and energy

  • Strong corporate balance sheets and high profit margins

  • High saving and investment rates

  • Favourable terms of trade

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Implications for canada3

Implications for Canada

Will a U.S. Slowdown spread into the global economy or will Emerging economies (BRIC) pick up the slack?

  • The extent of the negative impacts will depend on two factors:

  • 1.On whether the U.S. economy goes into recession, or not, and

  • 2. On how the rest of the world economy responds to a recession in the U.S.

  • The U.S. accounts for 25% of GWP and in the past has always served as the world’s growth engine

  • This time it may be different: for the first time in almost 100 years the rest of the world economy may be resilient enough to weather a U.S. downturn without provoking a global recession

  • In its October WEO forecast the IMF has said that China, India, Russia and Brazil (BRIC) account for more than 50% of growth in the planet’s economy

  • If the BRIC economies prove resilient enough to withstand a U.S. downtun, it will be the best-case scenario: it will help buttress the U.S. economy and help prevent Canada from going into recession

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Implications for canada and the world economy

Implications for Canada and the World Economy

Global Recession or Global Re-ordering?

  • Worst Case Scenario:

  • The U.S. economy slides into recession and brings down the rest of the world’s economy: resource prices fall, Canada’s terms of trade tumble and expose Canada’s two vulnerabilities: high concentration in resources and low productivity growth

  • Best Case Scenario:

  • Emerging economies take on the lead from the U.S. and maintain global growth albeit at slower rates, commodity and energy prices do not collapse, Canada’s terms of trade do not deteriorate materially enough to expose our weaknesses and allow the U.S. and Canada’s economy to make an orderly transition

Canbek Economics Consultants Inc.


The surge in the loonie

The Surge in the Loonie!U.S. Dollar WeaknessThe U.S. Sneezes, the World Falls SickIt May beTheir Currency,but it is Our Problem Now!Portends Further Problems for the U.S. Ahead and MajorChallenges for Canada and the World Economy We All Have a Stake in a Strong U.S. Economy

  • The End

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