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Andrew Allentuck

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Trade on an Olympic proportion

Andrew Allentuck

Canada is having a boom in trade with China — but can it last?

Canadian companies that mine or drill for commodities like potash, coal, and iron ore have seen their share prices soar in the last three years, thanks in large measure to demand from China.

Statistics Canada reported on Nov. 28, 2007 that exports to China grew at more than twice the pace of imports from China last year. For example, in the period from January to July, 2007, Canada's exports to China surged 43 per cent from the same period a year earlier, while imports from China rose only 17 per cent. Moreover, reports Statistics Canada, the rate of growth of imports last year surpassed that of any G-7 country and put China neck and neck with Japan as Canada's third largest export market after the United States and the European Union.

China became Canada's number two export market for crude oil, adds the Statistics Canada report. Chinese demand for commodities pushed their prices to levels not previously attained. For example, China's potash imports in 2008 rose 88 per cent through August, according to a report from Scotiabank's economics department.

Not all exports to China were raw materials and energy commodities. Exports of industrial goods in 2007 were three times their 2002 levels, reports Statistics Canada. Metals exports from Canada to China grew faster than those in any other major market, up from $300 million in 2002 to $2 billion in 2007. Moreover, 2007 exports of metals to China were 70 per cent higher in 2007 than in 2006, said Statistics Canada.

Trade with China rests on complex financial and political underpinnings.

Financially, it is sensitive to the value of the Canadian dollar, which briefly soared in early 2008 to a 10 per cent premium over the value of the U.S. dollar. However, the recent decline of the loonie to a discount of 7 per cent against the greenback is favourable to exports.

At a political level, it appears that the Government of Canada is aware of the values of the Chinese government in matter of human rights. The present government has said that it prefers to work within the Chinese system rather than challenging it from outside. This policy has dismayed many people who put human rights at a higher level than the Chinese government appears to do, but it does have the effect of not encumbering trade with non-financial concerns.

For the future, a critical value of trade with China will be the fate of the U.S. dollar. The immense U.S. trade deficit, the tax deficit, the cost of various wars, and the huge potential cost of rebuilding the U.S. highway system and other parts of the country's infrastructure suggest that at some point, the Chinese will have to revalue the yuan.

Were the yuan to rise by, say, 20 per cent against the U.S. dollar, the Bank of China would find the value of its holdings of U.S. assets like 10-year U.S. Treasury bonds shattered. There would be some clear beneficiaries such as foreign owners of casinos in Macao. They would see the value of their flows of yuan-denominated profits rise in U.S. dollar terms. But businesses that serve a wider market, such as Wal-Mart Stores Inc., would see their input costs rise drastically and, as a result their sales and/or margins shrink. Higher prices at Wal-Mart and other companies specializing in consumer products would have noticeable effects on consumer price index in Canada and the U.S. Moreover, if the yuan were revalued upward, Chinese exports would fall. The Chinese economy would have a reduced growth rate. Wealthy Chinese would benefit and the nation would be even more divided into those that have money to burn and the masses that remain poor. Those factors are widely thought to restrain China's eagerness to boost the value of their currency.

A worldwide recession is developing. That means less goods sold, fewer made, and less raw materials shipped. For Canadian exports to China, the general trend would be down, but with exceptions. Canada remains the world's largest producer of potash, a key source of metallurgical coal, a major source of aluminum, iron ore, and oil.

After the enthusiasm of the Beijing Olympics dies down, Canadian trade with China will remain. Increasing world demand for meat — the result of rising disposable real income in much of Asia — will still support Canadian exports of potash to grow the grass and grain that animals eat. Chinese industrialization will continue to bolster imports of coal and iron ore from Canada. The path of Canada-China trade is upward, though in the ensuing global recession, it is likely to take a relatively brief dip. Key to trade is the value of the Canadian dollar. Should the global recession increase in severity,

Canadian exports of materials would tend to decline. But key commodities should continue to have a strong market in China and elsewhere. The reason is simple, as Canada's Export Development Corporation noted in the summer, 2008 issue of its publication, Export Wise, we are the world's largest producer of potash. For metallurgical coal and silica for solar energy cells, metal ores and much more, we're simply difficult to replace.

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

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