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Monthly Economic Letter

March 2018
Feature article

What is blockchain and what does it mean for your business?

This new technology could potentially have major impacts in a wide range of industries

Bitcoin is getting a lot of press lately, but it’s the technology behind Bitcoin that has the potential to revolutionize how business is conducted. It’s called blockchain, and there’s a race on to develop applications for it across a wide array of industries.

How does it work? Simply put, blockchain is a continuously updated digital record of who holds what. Information about transactions—the time, date, amount and the participants involved—is encrypted into a “block” that is linked to other blocks to form a chain.

Everyone in a blockchain has access to the same information, providing transparency and continuous reconciliation. Because it exists on many computers, there is no centralized version of the information for a hacker to attack. And the use of encryption technology means it's no longer necessary to have a trusted third party verify information about you and a transaction you want to make.

No central verification of transactions

There is no one central authority controlling the blockchain and that’s one of the reasons why Bitcoin and other cryptocurrencies are so fascinating. They aren’t controlled by a central bank or single administrator. Instead, transactions between users are verified and recorded in a blockchain, using encryption technology.

But blockchain technology can be used for many things other than just currency. And that’s why several major corporations are investing in it, including Microsoft, IBM (with more than 400 blockchain projects around the world), Unilever and Toyota.

They are looking to apply blockchains to everything from fighting digital fraud to managing industrial supply chains to tracing the origin of foodstuffs around the world. But blockchains won’t impact just large corporations; your company may be affected in the not-too-distant future.

Some real-world examples of blockchain technology

The financial services industry is beginning to use blockchain to develop new services and save on costs.

For example, the Australian stock exchange recently announced it would begin using blockchain to settle transactions. The technology will be used to record shareholdings and manage the clearing and settlement of equity transactions.

Another example of blockchain in financial services comes from a firm called Abra. It’s a money transfer platform that allows workers abroad to send money home in 54 different currencies. Workers can send money back home quickly and more cheaply by using the platform, compared with a traditional service provider such as Western Union, which charges fees that average 7% of the amount sent, according to the World Bank.

Making food safer and more sustainable

Another blockchain project involves the World Wildlife Fund and three companies that are collaborating to sustainably source tuna in the Pacific Ocean. ConsenSys (a blockchain company), TraSeable (an IT firm) and SeaQuest Fiji (a tuna fishing and processing company) are using a blockchain to track where, when and how tuna are caught and sold.

From fishers to brokers to your local fishmonger or grocery store, each transaction is recorded on a blockchain. This allows consumers to be sure that they are buying good-quality, legally caught, sustainably fished tuna.

Tracking goods and making payments

In supply chain logistics, the combination of blockchain, smart contracts, and the Internet of Things will allow companies to track shipments and make payments when certain conditions are met (i.e., a product is delivered). Maersk, the world’s largest shipping company, began testing blockchain a year ago to track its cargo in conjunction with Dutch customs, the U.S. Department of Homeland Security and the company sending the goods.

Smaller companies could use this technology as well. Imagine a grocery store whose inventories are getting low. Smart containers holding the goods could be programmed to inform a wholesaler that they need to be restocked. The wholesaler would notify a trucking company to pick up the goods and deliver them to the retailer. Each step could be recorded and payments made via a blockchain because all would be verified amongst the parties.

Further refinement is needed

Despite all this potential, we are still in the early days of the blockchain. Three key issues need to be resolved before it goes mainstream. They include energy use, processing speed and interoperability across blockchains.

  • Verifying transactions to add to the blockchain is energy-intensive because of the computer power required to do all the computations, solving equations by trial and error. Technology firms are working on solutions to maintain the security but reduce the energy consumption.
  • Because of all the computations involved, the processing time is slow. But researchers are working on ways to simplify calculations and increase the number of transactions.
  • Currently there are many blockchains—some public, some private—that don’t talk to one another. The next generation of blockchain technology will likely address this issue.

Conclusion

Blockchain has the potential to transform many industries. As a stand-alone technology, it can verify and track transactions. In conjunction with the Internet of Things and smart contracts, it can make transactions more efficient.

How fast and how much the technology will change the economy remains to be seen.

What does it mean for entrepreneurs?

  • If you’re in the business of verifying transactions of any kind, investigate how blockchain could impact your company. You only have to consider the threat to the business of clearing and settling stock trades to see that the disruption to many back-office functions and other services could be substantial.
  • Assuming you belong to some sort of supply chain, your partners may ask you to start digitally tracking your processes. Especially if you’re a supplier to large companies, start thinking about where you fit into your customers’ supply chains and how you might be asked to participate in a blockchain.
  • If you’re a supplier to either consumers or other businesses, could you benefit from tracing your products back to their source? Think of the premium prices that a fishmonger selling guaranteed sustainable tuna might be able to charge.
Canadian economy at a glance

A solid report card for Canada in 2017 that bodes well for 2018

After a very strong first half of 2017, the Canadian economy settled into a slower pace, growing at an annualized rate of 1.7% in the fourth quarter of 2017. For the year as a whole, Canada grew 3.0%—the best performer of G7 countries as synchronized global growth, led by the United States, and the recovery in oil prices, fueled a broad-based expansion across the country.

The goods-producing sector bounced back last year, increasing by 4.6%, after declining in both 2015 and 2016, while service industries continued steady growth of 2.8%.

With consumers driving the economy, retail sales were solid, growing 5.4% in 2017, attributable largely to robust sales of motor vehicles, electronics, and building materials. In addition to durable goods, consumers continued to take on more debt to purchase homes. With home prices up 8.5% last year, it is not surprising that household credit grew 5.5% over the past 12 months. The most recent three months, however, show a slower pace of credit growth, both for mortgage and consumer credit.

Importantly, business investment picked up considerably in the last few months of the year, and grew 8.6% in 2017, compared with a decline of 8% in 2016. Investment was mainly for machinery and equipment, which grew 6% last year. According to the Bank of Canada, a significant portion of our imports related to business investment. Thus, despite trade being a net drag on last year’s growth, these capital investment imports are a positive sign because they will support the economy’s capacity to grow and increase productivity. In 2017, labour productivity growth improved to 2.1% from only 0.6% in 2016.

Governments also contributed to growth last year, accounting for about 15% of the total. Further spending will continue. According to the recent federal budget, the government will run deficits of just under 1% of GDP for the next few years. The budget includes $4 billion over 5 years in targeted funding for innovation, such as fundamental research, advanced computing and big data. There is also support for women entrepreneurs in high-growth areas of the economy as well as a reduction of the small business income tax rate from 10.5% to 10% effective January 1, 2018 and then to 9% effective January 1, 2019.

The labour market reflects the expanding economy, with 355,000 new jobs, largely full-time, created in the last 14 months. The unemployment rate across the country is low, at 5.8%, reflecting both strong demand and an aging population.

What does it mean for entrepreneurs?

  1. Businesses may see consumer spending slow down as interest rates continue to rise, limiting households’ disposible income.
  2. If you haven’t been upgrading or investing in new equipment and technology for your business, you should consider doing so, before your competition outperforms your business.
  3. With solid performance across the country, consider exporting beyond your provincial borders.
U.S. economy at a glance

Is the U.S. economy overheating?

Economic growth south of the border continues to show strength, but some commentators are worried the economy is overheating. They point to higher bond yields as evidence of coming inflation. While this does not appear to be the case just yet, credit conditions are gradually tightening.

Strong U.S. growth leading to supply constraints

U.S. gross domestic product grew 2.5% in the fourth quarter of 2017 and 2.3% for the year as a whole. There are signs parts of the economy may be hitting supply constraints. For example, overland freight shipping costs appear to be on the rise as trucking companies grapple with a chronic shortage of drivers and rail companies face delays after cutting workers and equipment in previous years. Both higher freight costs and rising fuel costs will eventually lead to higher consumer prices.

In addition, average hourly earnings grew 2.8% in January compared to a year ago and 2.6% in February, stronger than the 2.55% average increase for 2017. Also contributing to concerns about higher inflation is the slow pace of labour productivity growth. It failed to keep pace with wages in 2017, increasing by only 1.2%.

Inflation metrics not yet showing signs of overheating

However, these factors have yet to translate into higher prices. U.S. consumer price inflation rose 2.1% (or 1.8% excluding energy and food) in January compared to a year ago, while the U.S. Federal Reserve Bank’s preferred measure of inflation was a little lower at 1.5%. Inflation has remained below the Fed’s target of 2% since 2011.

There are various theories about why inflation has remained muted in most developed economies. Two plausible reasons are an aging population and the sharing economy (think Uber and AirBnb) as recently noted in a commentary from the Federal Reserve Bank of St. Louis. Specifically:

  • An aging population can put downward pressure on wages as older workers with specific skills leave their higher paying jobs and remain in the labour force. Some older workers need to work because they lack sufficient savings for retirement and may move into entry-level jobs, while others simply enjoy working. Either way, these older workers compete with younger workers.
  • The sharing economy, by putting more assets into productive use, creates more competition in different sectors, lowering prices. Consider how AirBnb offers previously idle bedrooms in homes to tourists visiting your city. Hotels need to reduce their room rates to attract tourists. The downward price pressure contributes to keeping inflation low.

Still, some believe rising bond yields indicate higher inflation is just around the corner. The bond market appears to be pricing in expectations the Fed will need to raise interest rates more quickly than it has signaled so far to slow inflation, potentially putting the brakes on the expansion.

Rising bond yields signal concerns about inflation

Long-term bond yields, which are closely associated with market participants’ inflation expectations, have risen about 90 basis points (0.9%) since September while short-term bond yields have risen close to 100 basis points (1%) on expectations that the Fed will hike interest rates more quickly than it has previously signaled.

Higher government spending driving higher bond yields

Government spending is the key factor leading market participants to expect higher inflation causing bond yields to rise. A related factor is the Fed’s normalization of its balance sheet.

Higher government spending today usually results in higher taxes tomorrow. Higher taxes tomorrow mean higher costs for businesses. Firms will pass these costs on to consumers in the form of higher prices, creating inflation.

The recent tax plan and budget deal will push the deficit to over US$1 trillion next year and add US$2.4 trillion to the federal debt over the next 10 years, with most of the cost coming in the first three years. The tax plan will reduce tax revenues by US$1.4 trillion while the budget deal to raise the debt ceiling will increase spending, notably for defence expenditures, by US$320 billion over two years.

We can already see the effect of larger deficits. The U.S. Treasury announced, in early February, that auction sizes for its bills, notes and bonds would be increasing over the coming months. The government must issue more debt to pay for the higher spending and a shortfall in tax revenues. To attract buyers for this debt, it must discount prices for buyers, thus raise the yield (a bond yield is inversely related to its price).

A related factor pushing bond yields up is the Fed’s normalization of its balance sheet. Following the financial crisis, the Fed bought government bonds to keep interest rates low to help stimulate the economy. In October, the Fed announced it would gradually reduce its purchases of government debt.

Higher growth to the rescue?

Businesses are expected to spend US$660 billion on improving or replacing assets this year, an increase of 8% compared to 2017, according to Goldman Sachs research. If the tax plan promotes significant capital investment, productivity should rise as new and improved capital assets make the economy more efficient and productive. With an expanded capital base, the economy will produce more and grow faster. Higher growth will generate more tax revenues, shrinking the deficit. This, in turn, could offset the effect of deficit spending on inflation described above.

What does it mean for entrepreneurs?

  1. Expect to see higher interest rates in the U.S. and continuing strong growth, at least in the next few quarters.
  2. The Fed is expected to hike its policy interest rate in March and June by 50 basis points while the Bank of Canada is expected to hold its rate steady during the next few months. Thus, the interest rate differential between Canada and the U.S. will grow, putting downward pressure on the Canadian dollar.
  3. With a weaker loonie and strong U.S. growth, Canadian exporters can take advantage of a growing market with the competitive edge a lower currency provides.
Oil market update—February 2018

Oil prices lost ground recently compared to January but still remain elevated. Higher production in the United States and a stronger U.S. dollar are responsible for the recent decline.

Globally, crude oil prices remain close to their highest levels in the past 3 years. Both global benchmarks, Brent and West Texas Intermediate (WTI), traded a few dollars a barrel cheaper on average over the past month compared to the run-up in prices at the end of 2017 and in January 2018.

U.S. producers continue to ramp up production…

Crude oil producers in the U.S. continue to hit new highs, reaching 10.3 million barrels per day in the first week of March. Production is expected to grow further, averaging 10.6 million b/d in 2018, according to the U.S. Energy Information Administration (EIA). The growth will largely come from the light tight oil found in shale rock.

...helping the U.S. get closer to self-sufficiency

The strength of the U.S. oil production industry has remarkably changed the amount of oil the U.S. needs to import. Compared to 10 years ago, the U.S. imports about 4X less oil today. The IEA anticipates that total U.S. production of oil and natural gas liquids will reach nearly 17 million b/d by 2023—nearly matching the level of its domestic demand for oil products.

But the U.S. still needs Canada’s oil exports

While the U.S. is predicted to become a net exporter of oil products in the next 5 years that does not mean that U.S. refineries won’t still need Canada’s crude oil. U.S. refineries need Western Canada’s heavier crude oil to blend with the lighter sweeter crude oil produced from shale oil to make diesel and gasoline. The incremental production of light tight oil is increasingly being shipped to Asia, mainly China, where it is refined for the petrochemicals industry.

Canada’s crude oil exports are important for U.S. refineries, helping them to maintain decent margins, especially given the discount at which Western Canadian Select (WCS) has been trading recently—in part due to delays in the construction of Keystone XL and Trans Mountain. While rail capacity is available, rail companies prefer to have long term contracts with oil producers and the cost is roughly double that of shipping by pipeline from Edmonton to the U.S. Gulf Coast.

The U.S. dollar and commodity prices are often inversely related

The other factor driving oil prices a little lower recently is the appreciation in the U.S. dollar.

Oil and most other commodities are priced in U.S. dollars. When the U.S. dollar appreciates against other currencies, it costs less U.S. dollars to buy those currencies. In other words, when the dollar appreciates, it makes oil more expensive to buy, and demand for oil will fall, which will drive down the price of oil.

The U.S. dollar depreciated against most major currencies in January, which meant that it cost more dollars to buy a barrel of oil, thus raising the price of oil. However, in February, the U.S. dollar appreciated somewhat, which pulled the oil price down.

Given the expected interest rate hikes by the U.S. Federal Reserve (the Fed) this month (see U.S. economy section), the dollar may continue to appreciate. This will put downward pressure on oil prices.

Bottom line

The ramp up in production, especially in the U.S., is putting downward pressure on prices. The fluctuation in the U.S. dollar will also impact the price of oil—inversely. Oil prices are expected to stay in the range of US$55-65/barrel over the coming months.

Other economic indicators

Bank of Canada held its key interest rate at 1.25% at its March meeting

Solid economic growth and a tighter labour market prompted the Bank of Canada to raise its overnight lending rate to 1.25% in January 2018. However, the bank held steady in March as the outlook for Canada is clouded by protectionist sentiment south of the border and uncertainty surrounding the renegotiation of NAFTA.

The loonie depreciated in February

After appreciating 2.8% on a monthly basis against the US dollar in January, the dollar depreciated 1.3% in February, closing at 0.78 at the end of the month (see chart). The Bank of Canada appears to be signalling that it will raise its policy rate more slowly than the U.S. Fed, increasing the differential between the two countries’ interest rates. This will put downward pressure on the loonie to depreciate against the greenback. Canada is moving more slowly than the U.S. because of the high debt load that many Canadian households carry as well as uncertainty related to global trade.

Business confidence—somewhat mixed across the country

The Business Barometer Index compiled by the Canadian Federation of Independent Business (CFIB) lost 0.4 percentage points dropping to 62.4 in February. While the monthly change is not substantial, the strong confidence gain in the Atlantic Provinces was insufficient to counterbalance the decline in confidence in Ontario and Alberta. Some service industries recorded weaker sentiment than the previous month, namely finance, insurance and real estate. For the third consecutive month, business owners expect that average wages will grow by a solid 2.7% over the next 12 months. Labour shortages continue to limit entrepreneurs’ ability to increase sales or production with 41.5% identifying the lack of skilled labour as an impediment to grow. On the other hand, a tighter labour supply stimulates domestic demand (see chart) which is good news for entrepreneurs.

Credit conditions gradually tightening for businesses

The effective interest rate for business has risen about 50 basis points (0.5%) since July when the Bank of Canada began to lift interest rates. The bank has raised its policy rate by 75 basis points since then. While the bank did not raise its key rate this month, commercial lenders are likely to continue raising their borrowing rates to manage their higher funding costs.

Key indicators–Canada

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