Enjoy The Commodities Boom. But Beware The Bust

Canadians think of themselves as good global citizens. But it's uncomfortably true that in the realm of economics, what is good for Canada is bad for the rest of the world--and vice verse. Oil prices: up. Natural gas prices: up. Metal prices: up. Feed grain prices: up.

All this represents bad news for billions of people around the planet. But in Canada: ka-ching. The dollar has vaulted past U.S. 94¢. Unemployment has dipped to a 33-year low. The Toronto Stock Exchange is testing all-time highs.

During the 1990s, when raw-material prices tumbled to new lows and the Canadian dollar scraped to 63¢, Canada's diplomats travelled around the world to explain that Canada was not a natural-resource economy. No, it was a sophisticated modern service economy!

That was true. But what they omitted to add was that Canada's sophisticated modern service economy served . . . natural-resources industries. When those industries swooned, so did Canada. When they soared, they took Canada along for the ride. And some ride it is.

The motor powering the ride is the takeoff of the Chinese economy. Two decades ago, China used little oil and imported less: In 1985, China was the world's number 20 oil importer. Today it is number two.

China imported little metal in the 1980s. Today, China voraciously consumes the stuff: Canadian nickel exports to China quadrupled between 2002 and 2004, then doubled in 2005 and again in 2006.

Food? As incomes rise in China and India, consumers want more and better meat for their tables. Unfortunately for customers--but happily for customers--the grains needed to feed animals can also be used to power cars. Result: a surge in grain prices that increased the value of Canadian grain exports by 33% in the single year 2006.

All of which may explain why you are suddenly seeing Maseratis in the streets of Toronto, Calgary and Vancouver.

So long as China (and also India) continue to grow, Canada should continue to profit. It will not last forever--personally, I'm pessimistic about the medium-term prospects for the Chinese economy--but it should last for some while.

This prospect opens some large possibilities for Canada--and some even more dangerous temptations. During the last great commodities boom, 1972-1981, Pierre Trudeau and his NDP allies bought Canada a vast toybox of costly new programs that nearly bankrupted Canada when commodity prices slumped. As they always do.

This problem is faced by many countries other than Canada, of course.

Copper-producing Chile, for example, has enjoyed a huge surge in its revenues since 2001. (China is now Chile's second-largest trading partner.)

"The question that plagues Latin America and other emerging markets is: How do you avoid the booms and busts from commodity cycles?" Chile's finance minister, Andres Velasco, told The Wall Street Journal in May. "In Chile we have a simple answer: spend that which is permanent and save that which is transitory." Chile is ruled by a socialist party, but they have found the discipline to resist a spending boom. Chile has already placed $6-billion of copper revenues in a stabilization fund; it expects to add another $6-billion by the end of 2007--a total equal to 10% of the country's gross domestic product.

Oil-exporting Norway has amassed a $300-billion bond portfolio.

Such funds are vulnerable to abuse of course, as Albertans know well from the unhappy history of their province's Heritage Fund.

And because Canada's federal government collects its windfalls in the form of increased collections of ordinary taxes--rather than natural resource royalties --it can be hard to determine what exactly should qualify as a windfall to be saved.

But here's something that can be decided: Canadians and their political leaders can resolve now not to repeat the errors of the 1970s--and to resist the temptation to be lured into permanently higher government spending by a temporary surge in government revenues.

Pierre Trudeau bequeathed a $30-billion-plus deficit when he stepped down in 1984. The new Mulroney government quickly brought Canada's operating budget into balance--but the Mulroney Conservatives incurred $300-billion in new debt to service the old debt left behind by the Trudeau Liberals.

Not until the late-1990s did Canada again balance a budget. Not until the early 2000s did Canada succeed in bringing its debt burden back in line with the G7 average. It took Canadians two full decades to clean up after Pierre Trudeau's wild party.

There is at least one political benefit from the ageing of the population: voters' memories are getting longer. Which means that as the money flows--and temptations rise--the Harper government should be able to find an audience for its core message: "Never again!"