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Inflation & Taxes

So Canada’s currency, like the Australian and New Zealand dollars remains strong – my gut feeling is that this is a bad thing, especially since on a “fair market value” the Canadian dollar is probably 5-7¢ lower!  However, a small economy, such as Canada, has little control over its currency, especially when the rest of the world seems to be run by a bunch of people intent on debasing their currencies.

Earlier today, Statistics Canada released the inflation figures for September 2010, bottom line inflation is weak in Canada and falling.  Core inflation that was edging around 2.1% in January is now around 1.5%, while the headline inflation rate is higher up by 0.2% over the month to 1.9% entirely caused by higher fuel costs.


 




Going forward the one element that is worrying is the service inflation, which at 2.2% is higher than desired – service accounts for a large percentage of the economy (45%) so this is not a trivial figure.  However, pressures seem to be abating there, so that expectations are for service inflation to fall off until the end of the year.  Moreover, contraction in excess capacity is slower than anticipated so there is little pricing power.  Based on the anticipated forthcoming American quantitative easing program, odds are that the Canadian dollar will be stronger until the end of 2010.

These factors (and other such as a slowing economic growth) are probably the core reason for the Bank of Canada’s Tuesday decision to keep interest rate very accommodative, at 1.0%.  Canada’s economy cannot be viewed in a vacuum, GDP growth from exports has been weak, in fact Canada’s central bank has reduced projected growth for 2010 to 3.0%, the 4th reduction over the past 7 months, and now below my target of 3.2%... Who knew, I was too bullish!

BTW, what is interesting here is the fact that inflation in Canada (and the US) is still very low and falling --  not rising as many naysayer were predicting.

There are two major changes in Canada’s fiscal environment:  (1) Federal corporate taxes will fall by 1% beginning January 2011, and (2) Unit trusts loose their flow-through status, forcing them to revert to “ordinary” company structures.

The first change has been sold as a $6 billion tax cut – its nothing of the sort, because the way Canada’s treasury department compute the benefits of tax cut is in a vacuum, assuming all other things equal – which is clearly wrong.  The impact of this first (of three) cuts will be to make Canada’s federal tax structure equivalent to its American neighbors, restoring Canada’s fiscal competitive position.  The second is rather more important, most investors don’t seem to know this, but when a Unit Trust distribution are always considered dividend, and so are treated as income (not capital gains), the implication for investors is dramatic…

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