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									Global Economic Research                                                                   September 3, 2010

                                                     Capital Points
Derek Holt (416) 863-7707

Gorica Djeric (416) 862-3080                      — A weekly look ahead at Canadian and U.S. financial markets

Canada’s Record-High Household Debt Service Burden                                                      Index
Canadian households are allocating more income to debt payments than ever
before, even compared to the throes of the early 1990s recession. This is despite                        1      Commentary
today’s record-low interest rates, and builds upon concerns that we expressed                           2-3     Canadian Preview
throughout the past year including in our paper “Did Canadians Learn Much from
the Global Crisis?” (September 1, 2010) and “Is There a Canadian Housing                                3-4     U.S. Preview
Bubble?” (November 24, 2009). This further speaks to our forecast for the BoC                            4      International Preview
to hike by 25bps next week in order to address such domestic imbalances.
                                                                                                         5      Auto Industry Update
Unlike the US where the Federal Reserve publishes its own measures for the                               6      Canadian Monetary Policy Comment
household debt service burden, no such measure exists in Canada and so we
                                                                                                         7      Fiscal Policy
maintain our own (top line in the accompanying chart). It is comprised of interest
payments on all forms of household debt available from Statistics Canada and                             8      Foreign Exchange Markets
shown in the dashed line, and principal payments on residential mortgages at                           9-10     International Markets
banks available from the Bank of Canada’s mortgage loans report and shown in
the other solid line. Both are expressed as seasonally adjusted and annualized                     11-12        Indicator Preview Tables
shares of after-tax personal disposable incomes.

We cannot obtain economy-wide figures for principal                              Canada's Household Debt Service Burden
payments on mortgages held by non-banks like credit             25
                                                                     interest payments on all debt +
unions or life insurers, but if we could then it might raise         mortgage principal payments              Total
the measure by 2-3 percentage points given that non-            20
                                                                     (% share of after-tax PDI)
bank lenders directly hold about 20% of mortgages. We
also cannot obtain principal payments on non-mortgage           15
products like installment loans, credit cards, or lines of
credit. Therefore, our measure underestimates the true          10                                                                Interest
debt service burden.
The culprit on this march to a record high has been                             Principal
rising principal payments after years of very strong          0
growth in mortgage debt. This effect has totally                82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
overwhelmed the modest downward swing in interest            Source: Bank of Canada, Statistics Canada, Scotia Capital Economics
payments as a share of incomes. The total debt service
ratio may have slipped a touch of late because households are going toward longer amortization periods on their
mortgages available only since 2007 in order to cope with stressed payments. But the average debt service burden
still stands in the realm of one-fifth of incomes going toward servicing debt. Note that within this average are
individuals with lots of debt, and individuals with none at all. At the economy-wide level, however, it shows a more
stressed position today than ever before. Now in fairness, the positive angle to this is that rising principal payments
essentially represent saving that is not captured in the conventional definition of the personal saving rate via
building net worth as long as house prices hang in. The negative angle, however, is that since interest rates are
about as low as they can go, there is no relief coming in this cycle like what happened after the early 1990s
recession and households are stuck with high long-term principal payments. That speaks to the best years for
Canadian housing and consumers lying behind us, and thus a lower BoC neutral rate.

The main conclusion that we draw is that comparisons between today's consumer cycle and prior cycles are to be
done with exceptional care in multiple debates. This is based on hard data, not, say, upon what payments would
look like to a potential entrant to today’s housing market under certain assumptions. As for other factors motivating
next week’s BoC announcement, we’ve written exhaustively about them but now also consider the key issue of
what effect sustained policy tightening by the BoC ahead of the Federal Reserve would have on the currency via
spread effects (page 6).

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Global Economic Research                                                                                 September 3, 2010

                                                                                                              Capital Points
Next Week’s Key Market Risks

Five G20 central banks meet this week, including the Bank of Canada, the Bank of England, the Bank of Japan, the
Reserve Bank of Australia and the South African Reserve Bank. The Bank of Canada is expected to continue to tighten
by 25bps to 1.0%, but remain on hold for the next two meetings in order to monitor global and domestic developments. We
continue to judge the risks to be toward a shorter pause than forecast. All the remaining central banks are widely forecast to
remain on the sidelines at next week’s meetings for the same reason — on higher uncertainty over global economic outlook
— save the South African Reserve Bank, which is predicted to continue to ease monetary policy on lackluster growth and
job prospects and moderating inflation. On the Canadian fundamentals docket, all eyes will be on the August jobs report,
with tail risks mixed between a sizable seasonal correction in the education segment and high base effects created by solid
gains registered over prior months. Housing and trade will also be key in formulating early expectations for Q3 GDP
growth. South of the 49th, the line-up will be light, with US trade figures likely to garner the most attention, as markets
continue to monitor whether the global and domestic appetite are showing further signs of slowing. A relatively sparse
economic release calendar carries over to Asia, where markets await employment reports from Australia, China and India
as well as Japan’s release of July leading index, machine orders and trade balance, the August reports on bank lending
and consumer confidence as well as the final print for second-quarter GDP. From Europe, we get July updates on
international trade and industrial production, key drivers of economic growth.


The Bank of Canada is expected to raise its key
lending rate for the third straight time on Wednesday.
We are looking for a 25bps hike to 1.00%. We’ve
written exhaustively about the BoC in recent weeks and
remain firm in our belief that the economy is sound
enough to continue to tighten, against the backdrop of
the household debt excesses that we flagged on page 1
and the modest CAD implications that we write about
on page 6.

July’s jobs report surprised with a contraction.
However, digging beneath the headlines, it was a
stronger report. As we argued in “Does An Out-Sized
Canadian Job Gain Lie Around the Corner?” (August
11th), Canada may be poised for a higher-than-average monthly job gain in August and/or September. If so, that could
reverse sentiments in some corners that the Bank of Canada faces a deteriorating labour market. The culprit behind the July
decline lies in the volatility associated with education sector employment in the summer months that make teacher and
related jobs look more volatile than Wall Street jobs. This effect began in a material manner in 2007, as education sector
contracts have changed materially on two accounts. One is greater use of temporary contracts that have gained as a per cent
share of overall employment in the education sector. The second a push toward shorter contracts than the past use of
twelve-month agreements that would get renewed each September. The accompanying chart shows that in recent years, this
distortion is not adequately controlled through seasonal
adjustment factors such that steep declines in July are
                                                              350               Canadian Housing Starts & Building Permits
then followed by strong gains usually the following
month. The strength in the underlying macroeconomic           300                Building Permits
momentum is expected to remain solid enough for the
Canadian labour market to continue to tighten in the
major sectors. We expect that about 50,000 new jobs           200
were generated in August, pushing the unemployment
                                                              150                        Housing Starts
rate a touch lower to 7.9%, much below the U.S. jobless
rate, highlighting once again Canada’s outperformance         100
during the cycle. The tail risk lies in the prospect of a      50
sizable gain in the teaching segment — either in August
and/or September — versus the downside risk posed by            0
the exceptionally high base effect comprised of strong            05           06          07          08         09       10
                                                              Source: Statistics Canada, Scotia Capital Economics
job gains in Q2.

Global Economic Research                                                                                   September 3, 2010

                                                                                                                 Capital Points

We get three key housing releases next week: housing starts, building permits and the new housing price index.
Housing starts and building permits are expected to have softened further in July — down 4.8% m/m and 4.7% m/m,
respectively — while the advances in new house prices are likely to have continued to decelerate, with our in-house call for
a flat reading in July. Canadian resale housing inventories are rising at an unusually rapid pace, are likely to rise further yet
to test prior highs, and that could well portend further weakness for the Canadian housing market in the months ahead. That
is likely to cause builders to be reticent to add supply at the same pace as earlier in the year. The resale supply overhang is
now pushing back up towards the range of late 2008 and early 2009, such that it would take about eight months to clear out
the total number of listings on the market at current selling rates assuming selling activity remains unchanged. Recent
housing market data provide preliminary evidence that homebuilders are being cautious on two counts, including signs of
softening conditions in the housing market and the effect of the HST on upper-valued homes. Currently elevated starts
reflect contracts signed in recent months to partly avoid the HST and to avoid higher borrowing rates in future, but this is
mostly an effect on resale homes whereas new homes are only impacted by the HST in terms of closing costs.

Headline second-quarter GDP growth disappointed because of a large import leakage effect that is conceptually similar to
the experience in the United States. Strong imports reflect a healthy domestic economy, but in a GDP sense subtract from
growth. In July — the first reading for the third quarter — Canada’s nominal international trade deficit with the world is
likely to have narrowed slightly. We estimate this gap to come in around -C$0.7 billion, from -C$1.1 billion in June.
Broadly higher commodity prices — the Reuters/Jefferies Commodity Research Bureau (CRB) Index up 6.1% m/m — and
stronger domestic demand were likely the key drivers, only partly offset by CAD appreciation. Looking ahead, we think
that the effects of net trade versus other components of GDP growth will continue to trade off against each another. A
continued rise in imports of machinery and equipment signals ongoing growth in domestic business investment. Canada
imports over 70% of its capital goods purchases, so the trade figures give us an early glimpse of what happened to business
investment in July and thus simultaneously give a glimpse at trade and domestic drivers of growth. Canadian businesses
continue to capitalize on three forces that are driving investment, including a strong currency, favourable financing, and
accelerated depreciation and tax incentives.

There are no government bond auctions or important speeches lined up for next week. The BoC enters a blackout period
that extends from this past Wednesday to the Wednesday following next week’s statement.


The U.S. fundamental lineup is sparse. In terms of top-tier 150                           U.S. Non-Petroleum Trade
indicators, only the July trade balance is due out on          140
                                                                      US$ billions, seasonally adjusted
Thursday morning. While stronger commodity prices will 130
lift the dollar value of net exports in Canada, it will have   120
the opposite effect in the United States given that the latter 110       Imports

is a net importer of petroleum. Add strong business
investment to this picture – as companies continue to                                                 Exports
retool after two years of holding back, although at a
somewhat slower pace than in the recent months – and
softening foreign demand, and we are likely to see a
modest widening in the international trade deficit in July,
                                                                    03      04        05        06      07     08  09 10
to US$51.0 billion from US$49.9 billion in the previous         Source: BEA, Bloomberg, Scotia Capital Economics
month, detracting from GDP growth. The second round of
revisions to second-quarter GDP growth revealed that net
trade was more of a drag on growth than the initial report suggested. Sure enough, exports were revised from a 10.3%
annualized gain to a 9.1% gain. Imports accelerated from the initial print of 28.8% to a gain of 32.4% now. Most recent
leading indicators reaffirm this view, as illustrated by an expanding ISM reading for manufacturing imports in August, and
a sharp decline in new export orders since May.

The Fed will publish the latest Beige Book — which will cover the period through mid-August — a survey of the private
sector that aims to gauge business sentiment on a variety of topics, including consumer spending, inventories, credit
conditions and commercial real estate, among others. The previous issue revealed that of the twelve Fed districts, two
(Cleveland and Kansas) reported that economic activity was merely steady, while another two (Atlanta, Chicago) indicated
that the pace of recovery was shifting into lower gear. This comes in contrast to June’s results when all twelve districts

Global Economic Research                                                                                  September 3, 2010

                                                                                                                Capital Points
reported growth. We expect that the August Beige Book will be laden with anecdotes of softening data particularly skewed
toward weak housing markets and abruptly slower business investment.

Minneapolis Fed President Kocherlakota — an alternate voter — is lined up to speak on “Inside the FOMC” at a noon
luncheon with business leaders on Wednesday at 2:30pmET in Missoula, Montana. This is the lone Fed speech of the

The U.S. Treasury is scheduled to sell $33 billion in 3-year notes on Tuesday at 1pmET. It is also set to reopen 10-year
($21 billion) and 30-year ($13 billion) notes at 1pmET on Wednesday and Thursday.

According to the Tentative Outright Treasury Operation Schedule Table, the Fed will complete more purchases of
Treasury notes, using the principal payments from agency debt and agency MBS. The purchase of notes is lined up for
11amET on Tuesday and Thursday.


Aside from the Bank of Canada, a handful of first- and second-tier central banks are scheduled to hold monetary policy
meetings next week, including the Bank of England, the Bank of Japan, the Reserve Bank of Australia as well as
central banks in Peru and South Africa. All central banks are expected to keep overnight rates on hold with exception of
the Bank of Canada — which is expected to hike by 25bps to 1.0% — and the South African Reserve Bank, widely
forecast to cut its key lending rate by 50bps to 6.0%, to lend a hand in stimulating a sputtering economy and a weak labour
market. South Africa is trying to recover from its first recession since 1992. Growth and inflation continue to moderate,
with the former predicted to average 3.0% through 2012 — below what’s needed for a sustainable recovery — and the latter
approaching the lower bound of the central bank’s 3-6% range, where it is expected to remain through 2012. Weakness in
mining and manufacturing remain the primary sources of weakness. South Africa’s National Treasury forecasts that its
debt-to-GDP ratio will climb to about 44% in 2015, before it starts to gradually come down.

The BoE, BoJ and RBA are likely to remain on hold, as they continue to monitor developments at home and globally.
Fundamental data, at a global level, have shown evidence of losing momentum, and look to weaken through the end of the
year. Markets are once again debating over the impact of the fiscal austerity measures, the likelihood, type and size of
additional stimulus as well as the possibility that the global economy could falter again, as some chase the upside and others
remain on the downside. The risk lies in the tone of the statements, and any mention of further easing.

Following two heavy data weeks, it should be quieter on the fundamentals front next week. In Asia, the highlight will be
employment data, including the Australian August employment report as well as the results of the latest Manpower
Surveys for China and India. There will be a steady flow of macro releases from Japan, which will include July leading
index, machine orders and trade balance, the August reports on bank lending and consumer confidence as well as the
final print for second-quarter GDP.

In Europe, July updates on international trade and industrial production will shed light on the latest developments in
two key components supporting growth in the region. The sixteen-nation economy’s trade balance powered back into
positive territory in June, with a €2.4 billion euro surplus after a sizeable deficit in May, led by manufacturing, underscoring
the importance of that industry to the overall economy. A wider energy deficit provided some offset. In contrast, the
twenty-seven member composite — which includes services-heavy United Kingdom and production-oriented Poland —
registered a €9.6 billion deficit, a sharp improvement from the prior month’s €14.8 billion gap.

Global Economic Research                                                                                             September 3, 2010

                                                                                                                            Capital Points

                                                                                                                      Carlos Gomes (416) 866-4735
Auto Industry Update                                                                                      

Canadians Buy More & Bigger Vehicles, Even As Global Volumes Moderate

While global auto sales are softening, Canada has been bucking the trend thanks to generous incentives even while such incentives
wane in the US. Those incentives may ease going forward, but be replaced by lagged positive effects stemming from solid job
growth. Implications for the Bank of Canada’s rate announcement next week stem from reasonable expectations for a solid retail
sales report on September 22nd given what we already know about the gain in vehicle sales.

Global Vehicle Sales Softening
Global car sales fell below a year earlier in July, a significant slowdown from a 16%                        Vehicle Sales & Detroit Three
surge in the first half of 2010. A double-digit slump in Western Europe, due to the                            Market Share — Canada
expiry of scrappage incentives, accounted for the fall-off. However, outside of                 1.9                                               58
Europe, purchases have also started to moderate, with volumes advancing year-                         millions of units, 3mma          per cent
                                                                                                1.8                                               56
over-year by only 9% last month — the smallest gain since last summer.
Purchases held up better in the United States, climbing to an annual rate of 11.5                                                                 54
million units in July, up from a first-half 2010 average of 11.2 million. Higher                1.7
                                                                                                                            Vehicle               52
retail activity accounted for the improvement, climbing to an annualized 9.2                    1.6                          Sales
million units in July — the highest level since last year’s “cash for clunkers”                                                                   50
program and up from 9.0 million in the second quarter and 8.6 million in the                    1.5                                               48
opening months of 2010. Strengthening retail sales is a key development for the                                                                   46
auto industry, especially since it occurred without much of an increase in incentive            1.4
spending and against a backdrop of softening in consumer confidence and weak                           Big Three                                  44
employment growth.                                                                              1.3   Market Share                                42
                                                                                          1.2                                            40
Canadian Vehicle Sales Out-Performing
                                                                                                     2008           2009            2010
While global car sales have softened over the summer, strong employment growth, as
well as enhanced incentives, such as “employee pricing for everyone”, have boosted
vehicle replacement demand in Canada, helping to lift new vehicle sales to the highest level in nearly three years. In fact, the recent
improvement in vehicle purchases has led us to raise our full-year 2010 Canadian sales forecast to 1.565 million units from 1.525 million.
July’s outsized m/m gain of 8% over June at a seasonally adjusted annualized pace (SAAR) was mostly retained even after August’s 4%
(SAAR) decline over July to keep the trend of strong sales intact. Despite the month-to-month moderation in August, sales gains are
broadening out to include more automakers — a positive for the industry. However, most of the strength is concentrated in the
heavily-incentivized light truck segments.

New vehicle sales have about a one-fifth weighting in retail sales. New and used vehicle sales have about a one-quarter weighting. Thus,
while it’s certainly not in the bag, we’re cautiously optimistic that such a solid gain in vehicle sales in July will translate positively into the
September 22nd retail sales report in nominal and volume terms, although the August retail sales report is likely to reverse the momentum
insofar as the decline in vehicle sales in that particular month is concerned.

We expect this summer’s escalation in incentives to moderate in coming months, as it represents a significant divergence from
developments in the United States, where automakers — especially those based in Detroit — have scaled back incentives. Industry data
suggest that US inducements have fallen by 4% so far this year, with incentives for light trucks posting the largest decline. We estimate
the average inducement to buy a new vehicle in the United States has fallen to about 10% of transaction prices, down from more than
12% in early 2009. In Canada, the current incentive binge ranges from 10% of MSRP for small cars to nearly 30% for light trucks — a
level that is clearly unsustainable.

However, even with lower incentives, we expect improving employment prospects after a tough recession to support modest sales
gains going forward. Vehicle replacement demand in Canada slumped to only 6% of the vehicle fleet last year, from an average of
nearly 7% over the past decade. This boosted the number of vehicles on Canadian roads that are at least 9 years old by nearly
80,000 last year to a record 8.6 million, with many in need of replacement. In addition, even as automakers scale back incentives,
we expect them to hold the line on pricing in the new model year, a development that will support industry volumes, as well as
more traditional market segmentation. We expect Canadian sales to total 1.59 million units in 2011, in line with the average of the
past decade. In contrast, even with some improvement next year, US volumes will still remain 20% below the decade-average.

Global Economic Research                                                                                         September 3, 2010

                                                                                                                       Capital Points

                                                                               Gorica Djeric (416) 862-3080           Derek Holt (416) 863-7707
Canadian Monetary Policy                                           

BoC Preview & Would the BoC Risk CAD Over-Reaction on a Hiking Path?

We offer some brief top reasons why we think the BoC should hike its overnight rate on September 8th, and elaborate below upon
one of those reasons insofar as the impact on CAD is concerned:

   The BoC can hike, and then take it back on the bias if it chooses as per the recurring theme over the past two statements. The
     purpose of a neutral bias or flagging greater uncertainty would be the same as in prior statements—keep markets guessing right
     up to the moment of the next statement so they do not prematurely tighten before the BoC is itself prepared to do so. This is
     the reverse of the conditional commitment, insofar as managing expectations on the exit phase of the cycle is concerned.

   The tone of recent Canadian data has been considerably better than interpreted by markets, though that’s somewhat less true of
     domestic accounts. Jobs fell in July, but largely through a one-off education distortion that will work itself out. Retail sales
     were soft in nominal terms, but up solidly in real terms. Q2 GDP missed expectations by a half point and about double that
     compared to BoC expectations, but largely through a large import leakage effect that sapped 1.2 percentage points out of
     annualized GDP growth but that nonetheless reflects sound growth in domestic business investment that drove much of the
     surge in imports through capital goods and industrial materials.

   The BoC could well look through near-term US weakness as a soft patch without being fundamentally knocked off course in its
     expectations for a continued US recovery into next year.

   Inflation is within the general direction of the BoC’s forecast for a soft patch on core CPI readings over the months following
     the HST via the indirect effects of refunded tax credits, and it is still reasonable to expect a 2% target a year from now.
     Further, markets didn’t notice that seasonally adjusted core CPI was up a touch, versus what flashed across their screens by
     way of a dip in the seasonally unadjusted print.

   Hiking would send a confidence signal to markets and the broader economy, versus the headlines that would follow should the
     BoC stop in its tracks on deeper worries.

   Through today’s products, households have a far greater ability to neutralize higher rates either through extending mortgage
     amortization or using revolving interest-only lines. That may lessen interest sensitivities in household consumption. As we’ve
     written over the past year, household imbalances through record-high leverage, house prices, home ownership rates and debt
     payments may all require monetary policy tightening to counter the too-low-for-too-long risk.

   Market easing through a depreciated CAD and lower bond yields that flow through to financing costs facing businesses and
     households has neutralized much if not all of what the BoC has done via a modest half-point hike to its overnight rate so far.
     Thus, the BoC may want to reassert tightening conditions by raising its overnight rate.

   The balance of global risks is often interpreted to just mean flagging downsides to US growth, but Europe has come on stronger than the
     BoC, ourselves, and markets expected to this point, while China is so far proving more resilient than earlier fears over an abrupt slowing.

As one final issue we explore for now, can the BoC sustainably raise interest rates ahead of the Fed insofar as risks to CADUS
would be concerned? We think that such concerns are somewhat exaggerated. Using widely cited research done by the Bank of
Canada on currency drivers (Issa, Lafrance and Murray, 2006, “Turning the Black Tide: Energy Prices and the Canadian Dollar,”)
we figure that a 100bps sustained rise in Canada-US spreads would result in about a 4% long-run appreciation in the Canadian
dollar. If today’s exchange rate were to accurately incorporate known information to date and if it contained no rate expectations
already built into today’s spot, then it would mean that CAD could rise to near parity against the USD over the next year should the
BoC keep hiking by another 100bps while the Fed sleeps. That’s roughly a four cent appreciation in the Canadian dollar’s rate of
exchange against the USD. Further, the real outcome also depends upon what is happening to other currency drivers like energy
and non-energy commodity prices given the effects that Issa, Lafrance and Murray empirically estimated. Every 1% rise in energy
prices leads to an appreciation of one-fifth that pace in CAD against the USD, and every 1% rise in non-energy commodity prices
results in a rise of about one-third that pace. Scotia Economics is of the view that commodity prices are generally moving sideways
into next year on an average annual basis, so CAD is unlikely to get a further lift. Indeed, if global growth disappoints as we think
it is likely to in 2011, then commodities may face a softening bias at points. So pushing CAD more than a few pennies above where
it is now as a long-run sustained forecast is a mild outcome stemming from the impact of a 100bps further interest rate differential.
Some of that, however, is already priced into the short-ends of the Canadian and US markets such that CAD’s rate of appreciation
could well be significantly less than what we’ve argued above. As for the economic impact of a stronger CAD, we continue to
believe that it’s a different ball game today than in past cycles over prior decades. See our “CAD Parity Doesn’t Mean What it
Used To,” (April 6th 2010). On balance, we figure that CAD appreciation would have a modest impact on the overall Canadian
economy notwithstanding regional or sector effects that are more the responsibility of fiscal than monetary policy.

Global Economic Research                                                                                               September 3, 2010

                                                                                                                              Capital Points

                                                                                                                           Mary Webb (416) 866-4202
Fiscal Policy                                                                                                  

U.S. Social Security— One Part of the Longer-Term Solution

President Obama charged the bipartisan Fiscal Commission with the                             U.S. Social Security Finances Under Current Law
Herculean task of developing policies for longer-term fiscal sustainability,               6.5
                                                                                                  % of GDP
with a mid-term goal of balancing the budget by 2015, excluding interest                                                          Outlays
payments. With the restraint of big-ticket entitlement programs key to this                6.0
mandate, the Congressional Budget Office (CBO) updated in July the
potential impact of a range of Social Security adjustments. Its review of                  5.5
the U.S. Social Security program’s basic arithmetic is timely in light of
the adjustments under way in Europe.                                                                                              Revenues*
In 2010, for the first time since the program amendments in 1983, Social
Security outlays in the U.S. are expected to exceed its annual tax revenues.        4.5
As the economic recovery and job creation progresses, Social Security tax                       09           20f         40f         60f          80f
revenues are expected to once again exceed outlays, but only until 2016, under       * Includes only dedicated taxes, not interest. Source: CBO,
current legislation. Currently, a 12.4% payroll tax, split evenly between           July 2010.

employers and employees on taxable earnings up to an indexed maximum
                                                                                    Impact of Selected Social Security Reform Options
($106,800 in 2010), provides about 97% of the dedicated tax revenues for
Social Security. The additional 3% comes from income tax on Social                                                Change to Social Security Balance
Security benefits paid by higher-income beneficiaries. Retirees and their                                                      percentage points of GDP
                                                                                                                                         2020f 2040f
families, and the families of deceased workers presently receive 69% and
                                                                                Options for Payroll Tax on Earnings
12% of the benefits, and Disability Insurance benefits account for the          Raise rate 1 percentage point in 2012                      +0.4     +0.4
remaining 19%. Any surplus of dedicated tax revenues is paid into the           Raise rate 2 percentage points over 20 years               +0.3     +0.7
Old-Age and Survivors Insurance (OASI) trust fund or the Disability             Eliminate taxable maximum with benefit increase            +0.8     +0.6
Insurance (DI) trust fund and the investment earnings of these two funds        Tax covered earnings above taxable maximum
                                                                                   with no benefit increase                                +0.9     +0.9
are continuously reinvested. The CBO projects that the DI trust fund will
                                                            1                   Options to Adjust Benefits
be exhausted by 2018 and the OASI trust fund by 2042 . From 2010 to             Trim personal insurance amount factors by 15%              +0.2     +0.7
2035, the number of U.S. residents 65 years or older will climb 90%             Index initial benefits to changes in longevity                 -    +0.2
compared with the rise of more than 10% projected for residents age 20-         Index initial benefits to prices not earnings                  -    +0.8
642. The Social Security program’s actuarial balance, calculated over 75        Lower initial benefits for top 50% of earners                  -    +0.3
years, is equal to the present value of projected tax and investment income Enhance low earners' benefits for years worked                 -0.2     -0.4
plus the two trust funds’ balances at the beginning of the period minus the Cut COLAs by 0.5 percentage points                             +0.2     +0.4
present value of the projected outlays and the cost of maintaining a reserve Raise Full Retirement Age to 68 by 2028
                                                                                                                                               -    +0.2
equal to one year’s benefits at the end of the period. From 2010 to 2084,       Source: CBO, July 2010.
the CBO estimates an actuarial shortfall equal to 0.6% of GDP or 1.6% of
the taxable payroll. While this shortfall may appear modest, in fact neither increasing the payroll tax by 2.0 percentage points over two
decades nor cutting benefits by 15% would result in sustainable solvency for the program.
Several potential Social Security changes from the 28 variations assessed by the CBO are summarized in the table above. Criteria
for assessing each option or combination of options include the financial impact and the incidence by income and age group. The
urgency in deciding upon reforms after years of discussion stems from the greater accumulated savings possible with earlier action
and the need to phase in changes to ensure similar tax and benefit rules for individuals of similar ages and circumstances. A number
of European nations have decided to raise the age at which workers can receive full retirement benefits. In the U.S., this age is
currently 66 (65 for workers born before 1938), rising gradually to 67 by 2022 for workers born after 1959. A one-year increase in
this age is estimated to trim a retired worker’s monthly benefit between 5% and 8%, a significant cumulative decline over a
worker’s retirement. Other options beyond specific tax and benefit adjustments include President Bush’s proposed introduction of
individual accounts. Another potential change, followed by the Canada Pension Plan, is broadening the trust funds’ investment
options beyond their current practice of investing solely in Treasury securities that currently yield far less than the assumed 3% real
rate of return. The Fiscal Commission’s potential recommendations with respect to Social Security are likely to represent just a
springboard for further negotiation. Nevertheless, the CBO paper reiterates the advantages of moving forward on longer-term policy
imperatives at the same time as measures are implemented to scale back Washington’s current deficit.
  When the DI trust fund was almost depleted in 1994, legislation allocated funds from the OASI trust fund. Assuming this happens again, the
CBO estimates that together the OASI and DI trust funds would be exhausted in 2039.
  If the age distribution of the U.S. population remained constant, Social Security outlays would drop from the current 4.8% of GDP to 4.5%.

Global Economic Research                                                                                        September 3, 2010

                                                                                                                      Capital Points

                                                                           Camilla Sutton (416) 866-5470         Sacha Tihanyi (416) 862-3154
Foreign Exchange Markets                                       

BIS’ Triennial Central Bank Survey Highlights Important Themes in FX Markets

This week the Bank for International Settlements (BIS) released its Triennial Central Bank Survey: Foreign Exchange and
Derivative Market Activity in April 2010. Detailed in the report is the size and structure of the FX market and the trends embedded
within. The report can be found on BIS website at:

Turnover in the FX market now stands at a staggering $4trn per day, representing growth of 221% since the 2001 survey and
growth of 20% since 2007 - see chart 1. In dollar terms a significant amount of the growth has come from EUR, which now
accounts for $776bn in daily turnover, however in percentage terms both AUD and CAD have shown significant growth in the last
9years (388% and 237%, respectively).

From the data presented in the report, we have drawn the following important themes:

1.   The percentage of daily turnover in USD is declining, while that transacted in EUR, AUD and CAD is increasing. In 2001 the
     percentage of daily turnover in USD was 45.0%1, this has dropped by a significant 2.5% to 42.5% (see chart 2); while liquidity
     in several of the more periphery currencies has increased. AUD now accounts for close to 4% and CAD 3%; MXN, NZD, CHF
     and EUR have also benefitted from the decline in USD. This supports the view that the status of the USD is slowly (ever so
     slowly) eroding, while the importance of other currencies (even some periphery ones) is increasing.
2.   The daily turnover in FX has grown to $4trn, which highlights that the shear size of the market is astonishing. With a market
     this size price manipulation becomes a challenging feat (including official intervention).
3.   The shifting importance of the central players hints at the importance of FX as a stand alone asset class. The growth in ’other
     financial institutions’ (small banks, hedge funds, pension funds, mutual funds, currency, funds, insurance companies and
     central banks) was substantial, increasing 11% in just three years. While daily turnover by non-financial customers (mainly
     corporates) dropped by 10% in the same period. The combination of the search for alpha and tighter credit standards has likely
     contributed to these diverging trends in counterparties.
4.   Between 2007 and 2010, the spot market increased by almost 50% (from $1.0trn to $1.5trn per day). The rise in algorithm
     trading is suspected to have accounted for a good share of this jump. On the other hand, the FX swap market remained almost
     flat at $1.7trn; hinting that tighter credit standards and a changing market are at least partially to blame.

The FX market continues to evolve. Larger volumes, a shift in players, a growing importance of some of the minor currencies while
that of the US shows early signs of erosion are just a few of the key themes that can be drawn from the new data. September 2013,
the release of the next report, should see these same themes magnified.

Note that the BIS reports the distribution of turnover out of 200, as it assume that one 20bn EURUSD trade is actually a 20bn EUR and a 20bn
USD trade. Accordingly, for simplicity we have used percentages. The BIS report the USD’s distribution of daily turnover in USD as 85 out of
200 in 2010, we have simplified this to 42.5%).

Global Economic Research                                                                                                                                                   September 3, 2010

                                                                                                                                                                                          Capital Points

                                                                                                                                                                       Oscar Sánchez (416) 862-3174
International Markets                                                                                                                                      

China-Asian Pull Growth Effects II

China is bound to continue to propel the rest of Asia.                                            China's Trade with Asia & Growth in Advanced Economies
                                                                                                  Exports: quarterly averages Growth: % quarter-over-quarter GDP change
Notwithstanding our expectation of a deceleration in advanced
                                                                     65                                                                                                                                                                                       6
economies in the second-half of 2010, China’s shipments to the            US$ billions                                                                                                             quarterly growth annualized

Asian region are likely to remain elevated through the rest of the   60                                                                                                                                                                                       4
year. The country’s exports to the rest of Asia have returned to
levels reached at the peak of the previous expansionary cycle in                                                                                                                                                                                              2
2008 (please see chart). Shipments in US dollar value terms to       50
the rest of Asia climbed up in the April-June period to US$60.9      45
billion, a level only surpassed by that observed in the third-                                                                                                                                                                                                -2
quarter of 2008 (US$62.4 billion) the peak of the quarterly          40
                                                                                                                                                          United States
series.                                                                                                                                                                                                                                                       -4
                                                                     35                                                                                   Euro Zone
                                                                     30                                                                                                                                                                                       -6
As to Chinese imports from the rest of Asia, the picture is                                                                                               Japan
                                                                                                                                                          China X's Asia (LHS)
similar as average second-quarter 2010 purchases have no             25                                                                                                                                                                                       -8

historical precedent at US$69 billion, and are only comparable
with levels registered in the second and third quarters of 2008.
Moreover, during the second-half of that year, inter-regional
trade transactions remained elevated (or at least continued within trend) coming down significantly only at the cusp of the global
recession during the first three months of 2009 (note the obvious seasonal effect present during the first quarter of each year).
Therefore, as the US and European economies contracted — in the second half of 2008 — international trade activity within Asia
continued to carve its way ahead independently.

Back to 2010, this time around expectations of rich-nation slowdown rely fundamentally on medium-term fiscal sustainability
issues rather than on risk of a recurring financial meltdown similar to what occurred two years ago. Thus, baring a significant
financial adverse shock (a replay of the Lehman collapse into bankruptcy), we expect inter-Asian momentum to continue to propel

Global Trade Flows
US$ billions, 2008
                                                 $490 (13%)                                         $801(12%)
(% Change w/2007)

                                                         EUROPE                                            $487 (12%)


                              THE                                                                                                                                            ASIA$2,181(15%)


                                                                     $476 (10%)

                            Inter-regional Trade                     $902(6%)
                            Intra-regional Trade                                                                  Source: WTO, International Trade Statistics

Global Economic Research                                                                                       September 3, 2010

                                                                                                                    Capital Points

                                                                                                            Oscar Sánchez (416) 862-3174
International Markets (continued)                                                               

Commercial exchanges between China and the rest of Asia are as high as with advanced economies as the following pie-chart
illustrates according to latest data available (second-quarter of 2010).
Moreover, as the trade flow chart also depicts, World Trade Organization data shows that up to 2008 inter-Asian exchanges are
advancing at a faster pace than anywhere else in the globe. Inter-Asian trade grew 15% between 2007 and 2008; the strongest gain
of any region worldwide. We believe that this trend likely intensified in the past year-and-a-half pointing further towards the
independence of the Asian growth engine.

Looking ahead nothing seems to indicate that a replay of the 2008 story cannot play out, with inter-regional trade remaining
elevated as the countries converge towards sustainable rates of economic expansion.

As to the foreign exchange implications of this outlook, recent Chinese yuan (CNY) vis-à-vis the US dollar seems to have been
reacting to expectations of a deeper slowdown in China. Given most recent indicators (Chinese PMI reverting losses and rising
again above the 50 threshold), we anticipate a resurgence of flows into China as growth prospects are perceived as healthier. As
expectations are redirected the CNY is likely to start strengthening back towards the 6.50 level. The CNY stands currently at 6.80.

                                                                                                                 Tuuli McCully (416) 863-2859
International Markets                                                                                

Despite Euro Zone’s Solid Economic Growth, Monetary Stimulus Remains in Place

The monetary policy stance in the euro zone remains accommodative; the European Central                            ECB RATES ON HOLD
Bank (ECB) left its benchmark interest rate unchanged at 1.0% following the Governing                                     (%)
Council meeting on September 2nd. The ECB also extended its support for the banking sector by       4.0

continuing to provide unlimited three-month funding until the end of this year. The monetary        3.5
policy decisions indicate that authorities maintain their view that the regional economy requires   3.0
continued support from an accommodative policy stance before emergency stimulus measures                                     FORECAST
can be withdrawn; we do not expect interest rate increases before the final quarter of 2011,
while some insights regarding the ECB’s exit strategy for emergency liquidity measures will         2.0

likely be provided at the end of this year at the earliest. In announcing the decision, President   1.5
Jean-Claude Trichet maintained his long-standing view that euro zone interest rates remain          1.0
“appropriate”. While he noted that uncertainty still prevails, he seemed significantly more
optimistic about the regional economic recovery, emphasizing that the economy is enjoying a
positive underlying momentum; nevertheless, a deceleration of growth can be expected in the         0.0
                                                                                                          08       09      10     11
second half of the year with euro zone output continuing to expand at a moderate pace.

For now, the euro zone is well entrenched on a much better than anticipated growth trajectory. The economy experienced the fastest
growth in four years in the second quarter of 2010 and outperformed the US, as output expanded by 1.0% q/q (1.9% y/y). Revised
data for the April-June period show that the recovery is well-balanced, with activity spreading from the external side to the
domestic economy. Exports continued to expand rapidly, but so did imports (both were up by 4.4% q/q); accordingly, private
consumption was an important source of growth, expanding by 0.5% q/q following a revised 0.2% increase in Q1. Moreover,
investment expanded for the first time since the first quarter of 2008, growing by 1.8% q/q. While Germany remains the star
performer of the euro zone (output was up by 2.2% q/q in Q2 — outperformed only by Finland with a 3.1% q/q expansion), there
are significant differences in economic performance between the core countries and the euro zone periphery. Nevertheless, a pickup
in domestic demand in the core economies is encouraging for the euro zone periphery’s revival as it should provide support to the
southern European nations’ external sectors at a time when their domestic spending remains subdued due to austerity measures. We
maintain our view that the economic momentum is carrying into the third quarter, as confirmed by improving economic confidence
in the euro zone. On the back of stronger-than-anticipated data, the ECB revised its real GDP growth forecasts to 1.6% for 2010
from 1.0% and to 1.4% from 1.2% in 2011. The regional outlook for 2011 is challenging as growth dynamics — particularly in the
export sector — will be affected by an economic slowdown in the US and a more moderate expansion in China. Inflationary
pressures should remain contained over the medium term on the back of weak money and credit growth; a flash estimate shows that
euro zone inflation eased to 1.6% y/y in August, remaining within the ECB’s target of “below, but close to, 2%”.

Global Economic Research                                                                            September 3, 2010

                                                                                                        Capital Points

Estimates for the week of September 6 – 10


Date      ET      Indicator                                              Period   BNS     Consensus      Latest
09/08   (08:30)   Building Permits (m/m)                                  Jul     -4.7       -5.3         6.5
09/08   (09:00)   BoC Interest Rate Announcement (%)                              1.00      1.00         0.75
09/09   (08:15)   Housing Starts (000s a.r.)                             Aug      180.0     185.0        189.2
09/09   (08:30)   New Housing Price Index (m/m)                          Jul        0.0       0.1          0.1
09/09   (08:30)   Merchandise Trade Balance (C$ bn)                      Jul       -0.7      -0.8         -1.1
09/10   (07:00)   Employment (000s m/m)                                  Aug      50.0      25.0         -9.3
09/10   (07:00)   Unemployment Rate (%)                                  Aug      7.9        8.0          8.0

           United States

Date      ET      Indicator                                              Period   BNS     Consensus      Latest
09/07   (07:45)   ICSC Chain Store Sales - Weekly (w/w)                 Sep. 04    --        --           0.1
09/07   (17:00)   ABC Consumer Confidence (index)                       Sep. 05    --        --           -45
09/08   (07:00)   MBA Mortgage Applications (w/w)                       Sep. 03    --        --           2.7
09/08   (14:00)   Beige Book
09/08   (15:00)   Consumer Credit ($ bn m/m)                              Jul      --       -4.8         -1.3
09/08             Kocherlakota Speaks in Missoula, Montana, on FOMC (14:30)
09/09   (08:30)   Initial Jobless Claims (000s)                         Sep. 04    465       470          472
09/09   (08:30)   Continuing Claims (mn)                                Aug. 28    4.42      4.44         4.46
09/09   (08:30)   Trade Balance ($ bn)                                    Jul     -51.0     -47.3        -49.9
09/10   (10:00)   Wholesale Inventories (m/m)                             Jul      --        0.4          0.1

Global Economic Research                                                                             September 3, 2010

                                                                                                         Capital Points

Estimates for the week of September 6 – 10


Date      ET      Indicator                                                Period   BNS    Consensus      Latest
09/06             ECB's Stark Speaks in Berlin (05:00)
09/07   (06:00)   GE Factory Orders (m/m)                                   Jul      --       0.5          3.2
09/07             ECB's Bini Smaghi Speaks in Beijing (02:00)
09/07             ECB's Stark Speaks in Wiesbaden (13:30)
09/08   (00:00)   UK NIESR GDP Estimate (q/q)                             Aug        --        --          0.9
09/08   (02:00)   GE Current Account (EUR bn)                              Jul       --      11.5         12.9
09/08   (02:00)   GE Trade Balance (EUR bn)                                Jul       --      13.0         14.1
09/08   (02:45)   FR Trade Balance (EUR bn)                                Jul       --      -4.1         -3.8
09/08   (04:30)   UK Industrial Production (m/m)                           Jul       --       0.4         -0.4
09/08   (04:30)   UK Manufacturing Production (m/m)                        Jul       --       0.3          0.3
09/08   (06:00)   GE Industrial Production (m/m)                           Jul       --       1.0         -0.6
09/08             Mersch, Juncker, Maystadt Speak At Event in Luxembourg (12:00)
09/09   (01:30)   FR Non-Farm Payrolls (q/q)                                Q2-F     --        0.2          0.2
09/09   (02:00)   GE CPI (m/m)                                               Aug     --        0.0          0.0
09/09   (02:00)   GE CPI - EU Harmonized (m/m)                               Aug     --        0.0          0.0
09/09   (04:30)   UK Visible Trade Balance (GBP bn)                          Jul     --       -7.5         -7.4
09/09   (07:00)   UK BoE Policy Announcement (%)                                    0.50     0.50         0.50
09/09   (07:00)   UK BoE Asset Purchase Target (GBP bn)                      Sep     --      200.0        200.0
09/09             ECB's Erkki Liikanen Speaks at the Finnish Parliament (05:00)
09/09             ECB's Ordonez Speaks in Madrid (13:00)
09/10   (02:45)   FR Industrial Production (m/m)                            Jul      --        --         -1.7
09/10   (02:45)   FR Manufacturing Production (m/m)                         Jul      --      0.7          -1.3
09/10   (04:00)   IT Industrial Production (y/y)                            Jul      --      5.70         8.20
09/10   (04:30)   UK PPI Input (m/m)                                       Aug       --       0.1         -1.0
09/10   (04:30)   UK PPI Output (m/m)                                      Aug       --      0.1          0.1
09/10   (05:00)   IT GDP (y/y)                                             Q2-F      --       1.1          1.1


Date      ET      Indicator                                                Period   BNS    Consensus      Latest
09/06   (19:50)   JN Foreign Reserves (US$ bn)                              Aug      --        --         1064
09/06             JN BoJ Target Rate (%)                                            0.10     0.10         0.10
09/07   (00:30)   AU RBA Cash Target Rate (%)                                       4.50     4.50         4.50
09/07   (01:00)   JN New Composite Leading Economic Index                  Jul       --      98.2         99.0
09/07   (01:00)   JN Coincident Index CI (index)                           Jul       --      101.8        101.3
09/07   (04:00)   TAI Trade Balance (US$ bn)                               Aug       --       2.2           2.2
09/07   (04:00)   TAI Exports (%)                                          Aug       --      24.2         38.5
09/07   (04:00)   TAI Imports (%)                                          Aug       --      28.0         42.7
09/07   (19:50)   JN Machine Orders (m/m)                                  Jul       --       2.0           1.6
09/07   (19:50)   JN Current Account (YEN bn)                              Jul       --      1535         1047
09/07   (19:50)   JN Trade Balance (YEN bn)                                Jul       --       865          769
09/07   (19:50)   JN Bank Lending (y/y)                                    Aug       --        --          -1.8
09/07   (21:30)   AU Home Loans (%)                                        Jul       --       1.0          -3.9
09/08   (01:00)   JN Eco Watchers Survey (current)                         Aug       --      49.9         49.8
09/08   (01:00)   JN Eco Watchers Survey (outlook)                         Aug       --      46.4         46.6
09/08   (21:30)   AU Employment (000s)                                     Aug       --      25.0         23.5
09/08   (21:30)   AU Unemployment Rate (%)                                 Aug       --       5.2          5.3
09/09   (01:00)   JN Consumer Confidence                                   Aug       --       --          43.4
09/09   (19:50)   JN GDP Annualized (q/q)                                  Q2-F      --      1.5           0.4
09/09   (19:50)   JN GDP Deflator (y/y)                                    Q2-F      --      -1.8         -1.8
09/09   (21:00)   PHI Exports (y/y)                                         Jul      --      28.5         33.7
09/10             JN BoJ Minutes – August 9-10

Global Economic Research                                                                                                   September 3, 2010

                                                                                                                                 Capital Points


Economics                                                                  Equity Research
Derek Holt, Vice-President                                                 John Henderson, Managing Director, Head of Equity Research                                     

Karen Cordes Woods, Financial Markets Economist
(Currently on maternity leave)                                             Fixed Income
Gorica Djeric, Financial Markets Economist                                 Roger Quick, Director                                  
Mary Webb, Senior Economist/Manager                                                Foreign Exchange

Corporate Bonds                                                            Camilla Sutton, Director
Robert Follis, Managing Director                                            Sacha Tihanyi, Associate Director
Stephen Dafoe, Director
                                                                           ScotiaMcLeod Portfolio Advisory Group
Francesco Sorbara, Associate Director                                        Paul Danesi, Director
Emerging Markets Strategy                                                  Geoff Ho, Director
Joe Kogan, Director
                                                                           Joey Mack, Director
Equity Markets
                                                                           Steve Uzielli, Director
Vincent Delisle, Director, Portfolio Strategy                    
                                                                           Gareth Watson, Director
Hugo Ste-Marie, Assistant Strategist                             

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