Forecasts for the Canadian dollar currently being
circulated by various economic and statistical agencies in Canada, suggest that
the currency is likely to weaken in the coming 12 months. In one projection
released by Nova Scotia Bank, the loonie, as the Candian dollar coin is
popularly called, will drop to around 86 cents against the US dollar.
Given Canada’s close trading ties with the United
States, any movement in its currency is significant. Those close ties also mean
that the performance of the loonie is correlated with American economic
activity: its recent softness has been attributed to both a dovish Bank of
Canada and the suggested earlier-than-expected interest rates rise by the US
Federal Reserve.
The Nova Scotia emphasizes the importance of the US
economy to the strength of the Canadian dollar (CAD). It notes, “Late in the
second half of the year, the CAD is expected to stabilize as a building US
economy recovery combined with a sustained depreciation in the currency flow
into the Canadian fundamental backdrop.”
The report continues, “in addition, by the second
half of 2014, there should be improved clarity on the future pipeline
infrastructure and oil exports into the US are likely to continue their steady
upward trend. These factors provide some reassurance but not enough to support
a strong CAD.”
Implications
of a weaker dollar for a Canadian exporting firm
In acknowledging the forecasted trends, this report
sets out to examine the issues surrounding a weaker Canadian dollar. In
particular, the report will focus on how the issues would affect a Canadian
firm with US exports. While the report cannot make precise forecasts, future
business decisions might consider the analysis provided within this document.
The first issue to consider in the environment of a
weaker Canadian dollar is how the weaker currency will affect transactions for
the firm. Firms which primarily import goods and services from the United
States will suffer as a result of the weakness, while those exporting are
likely to see an increase in their exports as their goods and services become
relatively cheaper for foreign firms and individuals.
Firms, however, can rarely be classified as 100%
imports or 100% exports; more often, they are a degree of both. Larger firms in
particular are more export than import-oriented, but even they will, for
example, contract foreign consultants. The Canadian oil exports referred to in
the Nova Scotia report are Canadian raw materials but the oil firms make
payments in US dollars for maintenance of pipelines in the United States and
some distribution costs where necessary, among other expenditures.
The importance of these oil exports to the United
States for Canada cannot be overstated. In mid-2013, Haver Analytics authored a
report[1]
which showed the divergence of Canadian non- energy exports with energy exports
(see above). The report illustrated how it was no exaggeration to say that
Canadian merchandise exports to the United States had (figuratively) “fallen
off a cliff.”
The blue line represents Canada’s net trade balance
in energy (primarily oil) and the red line represents Canada’s trade balance in
non-energy goods and services (primarily vehicles and technology). The trade
balance with the United States was only kept in check by a large energy trade
between the two countries in Canada’s favour.
The US-Canadian trade deficit forms only a part of
a much larger problem for Canada, however. As the chart on the right, based on
Statistics Canada figures illustrates, Canada is consistently and increasingly
showing monthly trade deficits across the board.
Canada’s
Trade Deficits in Context
The Canadian economy may be suffering from a
condition that economists refer to as “Dutch disease.” This economic condition
is commonly encountered by countries with large extractive industries (oil,
gas, forestry, etc.). As the extractive industries increase as a total
percentage of the country’s GDP, the country’s currency strengthens and
non-energy exports tend to suffer, becoming more expensive relative to their
foreign counterparts.
The Canadian dollar began to steadily climb against
the US dollar at the beginning of the last decade, overtaking it for the first
time on September 26, 2007.[2]
This growth of the Canadian dollar happened largely in synch with the growth of
energy prices – a barrel of oil reached US$100 for the first time in January
2008[3],
as the world economy at large reacted to growing Chinese demand for energy.
The relationship between the Canadian dollar and
the US dollar is clearly essential to the health of the Canadian economy. As
much as Canadian premier Stephen Harper would like to market Canada as “an
emerging energy superpower,”[4]
the trade deficit currently facing Canada shows that the growth in energy sales
is a zero-sum game when taken in tandem with the drop-off in non-energy
exports.
As the Canadian dollar has hovered around parity
with the US dollar in the past five years (see graph on left), Canadian
exporters have suffered – providing the human stories behind the figures. For them,
the predicted fall in the Canadian dollar will be welcome news. In theory, it
will allow them to compete on a more even footing with their competitors across
the border in the United States, who have not only benefitted over the past few
years from the currency exchange rate but also historically low borrowing rates
in their domestic environment.
Elsewhere, growth in these non-energy industries
will hopefully offer an incentive to Canadian employers to provide more
employment opportunities. Canada’s unemployment rate remains stubbornly high,
at over 7% according to Statistics Canada. Over the border in the United States
on the other hand, the US Bureau of Labor Statistics says that unemployment
continues to fall and currently stands at just over 6% using US employment
metrics (different to those used in Canada). Canadian economists will keen to
note that these employment gains in the United States are often provided at
firms whose exports are growing, and the employment effectively comes at the
expense of Canadian employment (where the profile of the workforce is relatively
similar to that of the US).
Canadian Inflation
and the Loonie
The strong currency which has been a trademark of Canada over the past
ten years has also been a product of low inflation. Indeed, for a period at the
end of 2009, Canada – like a number of developed nations - even experienced
deflation with prices dropping, mainly as a result of falling energy prices.
The low inflation rate is also no doubt a product of the Canadian
government’s policy of raising interest rates after the global financial
collapse. This was done in stark contrast to the rest of the developed
economies, who all lowered their benchmark interest rates. The United States
even lowered its benchmark rate to 0%. Again, the marked contrast between the
two countries and their policies seemed to stymie the Canadian dollar.
The news at the start of this document that the US Federal Reserve will
raise interest rates later this year can only be good news for advocates of
higher inflation in Canada in the short term. In theory at least, more capital
will flow to the United States to take advantage of the higher interest rates,
creating a demand for the greenback and less demand for the loonie. This in
turn will lead to a stronger US dollar and a weaker Canadian dollar, leading to
increase consumption in Canada and in turn, higher inflation.
Despite the significance of the relationship between the loonie and the
greenback, something else is at play – something which Canada has little effect
over. Because of the loonie’s low inflation and Canada’s stability as an
economy in general, the Canadian dollar is increasingly being added to the
basket of the world’s currencies. Analysis shows that it currently ranks in the
top 5 most held currencies in the world. Traditionally, the US dollar has been
the world’s reserve currency because of a range of its characteristics, but
quantitative easing of the US dollars has hit many holders of US currency
reserves.
Canadian GDP and
the Loonie
Exports account for around 30% of Canadian GDP[5], so in theory, a weaker
Canadian dollar will increase Canada’s exports and in turn, increase its
national output – the GDP. GDP is a delicate balance where the currency is
concerned, however. Although a weaker currency can often lead to higher
employment and increased exports, in dollar terms (the standard measure for GDP
across nations) a rise may not occur if the increased output is offset by the
weakness.
Canada’s GDP rebounded faster than most after the global economic crisis
and continues to do relatively well. Statistics Canada points out that GDP is
on course to increase by 2.3% in 2014,[6] with most sectors in the
economy increasing by some degree. Many of these sectors – as this document
notes – will benefit even further from a weaker Canadian dollar.
A final point to note about Canadian GDP and a weaker Canadian dollar is
that energy prices are sticky. That is to say that the price of a barrel of oil
isn’t decided in Canada or by the strength of the loonie – it is ultimately
decided by world markets. Therefore, even if Canada’s currency weakens, its
energy exports are unlikely to suffer significantly provided that energy prices
remain high.
Conclusions
The Canadian dollar has traditionally traded below parity with the US
dollar. However, since the beginning of the last decade, it began a steady
ascent against the dollar and a number of other currencies. This rise in the
Canadian dollar is primarily attributed to the burgeoning energy sector in
Canada (and to a lesser extent for now, the predicted rise in importance of tar
sands).
The implications for Canada of a stronger currency are thought to have
been mainly negative. The increase in energy sales that occurred over the
period discussed did not offset the concurrent fall in exports, primarily with the
country’s main trading partner, the United States. The discrepancy between the
two nations in terms of trade divided between energy and non-energy exports for
Canada is worrying. For this alone, the predicted weakening of the Canadian
dollar in the short to medium term will be a welcome relief for the Canadian
economy.
As this document has sought to
illustrate, shifts in the value of the Canadian dollar have had a material
impact on Canada’s economy. It is important that these issues are addressed as
best as possible by the powers that-be in the Canadian economic system, so that
they don’t become longer-term questions. As it stands, the stronger Canadian
currency has already made Canada less competitive in an increasingly
competitive and connected global economy.
Although currency moves are
exogenous, the government and the Bank of Canada can influence them through
measures such as issuing government bonds and setting the benchmark interest
rates. The hope is that these decisions are taken on a long-term basis in
Canada’s interest, rather than on a short-term basis in the political interest.
[1] http://www.huffingtonpost.ca/2013/03/06/exports-canada-dutch-disease-dollar_n_2820041.html
[2] http://usd.fx-exchange.com/cad/exchange-rates-history.html
[3] http://www.nytimes.com/2008/01/02/business/02cnd-oil.html?_r=0
[4] http://www.alternativesjournal.ca/community/blogs/renewable-energy/canada-suffering-dutch-disease
[5] http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS
[6] http://www.cbc.ca/news/business/canada-s-gdp-expands-at-2-3-pace-in-may-1.2723591
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