The past year has seen a substantial U-turn in Canada’s dollar. A year ago, it was trading near $1.02 (U.S.). Tuesday, it settled around 93 cents – a 9 per cent decline.
This is a welcome but overdue reversal to a decade-long updraft. From 2002 through 2007, the loonie shot up more than 60 per cent. Since then, it’s bounced around par with the greenback. Now, it’s finally heading back down. Most economists think the slide will continue, potentially falling below 90 cents this year.
At or near par with the U.S. dollar, the loonie was substantially overvalued by any fundamental measure. The most common way to estimate the “fair value” of a currency is according to relative price levels in different countries – what economists call “purchasing power parity.” On this basis, the Organization for Economic Co-operation and Development pegs the loonie’s benchmark at 81 cents (U.S.).
Temporary factors such as investor expectations, big financial flows or unusual success in export markets can push the exchange rate away from its fair value – for a while. But even waterfowl can’t stay aloft forever, and it’s been clear for years that the loonie would have to come back to earth. At par, the inflated dollar was making Canadian-made goods and services artificially expensive to foreign buyers, a cost penalty of about 25 per cent. Consequently, anything we sold to foreigners (other than resources, which are usually priced in U.S. dollars) was priced out of the market.
In 2004, I published a report predicting the loss of 400,000 manufacturing jobs if the dollar stayed above 85 cents (U.S.). It turns out my guess was conservative: Almost 500,000 have disappeared since the currency took off.
And it’s not just manufacturing that suffered from this flight of fancy. Other export-oriented sectors got hammered even harder. Tourist visits to Canada, for example, have plunged by almost half since 2000 (from almost 50 million per year to just 25 million), reflecting Canada’s status as one of the most expensive destinations in the world. Border towns were devastated; southbound cross-border shopping made matters worse.
Indeed, Canada’s overall trade performance was among the worst in the world during the loonie’s manic flight. Exports plunged from 44 per cent of GDP in 2000 to just 30 per cent last year, making a mockery of the federal government’s supposed trade agenda. Combined with surging imports, this produced an enormous deficit in international payments: more than $60-billion last year, the highest in Canadian history. Since late 2008, our debt to the rest of the world has grown by $290-billion. (That’s twice as much as the growth in federal government debt over the same period.)
Unfortunately, Canadian policy-makers (including Finance Minister Jim Flaherty and successive governors of the Bank of Canada) endorsed the dollar’s rise – even celebrated it, perversely. Unlike other countries that intervene to manage exchange rates (such as Norway, Australia, Switzerland, Brazil, China and Japan), Canadian authorities let the currency float wherever markets took it. Now, finally, Canada’s miserable trade performance is sinking into traders’ consciousness, and the loonie’s flight is reversing.
Several factors combined to drive the loonie back toward earth last year. After clearly inflating the dollar over the past decade, the bitumen boom lost some steam in the face of infrastructure and political constraints. Short-term “hot money” inflows have turned tail, as the Bank of Canada softened its stance on interest rates. Other central banks had been purchasing loonies as part of their own currency interventions, but that buying pressure is now easing, too.
The dollar’s softening is welcome, but needs to go further (toward the OECD’s benchmark) to restore true balance. Unfortunately, much of the damage from the past decade will be permanent. Many industrial jobs that left Canada won’t come back, even if the dollar returns to normal. And global companies worry that if currency traders are infected by another bout of loonie-mania (sparked by oil prices or some other cause), our government will go along with it, destroying competitiveness in the process.
So while I welcome every downward tick, I won’t be popping champagne corks. Canadian policy-makers haven’t learned the lessons of this pointless, destructive escapade – which means it could happen all again.
Jim Stanford is economist with Unifor, Canada’s largest trade union in the private sector.