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Understand the loonie: Part 1

What should the value of the Canadian dollar be? Add to ...

Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the first of a four-part series on understanding the Canadian dollar.

There is much talk these days about the Canadian dollar. First was its rapid rise in value versus the U.S. dollar. Lately it has been fluctuating quite significantly in value. Up one day - down the next - sometimes by a cent or more in one day.

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Not long ago, it was common to hear jokes on both U.S. and Canadian television programs and talk shows about the Canadian dollar's value. Not so today.

The key questions that arise are:

  1. Why the fast appreciation in recent months and
  2. What are the consequences of the dollar's rise possibly to parity with the U.S. dollar - and perhaps even beyond?

Understanding the Canadian dollar: A four-part series

  1. What should the value of the Canadian dollar be?
  2. When the Bank of Canada likes the rising loonie -- and when it doesn't
  3. Who sells Canadian dollars
  4. Why the Canadian dollar has been bouncing higher

Before moving on to those questions, though, let's get one thing clear. If we had called our currency a peso, a pound, a lira, or a loonie for that matter, we would not assume that it would equal the value of one U.S. dollar. Because we chose to name our currency a "dollar," we tend to think that one Canadian dollar should equal one U.S. dollar. But there is no reason why that should be the case.

The value of a Canadian dollar in terms of a U.S. dollar reflects the extent to which buyers and sellers in foreign exchange markets want to buy or sell each of the two currencies. Foreign exchange markets exist all around the world. And people buy and sell currencies for various reasons.

In the end, it comes down to a relatively simple fact: if people want to buy relatively more Canadian dollars than U.S. dollars, the value of the Canadian dollar will rise relative to the U.S. dollar. It's all about the basic law of supply and demand.

So what should the value of the Canadian dollar be? The value of the dollar should reflect the strength and potential of our economy - our level of productivity; how well we produce products and services compared with others in the world; whether or not we produce what the world wants to buy; what price global buyers are willing to pay for what we produce; and the level of confidence people have in Canada's currency and economy. These are the factors that affect the buying and selling of our currency; therefore, they are the factors that will affect its value.



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If we are less productive and competitive than another country - and if we are less able than that other country to sell products and services in global markets - then our currency should fall in value in terms of the currency of that other country. In simple terms, that country would deserve a higher-valued currency because of its superior economic performance.

On the other hand, if we invest well, develop new technology (and apply it), educate and train our labour force well, and become more productive and competitive in global markets, then more global buyers will buy from Canada. That increases demand for our dollar - and pushes up its value. And the Canadian dollar would deserve to be higher.

Not only that, but if we improve our productivity, our producers will also be able to contend better with a higher-valued dollar. Currently, we often hear exporters complaining about the challenge they face because of a higher-valued dollar since it makes our exports more expensive. But if we earn that higher-valued dollar because of our improved productivity, our exporters will be better able to overcome the challenges presented by a higher-valued currency.

At the same time, our higher productivity may also lead Canadians to buy more products and services built in Canada - and fewer imports. If that is the case, it reduces the selling of Canadian dollars. Less selling of our dollar also helps to push its value higher.

Therefore, once we eliminate and discount the impact of any speculative buying on the value of the dollar, our dollar should be worth what we make of it - by how competitive, productive, efficient, and capable we are as a player in the global economy. That is the challenge that lies in our future. That is what will ultimately determine the "right" value for our dollar.

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