Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the second-part of a four-part series on understanding the Canadian dollar.
Let's look at who buys Canadian dollars?
Purchasers of our exports
When Canadian producers sell products and services to buyers in other countries, our producers usually want to be paid in Canadian dollars. So buyers of our exports will need to buy Canadian dollars to buy Canadian products. Alternatively, if our exporters are paid in another currency (perhaps, for example, U.S. dollars), our exporters will usually convert the currency to Canadian dollars. Either way, Canadian dollars are bought when our exporters sell their products and services abroad.
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Understanding the Canadian dollar: A four-part series
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The more we sell to other countries, the more buyers there will be for Canadian dollars. The higher the prices of the things we sell, the more dollars those who wish to buy our exports will need to acquire. As the global economy is beginning to recover, Canada has been selling more and more exports - especially our commodities such as gold, oil, and other minerals - to foreign buyers. As we sell more exports, and as the world prices for the things we sell rise, there is higher and higher demand for Canadian dollars.
This has been one of the most significant factors influencing the recent rise in the value of the Canadian dollar. And that's not such a bad thing because we want to have success selling our exports into global markets. That is why the government and the Bank of Canada are less concerned when this factor causes the dollar's value to rise.
Foreign investors investing in Canada - and the Canadian dollar
There has been a great deal of talk over the last few years about the number of Canadian companies that have been sold to foreign buyers. Some examples include Inco, Stelco, Dofasco, Harris Steel, ATI Technologies, Hudson's Bay Company, Four Seasons Hotels, and Sleeman Breweries. When takeovers happen, the buyers of these companies have to buy Canadian dollars to invest here. This increases the demand for Canadian dollars in foreign exchange markets and helps to push up the value of the Canadian dollar.
Investors around the world also look to buy stocks, bonds, and other investments in other countries. The Canadian stock market has been rising lately, which attracts more investors wanting to buy Canadian stocks. This increases demand for our dollar too.
In addition, the value of the U.S. dollar has been falling as currency traders have been concerned about the state of the U.S. economy, its debt level, and other factors that have reduced confidence in the U.S. dollar's value. This has led them to sell U.S. dollars and buy other currencies - such as the Canadian dollar - to put in their investment portfolios.
This decline in confidence in the U.S. dollar has been another significant factor affecting the value of the Canadian dollar lately. It is important to understand, however, that if the Canadian dollar rises because investors sell U.S. dollars and buy Canadian dollars, that doesn't really help Canada's economy at all. We haven't sold anything in global markets. There have been no Canadian jobs or incomes generated. It simply means that some investors are holding less U.S. dollars in their investment portfolios and more Canadian dollars. That is why the government and the Bank of Canada are more concerned when this factor causes the dollar's value to rise.
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Canadians investing and lending money abroad
If Canadians invest in other countries and lend money to foreign borrowers, they will earn interest and dividends. Therefore, Canadian dollars will need to be purchased by foreign companies, governments and others that have to pay interest and dividends to Canadians.
Speculators who think the dollar's value will rise
There are those who "speculate" on the value of currencies, that is, they try to make money by buying a currency when its value is relatively low and selling it when its value is higher. For example, if someone thinks that the value of the Canadian dollar is going to rise against the U.S. dollar's, they can potentially make money if they use U.S dollars to buy Canadian dollars now. If they are right and the value of the Canadian dollar rises, they can then use the Canadian dollars to buy back the U.S. dollars and get more U.S. dollars than they started with - and end up better off. They will have made money on their speculation that the value of the Canadian dollar would rise.
So if speculators think the value of the Canadian dollar is going to rise versus the U.S. dollar, they will sell U.S. dollars and buy Canadian dollars. Interestingly, of course, their buying helps to push the dollar's value up - something they are hoping will happen. In other words, it is a bit of a self-fulfilling prophecy: if there is a general belief that the value of the Canadian dollar will rise, and people then buy more dollars, this helps cause the value of the dollar to rise.
Lately, speculators and currency traders have made the assumption that the value of the Canadian dollar will likely rise in terms of the U.S. dollar. This has led to more speculative buying.
The catch will be when those same speculators think the value of the dollar has peaked. Then they will begin to sell. Should the value of the Canadian dollar start to fall, others will jump on the bandwagon in an effort to cash out before the value of the dollar falls significantly. That selling by speculators can result in a relatively rapid decline in the Canadian dollar's value - back to where the "speculation component" is taken out.
Part three of this series on Thursday will look at who sells the Canadian dollar, and part four on Friday will examine the dollar's recent rise and volatility.
Gary Rabbior