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Understand the loonie: Part 4

Why the Canadian dollar has been bouncing higher Add to ...

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

The main reasons for the rise in the value of the Canadian dollar in terms of the U.S. dollar over recent months are as follows:

• As the global economy recovers, Canada is selling more exports to the world, especially commodities such as oil, gold, and other minerals.

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• In addition, many see purchases of our commodities increasing as the global recovery gathers steam. This increases confidence in the prospects for the Canadian economy - and can lead to more buying of our dollar.

• At the same time, the prices of the commodities we sell in global markets have been rising, which means foreign buyers have to purchase even more Canadian dollars when they buy the commodities they need.

• A weak U.S. economy and a lack of confidence in the future value of the U.S. dollar are leading people to sell U.S. dollars and buy other currencies - such as the Canadian dollar.

• As the Canadian economy strengthens, there is a belief among some that the Bank of Canada may start to raise interest rates here. That has led to some buying of the Canadian dollar. However, with the dampening effect that the rise in the dollar may have on the Canadian recovery, higher interest rates seem less and less likely. Bank of Canada Governor Carney basically said as much recently when he noted that the rising value of the dollar had offset many of the gains that had occurred in other aspects of our economic recovery. So a rise in interest rates is likely a considerable way off in the future unless things change rather quickly - and significantly.

• Speculators have been buying Canadian dollars (assuming its value will rise) and selling U.S dollars (assuming its value will fall) in the months ahead.



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 loonie has been rising and volatile


At the same time, there has been significant volatility in the value of the dollar - up two cents one day, down a cent and a half the next, up a cent the next, and so on. Much of this volatility relates to the volatility in commodity prices. The world prices of oil and gold and other commodities have been bouncing around - and the value of the Canadian dollar has been bouncing around with them.

Before concluding, there are a couple of things to note:

First, the two most significant factors affecting the value of our dollar are (a) the buying of our exports - especially those commodities that are selling at higher prices and (b) currency traders selling U.S. dollars and buying Canadian dollars. These two factors have different impacts on Canada's economy.

Those buying our commodities put money into Canada and help boost spending and employment. The Bank of Canada and the government are not as concerned about this factor and its impact on the dollar because it brings economic benefits with it.

However, when investors, currency traders, and speculators simply sell U.S. dollars to buy Canadian dollars as part of an investment portfolio, there is no benefit at all to Canada's economy. That is the factor that is of greater concern to the Bank and the government. Such buying of the dollar leads to a higher value but brings no economic benefit.

Second, who wins from a higher Canadian dollar? Those buying imports, those travelling to the United States, those buying U.S. investments, and possibly consumers - if the lower cost of imports is passed on through lower prices. Important winners are the companies that are now able to import new equipment and machinery at a lower cost - thanks to the higher-valued dollar. This can provide an opportunity to upgrade production capabilities and increase productivity. This was an opportunity that was provided the last time the Canadian dollar rose in value, but it is felt that Canadian companies didn't take as much advantage of it as they could have. It is hoped that won't be the case this time.



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On the other side, who can lose? Those looking to buy investments in Canada, those looking to visit and travel in Canada, and, most significantly, our exporters - and especially the manufacturers in central Canada who have been so hard hit by the recession. However, as we noted in an early part of the series, if our exporters can improve their productivity, this can help offset the challenges that are posed by a higher-valued dollar.

And finally, it is important to note that one of the worst case scenarios for businesses, investors, and governments is to have a constantly fluctuating dollar with erratic swings in value. That makes it hard for everyone to plan and to manage their international affairs.

The best case scenario would be for the dollar to settle in, and stay around, its appropriate value - and that would be the value that it deserves based upon Canada's economic resources and productivity, competitiveness, and ability to sell its products and services in global markets. Over time, then, it could move up or down according to the value it - and Canada - deserves.

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