James Powell is former chief of the Bank of Canada’s international department and author of A History of the Canadian Dollar.
What’s happening to the loonie? From parity with its U.S. counterpart as recently as spring, 2013, the Canadian dollar has depreciated by more than 30 per cent, and the pace of its decline seems to be accelerating.
This week, our battered currency fell below 69 cents (U.S.) for the first time in 13 years, down more than three cents since Christmas. Forecasters also seem to be constantly revising their predictions downward. One currency expert now sees the loonie falling to 59 cents by the end of this year, almost three cents below its all-time low of $0.6179 in early 2002.
The answer isn’t hard to find. First, the Canadian dollar is trading against a resurgent U.S. dollar that has risen against all major currencies. Over the past three years, the Japanese yen and the euro have fallen by more than 20 per cent vis-à-vis the greenback, while the pound sterling is down almost 10 per cent.
The strength of the U.S. dollar reflects in large measure the better performance of the U.S. economy in recent years compared with other major economies. With slack in labour and product markets now largely gone, the U.S. Federal Reserve has begun to tighten monetary policy, providing an additional fillip to the currency.
A second, and more fundamental, factor has been a sharp decline in global commodity prices, notably that of oil. In the three years ending December, 2015, Bank of Canada statistics show that the price of Canadian energy exports has fallen by more than 55 per cent, while non-energy commodity prices have declined by more than 28 per cent.
With natural resources accounting for 20 per cent of Canada’s gross domestic production and more than 50 per cent of its exports, the sharp decline in export prices has had a substantial negative impact on the value of Canadian exports, and the economy more generally.
Particularly affected have been Alberta, Saskatchewan and Newfoundland and Labrador, where natural resources account for roughly a third of the provincial economies. Deteriorating prospects for the Canadian economy owing to the commodity rout has also led the Bank of Canada to reduce interest rates. This has accentuated the divergence in the stance of Canadian and U.S. monetary policies, and contributed to further downward pressure on the Canadian dollar.
Looking over the sweep of history, the loonie’s recent sharp downward slide is hardly an isolated one. Over the past century, Canada has experienced a series of booms and busts in the resource sector that have affected our economy and the value of our currency.
After the prosperous Roaring Twenties, commodity prices collapsed during the Great Depression, contributing to a sharp decline in the Canadian dollar’s value. Twenty years later, during the Korean War, a new commodity cycle started. This time, strong commodity prices attracted massive inflows of foreign capital into the Canadian resource sector, forcing the Canadian government to float the Canadian dollar in 1950. Fixed against the U.S. dollar since the beginning of the Second World War, our currency rose sharply.
History repeated itself in 1970. After having returned to a fixed exchange rate in 1961, the government refloated the Canadian dollar due to soaring commodity prices and strong capital inflows. It rode the commodity wave up through the first half of the 1970s, then rode it down again through the second half of the decade.
The most recent commodity-price cycle began in the early 2000s. Growing demand for natural resources, especially from China, caused the price of most commodities to surge, once again benefiting Canada and other natural-resource exporters. From its all-time low in 2002, the Canadian dollar appreciated strongly, briefly touching a modern-time high of $1.1030 (U.S.) in November, 2007.
After commodity prices and the Canadian dollar temporarily softened in 2008 amid the global financial crisis, recovery took hold the following year. Against a backdrop of sustained strong commodity prices, the Canadian dollar firmed to trade narrowly around parity with its U.S. counterpart for several years.
But, as in the past, bust followed boom. Commodity prices began to stumble in 2013-14, reflecting ebbing Chinese demand and an unwillingness by the Organization of the Petroleum Exporting Countries (OPEC) to sustain oil prices at a high level. With commodity prices falling, so did the Canadian dollar.
So what happens now? Asset prices have a habit of overshooting. But it’s hard to say whether the worst is behind us. Should oil prices decline to the $20 to $25 range, as some experts predict, further weakness in the Canadian dollar can be expected.
The good news is that our flexible exchange rate is functioning as it should. By falling with lower commodity prices, it has acted as a shock absorber for our economy. For Canadian resource producers, whose costs are largely in Canadian dollars, the depreciation has partly cushioned the blow of lower U.S. dollar commodity prices. For exporters of manufactured goods and services, the weaker dollar has improved their international competitiveness and their profit margins.
For Canadian consumers, it’s a mixed blessing. On one hand, they benefit from lower gasoline prices and home heating costs, but prices of imported goods and services will likely rise, as will the cost of foreign vacations.
But let’s make no mistake about it, the commodity price decline has on balance delivered a nasty shock to the Canadian economy. Bank of Canada Governor Stephen Poloz recently estimated that the decline in global resource prices will cost the Canadian economy an estimated $50-billion a year, and could last for five years.
For the resource-intensive provinces of Alberta, Saskatchewan, and Newfoundland and Labrador, this means that the fat years are over. Already we’ve seen fallout from lower oil prices; the oil patch is reeling with idle rigs and regional unemployment is rising. In contrast, the recent lean years experienced by Ontario and Quebec, the manufacturing heartland of the Canadian economy, may be at an end.
While it will take time, it is likely that resources, both labour and capital, will eventually be attracted back to this region to take advantage of its new-found competitiveness – at least, that is, until the commodity cycle turns again.Report Typo/Error