If you're a Canadian "snowbird," or someone who is planning a trip south of the border soon, your smile has probably been getting wider and wider as the Canadian dollar continues to climb. On Monday, the loonie breached the 78-cent mark -— a level not seen for a decade or so -— as the U.S. greenback weakened, continuing a trend that is likely to persist for much of the coming year. How Canadian businesses will deal with the reality of a high dollar, however, remains to be seen.
Although it would be nice to think that the rise in the loonie has come about solely because we have such a wonderful country and a top-notch economy -— and are so darn nice to boot -— the main reason the Canadian dollar has been rising, and will likely continue to do so, is the weak U.S. dollar. And there aren't any signs of that particular trend abating any time soon.
It's true that Canada's economy has shown signs of strength that might encourage foreign investors to buy our stocks and bonds -— the commodity sector in particular has been strong, with higher prices for gold, natural gas and other commodities that Canadian companies specialize in. But the main draw for investors is the interest-rate gap between Canada and the United States. In effect, we are paying people to hold assets denominated in our currency, and the United States is not.
From all appearances, both the U.S. Federal Reserve and the Bush government are content to let the U.S. dollar slide until it becomes clear that the economic recovery is well under way and the stimulus of low interest rates is no longer required. On Sunday, for example, Fed governor Ben Bernanke said that the risk of a destabilizing fall in the U.S. greenback is "quite low," a message the market took to mean the central bank isn't worried enough to raise rates in the near future.
The Fed governor said that the benchmark lending rate will stay at a 45-year low of 1 per cent "so long as the conditions apply that inflation is low, at the bottom of the range, and resource use is slack." As Mr. Bernanke pointed out in his speech to economists, the inflation rate is at its low point now, and if anything there is still the risk that it could decline further. In other words, the level of the dollar isn't going to force the Fed's hand, at least not while inflation remains off the radar screen.
The dollar's slide has continued despite some of the strongest economic news the United States has seen in decades. For the past three years, even as the consumer has remained strong and housing sales have stayed high, there has been little sign of activity from the industrial sector of the U.S. economy -— apart from continued layoffs, of course. But that has changed in recent weeks, with several signs of life from the U.S. manufacturing sector.
In particular, the Institute for Supply Management (ISM) came out with its monthly survey of manufacturing-related spending last week, and the number for December blew away even the most optimistic estimate, coming in at 66 instead of the consensus of 61. That's higher than the index has been since December of 1983 (one component of the index that tracks new orders hit its highest level since 1950). And U.S. GDP grew at an annualized rate of 8.2 per cent in the third quarter.
Despite all that good news, foreign investors remain fixated on the low interest rate -— and the likely prospect that it will stay at 45-year lows. They also have their eyes trained on the twin deficits the U.S. is carrying: the massive trade deficit and a projected $450-billion (U.S.) budget deficit. As long as both of those remain at or near record levels, economists say, the U.S. dollar's trend will continue to be down.
As a result, the trend in the Canadian dollar will likely continue to be up, as it has been for the better part of last year -— a year in which the loonie climbed by 21 per cent against the dollar, its best one-year performance since the 1950s -- unless the Bank of Canada decides to cut interest rates. Some export-oriented groups have been clamouring for the central bank to do just that, to ease the pain they are feeling as a result of the exchange rate. Others argue that Canadian companies need to become more efficient, and that a higher dollar will force them to do so.
The reality is that virtually every sector of the economy will continue to be affected on some level by the continuing pas-de-deux the Canadian and U.S. dollars are engaged in. Anyone whose costs are primarily in U.S. dollars will enjoy a benefit, while exporters will find themselves squeezed to the point where they have to cut costs dramatically -— just as U.S. companies have over the past decade, something that in turn has helped produce the staggeringly high productivity numbers the U.S. economy keeps on churning out.
That may not be a pretty picture if you work in an export industry -— but the smiles on the faces of those snowbirds are just going to get wider.
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