Widely considered a peaceful nation, Canada has emerged victorious from the most fiercely-contested financial war: the currency war.
The term "currency war" refers to the prevalence of central bank actions designed to weaken their respective currencies, the imposition of pegs to prevent currency appreciation, or monetary policy makers "talking down" their currencies. The end goal of these actions is to promote exports by making them less expensive, and therefore more competitive.
According to Bespoke Investment Group, the loonie has declined by more against the currencies of its major trading partners since the start of 2014 than any of 14 trade-weighted currency indexes tracked by Deutsche Bank, which include those of the euro, the aussie dollar, and the yen.
Unlike central bankers in Europe, Australia, and Japan, Bank of Canada chief Stephen Poloz has never explicitly advocated for a lower currency – the tumbling price of oil has done enough to cripple the Canadian dollar. His surprising rate cut, however, did add fuel to the fire.
At the present moment, the negative effects of the "swoonie" are the most obvious: Vacations abroad have become more expensive, and Canadians will face higher prices for imported goods like fresh fruit and vegetables. Meanwhile, our trade balance has sunk back into deficit in the fourth quarter of 2014 after recording surpluses in most of the previous months of the year.
Attempts to keep give the loonie a boost through overhawkish monetary policy, however, would be counterproductive, resulting in higher borrowing costs for households and businesses and a dropoff in the competitiveness of our non-commodity exports.
That being said, there are instances in which active intervention in foreign exchange markets can protect domestic industries – and the jobs associated with them – from being savaged. Canada has learned the hard way that those who fail to participate in currency wars lose them. As the dust from the financial crisis was settling in 2009, the Canadian dollar experienced massive inflows, attributable to our new-found status as a safe haven because of how well our banks and economy weathered the storm.
At the time, CIBC World Markets chief economist Avery Shenfeld advised that the Bank of Canada should take action to mitigate these inflows into the Canadian dollar. Mark Carney, who was then at the helm of the Bank of Canada, elected not to do this although it was well within his power.
Manufacturers were making decisions on where to close down plants in light of the collapse in global demand. With the Canadian currency at lofty levels, our manufacturing plants would come under the knife, said Mr. Shenfeld – a diagnosis that turned out to be painfully prescient.
Canada's victory in the currency war, it is hoped, will help restore what has been lost and offset the shock of the decline in oil prices.
The lower Canadian dollar will make our products more attractive to Americans. But to fully cash in on demand from the resurgent U.S. economy, we'll need to see a meaningful expansion in business investment. Many of the surviving firms in the manufacturing sector are operating with little excess capacity.
For existing companies, however, the loonie's clipped wings may serve as deterrent to expansion – the imported capital equipment that would be required is now much more costly. As such, attracting foreign capital is of paramount importance. Unfortunately, Canada's place in the supply chain for U.S. manufacturing and proximity to the nation's engines of growth is not what it was in the days of yore. That's one reason that Mexico, to be blunt, has been eating our lunch when it comes to U.S. export growth.
For Canada, winning the currency war may turn out to be a Pyrrhic victory, as our entry into these hostilities came far too late.