Skip to main content

The causes and effects of the Canadian dollar's depreciation are often poorly explained.

No matter how many times Bank of Canada Governor Stephen Poloz says the most import thing for Canadian exporters is U.S. demand, and a weaker currency is only "icing on the cake," it's the icing that gets all of the attention.

Finance Minister Jim Flaherty said in an interview that he thought the Canadian currency's drop to around 90 U.S. cents would be good for manufacturers. Journalistic shorthand tends to explain the benefit by asserting that exporters will sell more stuff because their goods suddenly are cheaper for foreigners to buy. Currency traders assume monetary policy always is geared to keeping exchange rates low so companies can generate more sales.

Reality is far more nuanced.

The current conspiratorial refrain that Mr. Poloz is softer on the dollar than his predecessor ignores the fact that economic risks have shifted considerably since Mark Carney left Canada last summer. And there is no immediate correlation between the exchange rate and sales of finished goods : orders are booked months in advance.

The real benefit from the exchange rate is on profit margins. When you are paid in a currency that suddenly is worth 10 per cent more than the one you use to pay your bills, those bills suddenly are easier to pay. A well-run company in that scenario will have lots of money left over. When Mr. Poloz suggests a weaker currency is helpful, it's because he hopes Canadian executives will use their windfall to invest and hire people.

But even here, it is too simple to assume every Canadian exporter will get a big boost from the exchange rate. Inputs sourced from outside Canada become more expensive, and international competition will have an easier time buying its way into the Canadian market. Any gains Tim Hortons Inc. earns on its U.S. sales could be erased, for example, if Starbucks Corp. decided to more aggressively pursue winning market share in Canada.

Marc Pinsonneault, an economist at National Bank in Montreal, has made perhaps the best attempt yet to estimate the effect of the weaker dollar on Canadian profit margins. Using Statistics Canada, Mr. Pinsonneault calculated the relative importance of exports and imports for 82 industries, assigning a "net exports coefficient" to each one. The larger the coefficient, the bigger the estimated increase in profit margins. He based his assumptions on a 10-per-cent depreciation in the dollar's value from its third-quarter average of 96.3 U.S. cents.

Mr. Pinsonneault's research determined that the manufacturing industry exports 41 per cent of its production and imports 26 per cent of its inputs. (Labour costs represent 18 per cent of the value of production.)

Overall, the simulation widened the profit margins of Canadian factories to 6.8 per cent from 5.4 per cent. Mr. Pinsonneault said in an email that an increase of that size equates to extra profits of about $10-billion a year, which would be a 4 per-cent rise on total Canadian corporate profits of about $237-billion.

But the impact varied. Makers of computers and electronics had the largest export coefficient at 4.2 per cent. Yet that was only enough to narrow the industry's losses. As Mr. Pinsonneault said, the issue for BlackBerry Ltd. (which dominates Canada's computers and electronics category) is demand for its phones, not the exchange rate. On the other hand, the 3.2 per cent increase in the margins of paper companies is enough to pull them out of the red and comfortably into the black. Surprisingly, makers of automobiles, electronics and furniture gain relatively little – only about 1 per cent.

Another surprise: factories aren't the biggest winners from the currency's depreciation; oil drillers are. Mr. Pinsonneault's calculations show a 5.7-per-cent gain in profit margins of non-conventional oil extractors and a 4.7-per-cent increase in the profitability of conventional oil producers.

Not that there's anything wrong with that. It's just that politicians tend to like associating themselves with doing what they can to help manufacturing. Mr. Flaherty is less likely to make note of the fact that while a weaker currency is good for factories, it's even better for oil companies.