What’s Fueling the Canadian Dollar?

About four years ago, the Canadian dollar was a joke on the currency markets. Today, it is perhaps the biggest story in North America. In the spirit of a true underdog, the Canadian dollar went from a low of CDN$0.62/US$1.00 in 2002 to today’s rate of CDN$0.94/US$1.00. Percentage-wise, our dollar increased steadily by more than 50%. Better yet, economists are even calling for parity, something that hasn’t happened since 1976, if I’m not mistaken.

So, what’s fueling the Canadian dollar? The most economically relevant measure of our dollar is how it fares against the U.S. dollar. Because the U.S. economy has been walking on wobbly legs for quite some time now, the Canadian dollar is appreciating significantly.

Just to give you an idea, in 2005 the U.S. net trade account deficit (a government account that balances off a country’s imports versus its exports) hit a staggering figure of US$723.6 billion. This means that Americans imported US$723.6 billion more goods and services than they exported.

In case you’re wondering who paid for those imports — mostly crude oil, natural gas and foreign cars — it was selling the USD in international money markets. As the U.S. flooded the international markets with its currency, its price had nowhere else to go but down.

But that’s not the only reason why the Canadian dollar has been performing so well. Canada is also a major commodity-exporter, and the prices of these commodities have skyrocketed in the past two or three years. I’m not talking just about oil, but also about nickel, copper, aluminum, and zinc.

In addition, Canada’s unemployment rate has dropped to a low of 6.3%, something not seen in the last three decades. Not surprisingly, the long-run aggregate supply curve shifted to the right, thus keeping the GDP annualized growth rate steady at more than three percent.

To curb the inflation and keep Canada’s output levels in check, the Bank of Canada, (the northern equivalent of the Fed), had no other recourse but to more than double interest rates since 2004. In return, rising interest rates made capital investments in Canada more appealing than in the U.S., resulting in appreciating domestic currency. (Ah, you gotta love how those macroeconomic ducks sometimes line up!)

The next question should be interesting to PROFIT CONFIDENTIAL readers: Who has benefited and who hasn’t from the soaring Canadian dollar? The obvious losers are Canadian exporters, whose products and services are now more expensive in the U.S. and thus less attractive to U.S. consumers.

The macroeconomic theory argues, however, that this is true only in the short run. In the long run, those 189,000 manufacturing jobs that have evaporated since 2002 will be readjusted once Canadian companies have had enough time to regroup their factors of production and improve efficiency.

Furthermore, a stronger Canadian dollar will provide Canadian companies with more buying power in the U.S., which is why the economists on both sides of the border are calling for more investment activity flowing southbound rather than northbound.