CAD to USD: If You Own Canadian Dollars, You Need to Read This

Canadian DollarCanadian Dollar Forecast for 2016

Anyone keeping score of the CAD to USD exchange rate knows that 2015 was a bad year for the Canadian dollar, but here’s the kicker: 2016 could be worse. Low oil prices decimated Canada’s energy sector, starting a chain reaction that can’t be undone.

Things have gotten so bad in the Canadian economy that the Bank of Canada is considering negative interest rates, a situation economists thought was impossible until it happened to some European countries this year.

Yields on sovereign debt in Switzerland, Germany, and Denmark dropped below zero, as investors clamored for safe assets in a chaotic market. I wrote about that possibility last week and its implications about Canada’s economic health, but there’s more to be said.

The problems weighing down the Canadian dollar don’t really seem fixable. Cutting interest rates won’t work when people are heavily indebted and losing their jobs.

Here’s why…

Weak Canadian Economy Slashes Outlook for the Loonie

The first thing to understand is the logic behind low interest rates. By making it less expensive to borrow money, central banks are campaigning for more spending in the economy. Every dollar spent by someone is earned by someone else, driving up optimism about the future and encouraging businesses to invest.

After all, companies just want to know that demand exists. When sales begin to grow, they’ll increase hiring and dedicate cash to expansion. The weakened currency will help export-based companies move their goods in overseas markets and everything will be sunshine and rainbows again. The market will find equilibrium.

Sadly, that logic doesn’t hold up when you look at the bigger picture of the Canadian dollar. The argument supposes that people can be persuaded to spend more with the offer of cheap credit. As far as human nature goes, that’s not a bad assessment.

Except, of course, that Canadians are swimming in debt right now. The ratio of debt to disposable income topped 163.7% in the third quarter of 2015, which is higher than the debt levels seen in the U.S. right before the housing collapse. People have too much debt as it is; they’re not going to take out more. (Source: “Debt-to-income ratio rose to 163.7% in third quarter, Statistics Canada says,” CBC News, December 14, 2015.)

So maybe exports can fill the gap? Yeah, I wish. It would be comforting to think a weak Canadian dollar will lead to an export boom, but there’s bad news on that front, too.

Devaluing the Canadian Dollar Won’t Help

The Bank of Canada would love to execute a controlled devaluation of the Canadian dollar. It would be great to get the “loonie” down just far enough to raise exports, but not low enough to hurt the international purchasing power of Canadians.

That would be a hole-in-one, a bull’s-eye, a grand slam…take your pick. Unfortunately, Canadian exports are by and large in the commodity sector. To be specific, roughly 53% of the country’s exports in 2014 were in energy, minerals and metals, and forestry. (Source: “Key Facts and Figures on the Natural Resources Sector,” Natural Resources Canada web site, last accessed December 15, 2015.)

Those are the industries that are suffering the most right now! Commodity prices are in the dumps, from gold to silver to crude. There is a massive supply glut in natural resources, which means that revenues don’t have much room for growth.

So depreciating the Canadian dollar, which is supposed to prop up exports, won’t actually make a difference in the sectors that are hardest hit. The hamster-in-a-wheel metaphor comes to mind. Ultimately, I’m scared the Canadian dollar could get trapped at a permanent discount to the U.S. dollar.

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