[Previous entry: "Strawberries, Goats and Sheep ... trouble in food supply?"] [Next entry: "Global Influence of the Renminbi and Chinese Monetary Policy"]

04/21/2010: "LOONIE = GREENBACK"

Canadian and foreign media are reporting that the Canadian dollar (the loonie) has hit parity with the U.S. dollar (the greenback). That means that one Canadian dollar can be exchanged for one U.S. dollar. As the graphs below illustrate, this is not the first time that this has happened.




A word of caution is in order. Statistics Canada, the Bank of Canada and most economists in Canada, including Professors Ragan and Lipsey, define the exchange rate to be the number of Canadian dollars that can be purchased for one U.S. dollar. The popular media, including television and newspaper, and some economists such as Professor Parkin and Dr. Bade, define the exchange rate as the number of U.S. dollars that can be purchased with one Canadian dollar. While it makes no difference which way we define the exchange rate, since one is the inverse of the other, it will affect our analysis. Note that the two graphs above are perfect inverses of each other; the one on the top is the way it is presented in the text and the one on the bottom is how the media presents the exchange rate.

An article from the Globe and Mail on April 6, 2010 suggests that the recent appreciation of the Canadian dollar is a result of rising oil prices, and the expectation that Canadian interest rates will rise before those in the U.S. This expectation is based on the premise that the Canadian economy, with its lower inflation rate, lower unemployment rate, lower debt and deficit and higher economic growth rate is the healthiest of the G7 countries. Some of the projected consequences of an appreciating currency include a decrease in import prices and more affordable travel costs to the U.S.

The headline of a second article from the Globe and Mail, dated April 13, 2010 suggests that the trade surplus has been increasing in spite of the appreciating dollar. The implication is that the higher value of the dollar should be causing a reduction in net exports, decreasing the trade surplus. Exports of industrial goods and materials are up and prices are rising. Imports are also up, but prices are falling. Exports to all of our major trading partners are up with the exception of Japan. This is consistent with the recovery from the global economic downturn of 2008-2009. Various economists have predicted that the growth in exports will continue and that the Canadian dollar will remain at or above par for some time.

A third article from Reuters, also dated April 13, 2010 argues that the high value of the Canadian dollar is a result of the trade surplus which is a very different view taken by the Globe and Mail. The argument is that the trade surplus (net exports) is increasing due to the global recovery which has lead to an increase in oil prices. The increase in both domestic and foreign spending in Canada increases domestic output. As GDP increases, the Bank of Canada may increase interest rates to slow inflationary pressure. The Reuters article argues that the potential for higher domestic interest rates coupled with the ongoing problems surrounding the Greek debt crisis are what is causing the dollar to rise in value.

For further information see:

Bank of Canada Fact Sheet - The Exchange Rate

Bank of Canada Daily Currency Converter (over 50 foreign currencies)

International Monetary Fund Data Mapper - Balance of Payments Statistics

To review these articles, see the "Sources" section below.

Relevant Learning Objectives

LO #28-4 about the transmission mechanism of monetary policy.

LO #35-2 about the demand for and supply of foreign currency.

LO #35-3 the various factors that cause fluctuations in the exchange rate.

Sources

Statistics Canada, CANSIM data base: Table 176-0049: Foreign exchange rates, United States and United Kingdom; Canada; Series v37694 Canadian cents per United States dollar, spot rate (cents)

Macroeconomics; Canada in the Global Environment, 7th edition, Michael Parkin & Robin Bade, Pearson Canada 2010 Ch 25 pp 593-605

Canadian dollar hits parity, the 'new reality' Tavia Grant, Globe and Mail Tuesday, Apr. 06, 2010 Accessed April 12, 2010

Trade surplus defies strong Canadian dollar Tavia Grant, Globe and Mail Tuesday, Apr. 13, 2010 Accessed April 13, 2010

Trade data helps boost Canada dollar Jennifer Kwan, Thompson Reuters Tue Apr 13, 2010 Accessed April 13, 2010

Questions

1. One of the Globe and Mail articles argues that the trade surplus should fall as the exchange rate rises, while the Reuters article argues that the dollar is rising because of the increased trade surplus. Refer to Chapter 35 in Ragan/Lipsey to see if you can determine which view is correct.

2. Paying attention to the caveat at the beginning of this blog and the material in Chapter 35, explain why a fall in the exchange rate will make travel to the U.S. cheaper.

3. Considering the transmission mechanism for monetary policy, how might the Bank of Canada's expected interest rates increase effect the trade surplus?

4. Using intuition, why might exports to Japan not be increasing along with exports to our other trading partners?

5. Greece, along with Spain, Portugal, Italy and Ireland, has a budget deficit and total debt that exceeds the guidelines for the 16 countries that use the euro. Greece is currently in danger of defaulting on their debt. The Reuters article suggests that the Greek debt crisis is affecting the Canadian dollar exchange rate. Use the determination of exchange rates to explain this.

Michael S. Leonard
Kwantlen Polytechnic University
Surrey, BC