Joe Barbieri
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The Canadian Dollar: Same Old, Same Old

Why is the Canadian dollar declining in value? It has a lot to do with what is going on in the rest of the world as opposed to what is happening here. First of all, the price of oil has plunged. Since the Canadian economy is heavily based on oil for export, the price of oil affects the Canadian dollar. The second factor in predicting the value of the Canadian dollar is the budget deficit. Since oil revenues are expected to plunge, the budget deficit is expected to swoon, and this generally is bad for a currency. Lowering the Bank of Canada rate recently was designed to prop up the economy, but it is also a negative for the Canadian dollar.

The US is talking about raising their interest rate. Although it is not clear whether this will happen or not, the different directions in interest rate policy that Canada is heading in versus the U.S. is causing people to reevaluate the future value of the Canadian dollar versus the U.S. dollar. A fourth factor is the idea that the Canadian real estate market is overvalued. The three reasons why this is cited as a problem is because Canada was largely unscathed by the subprime crisis of 2008: Real estate did not tank in Canada the way it did in the U.S. and Europe. The second reason why this may be a problem is due to Consumer indebtedness. Why does this matter? If consumers have too much debt, they cannot spend money to buy actual things. The third reason why real estate is critical is because it is the collateral behind most mortgages and bank debt. If real estate goes into the tank, so will the mortgages and the Canadian banking industry. Since banks are pivotal to the economy, the effect will spill over into every other sector. A last factor to consider is that the U.S. dollar is getting stronger versus all currencies, so the Canadian dollar will go down even if these other factors were not present.

One indicator that does not seem to be present is currency speculators that “take a run” at currencies simply for profit. This may be counteracted by the Bank of Canada neutralizing their trades to stabilize the Canadian dollar. While this can occur at any time, it is not easily forecast. If there is large volatility in the currency without much explanation, or a large one way move in the value of the currency without any real cause, speculators could be the reason. What tends to happen is that existing trends get amplified and taken to the extremes until the fundamentals change.

On the plus side, a lower Canadian dollar will mean cheaper exports and more spending in general. It will also mean more investment from foreign investors within Canada. These two things will help mitigate the effect of the lower currency over time.

What to do? Now that you know what will affect the Canadian currency, the way to know what will happen is to examine these factors to see which ones play out. In general, oil is bound to rebound eventually. The budget deficit will still be there, but a combination of spending cuts and more taxes can counteract the lower revenues. The U.S. dollar can always get weaker again and the Canadian real estate market can go down, but when is not clear. In other words, there is not much new here in terms of what the Canadian dollar is doing.