Consequences of a lower Canadian Dollar

Untitled-1After hovering around parity with the US dollar for three years, Canada’s loonie fell sharply in 2013 to near 90 cents (US), where it still hovers. Initially, the lower dollar was greeted with relief, especially for manufacturing exporters. However, as the dollar continues to languish, awareness grows that the benefits of weaker loonie are small compared with its costs.

Our lower exchange rate automatically raises the Canadian price for goods where an integrated North American market sets one price in US dollars mostly gasoline and home heated fuels. The lower Canadian dollar already has opened up a gap between the price for these goods in the US and in Canada. In January 2014, for example, the price of gasoline in the US edged up 0.1 percent from January 2013, while in Canada it was up 4.6 percent. Prices will rise soon for products that consume a significant amount of energy, such as air travel.

Prices for some other products are sensitive to the exchange rate. The cost of fresh fruit and vegetables, mostly imported during our winter months, was up an average 4.1 percent in Canada from a year earlier, compared with a slight decline in the US. Of course, cross-border shoppers face large price increases, they automatically have to pay more to buy US dollars. The same increases will face internet shoppers buying products prices in US dollars.

Not only consumers will pay higher prices. Businesses import most of their machinery and equipment. Faced with higher prices, firms will trim their outlays for machinery and equipment, which ultimately will depress productively and wages in the future. Meanwhile, governments will feel an increased burden of their debt that is denominated in US dollars.

The benefits of a lower exchange rate go primarily to exporters. Firms that earn US dollars from exporters will profit from a lower exchange rate, as these US dollars buy more Canadian dollars when they are repatriated. Even here, the benefits are likely to be limited to prices, since the volume of exports shows little sensitivity to the exchange rate. The volume of Canada’s exports is largely determined by the trend and composition of demand in our major export markets.

Some may view a lower dollar favourable out of hope it will lift growth from natural resources to manufacturing. They will be disappointed. The most stimuli to exports from a lower dollar is for natural resource, which need it the least, and the least stimulus is for manufacturing, which needs it the most. This reflects how manufactures adapted to the higher dollar over the past decade. When the dollar was near parity with the US greenback, firms hedged their exposure to the high dollar by reducing their reliance on exports and increasing their use of imported inputs. This “natural hedge” reduced the net exposure of manufacturing firms to exchange rate fluctuations by almost ten percent source industries have the highest net exposure to a lower dollar, because they export most of their output most commodities, this further tilt our economy towards natural resources.

The other major beneficiary of a lower exchange rate is to Canadians invested aboard, who pocket more Canadian dollars when they repatriate these investments. This is a dubious benefit for our economy. It rewards people for not investing in Canada at the cost of lowering the value of all assets in Canada. The losses foreigners will feel on these investments will make Canada a less attractive place to invest in the future, while encouraging Canadians to invest more aboard. The myth that a low exchange rate encourages economic growth took hold in Canada in the 1990s. Canada’s manufacturing growth was led by low-wage industries such as clothing, textiles, and furniture, where employment rose 29.7 percent from 1992 to 2000. The flimsy basis for this allocation of resources was fully revealed when a rising dollar and China’s exports devastated these industries. IN retrospect, one can only look back with wonder and astonishment that Canada acted as if our future lay in investing in low-wage industries predicated on a chronically low exchange rate. Even the 1990s boom in autos and high enabled these exporters to reap export earning in US dollars while paying their Canadian workers the equivalent of 63-cent US dollars. It was a business model doomed to fail when the exchange rate started to appreciate.

Devolutionists should be pleased that the boost to manufacturing indeed seems to be happening. Factory jobs have risen 1.5 percent since last October, while investment in manufacturing is projected to rise further in 2014. However, there is no sign this is boosting the overall economy, as both total employment and business investment have installed. Apparently, there is something more to economic growth than just revving up factory output. At least we no longer have to listen to the acrimonious and tiresome debate about Canada’s manufacturing sector suffering from “Dutch Disease”. But what do you call an economy languishes? Perhaps “Asian Disease”, where exports flourish but domestic demand retards growth.