Canadian Dollar Depreciation
Canada has been increasing its prestige as a
high-tech, industrial, society
since the end of World War II. In many ways it
resembles very closely its
southern North American cousin, the United States.
Some of those similarities
are residing in its market-orientated system,
pattern of production, and its
high standard of living. Most years following
the war up to the present, Canada
has experienced some kind of continued
growth as a prosperous and developed
country. However, during the year of
1998, Canada experienced an unexpected
large depreciation in their dollar
relative to the United States. Late in August
of that year, in fact, the
value reached an all-time low. During this paper, I
will try to present some
of the possible economic factors that may or may not
have led to this change
in Canada’s exchange rate. I will also examine some
additional analysis and
theories as to why the trend possibly occurred. Exchange
Rate As the year
1998 approached, the trend for the Canadian dollar was on a
steady decrease
in value in relation to the U.S. dollar. With each passing year
the dollar
lost some value as the table below demonstrates. Year 1990 1995 1996
1997
1998 Exchange Rate 1.16 1.38 1.36 1.38 1.48 *All data tables
extrapolated
from the Cambridge Forecasts Country Report, unless otherwise
noted. It took an
exceptional hit during the year, moving the rate from 1.38
U.S. dollars to 1.48
in U.S. dollars. The plunge is better exhibited in
Appendix 1, with the sharp
decrease of the dollar illustrated graphically and
more specifically, with
Appendix 2 showing the drop throughout the year
of 1998 alone. Growth Rate In
terms of growth rate, the years leading up to
the exchange rate drop in 1998
showed very typical numbers. There was nothing
out of the ordinary, or anything
to hint at a sharp decrease in the value of
the Canadian dollar. As highlighted
below, up to 1998, the economy was
growing at a slow but steady rate each year.
Both the Total Gross
Domestic Product and percentage of GDP real growth were
increasing overall.
Year 1990 1995 1996 1997 1998 GDP (bill. of U.S. $) 573966
584044 611602
631193 603978 Year 1990 1995 1996 1997 1998 GDP Real Growth (%)
N/A 2.3
1.6 3.7 3.1 However as the numbers for 1998 indicate, the depreciation
of the
dollar definitely took a significant chunk out of the Total
Gross
Domestic Product, dropping it below 1996’s levels. This is to be
expected as a
depreciated currency would effect the value of the products,
however as pointed
out before, nothing in growth rate eluded to the
depreciation that took place in
1998. Inflation Rate Similar to the
growth rate, the inflation rate also had
nothing to offer in terms of an
indication of the lowering exchange rate. In
fact, as highlighted below, the
inflation rate was steadily declining as 1998
approached. A trend usually
linked to a healthy economy overall. Year 1990 1995
1996 1997 1998
Consumer Price Inflation N/A 2.2 1.5 1.6 1.0 Even the figures
from 1998
indicate, the inflation rate seemed to be unaffected by the
depreciation of
the Canadian currency. "...that (increase in) performance (of
Canadian
companies), is due almost entirely to the depreciation of the currency
and,
to a much lesser extent, to the lower inflation that Canada has
experienced
during the last decade..." Therefore using the inflation rate as
an economic
indicator in this case is not always conclusive to the ideal that
the dollar
should have been in good shape, with a thriving economy. Dollar
Reserves Again,
looking at the numbers of dollar reserves, no significant
trend seems to point
in the direction of increased weakening. Year 1994 1995
1996 1997 1998 Dollar
Reserves (mil of U.S. $) 392 -2710 -5498 2392 N/A
The fluctuations in the
numbers seem to be quite normal and constant
throughout Canada’s time of both
economic prosperity and slowdown. Trade
Balance The trade balance however starts
to show a different story. The
numbers up to 1997 look very healthy with the
amount of exports far
outweighing the imports. 1997 spelled a big decrease in
the trade balance and
the numbers from 1998 show much of the same. Year 1994
1995 1996 1997
1998 Exports (mil of U.S. $) 228,167.10 265,333.90 279,891.80
301,381.40
322,262.40 Imports (mil of U.S. $) 207872.50 229936.50
237917.20
277707.80 303399.70 Trade Balance 20294.60 35397.40 41974.60
23673.60 18862.70
*Data extrapolated from CANISM, Statistics Canada’s online
statistical
database But as Appendix 1 indicates, 1997 was the beginning of
the gradual
decent of the Canadian dollar, until it reached it’s low in
August of 1998.
This translates to the relatively more expensive foreign
products (imports), as
Canada’s ability to purchase and make good on its
domestic products (exports)
being sold overseas decreases. In other words,
the cost to buy foreign products
rose while the amount of money taken in on
imports when converted to their
currency fell. This is again demonstrated as
you look at the amount of exports.
It continues rise, but not as quickly
due to the lower exchange rate. Couple
that with higher prices paid for the
imports equals a significant decrease in
the trade balance. The balance in
1998, in fact, was lower than the balance in
1994. Interest Rates A final
economic indicator that helps us to explain the
reasons behind the exchange
rate drop is to look at a few of the key interest
rates in the economy in and
around that time. Year 1995 1996 1997 1998 1999 Bank
Rate 7.31 4.53 3.52
5.1 4.91 Prime Business Loan Rate 8.65 6.06 4.96 6.6 6.43
Consumer Loan
Rate 11.88 9.19 8.75 9.27 10.18 *Data extrapolated from
CANISM,
Statistics Canada’s online database As exhibited with the
figures, there is
serious decrease in all of these interest rates from 1995
to 1996. "1998
started off well enough, but by mid-year the optimism was
being abruptly clouded
by a decreasing currency, which seemed to be related
to the low rates of
interest being charged." This decrease demonstrates a
strong economy at this
time, but with them being too low, it causes a capital
inflow to the country, in
turn making the currency’s value depreciate as more
of it is supplied and
demanded. The trend in 1997 and 1998 indicates that the
interest rates are
starting to climb again with hopes to regain the original
strength the dollar.
Other Factors Besides these basic economic
indicators two other main factors
influenced the depreciation of the Canadian
dollar. The first of these resting
in the hands of the Federal government’s
action, or as some would put it, lack
of action. The Prime Minister and
finance minister did nothing in terms of
trying to stop this devaluation of
the dollar. In fact, they encouraged it.
Their thinking was that a
weakening dollar would reduce the labor costs of many
companies, therefore
increasing the amount production and increasing margins.
The opposite
occurred. With the lower value of the dollar, companies were less
motivated
to innovate and reduce costs because they were so sheltered by the
strong
foreign competition. The weaker dollar also raises the price of machinery
and
equipment, which of it, 60% is imported. With these factors comes a
decrease
in competition with the foreign firms and overall decrease in the
health of the
country. Jeff Rubin, an economist at CIBC World Markets agrees
that this
depreciation in the currency has also had a "huge erosion
in
competitiveness." Mr. Rubin also agrees that the lack of action taken by
the
government has hurt competitiveness. "...the protective aspect of the a
weak
dollar is to blame for the plunge in competitiveness and that the
currency’s
devaluation was engineered by the Bank (of Canada)." Yet another
source has
the same opinion, "The dollar’s decline was intensified by the
Bank of
Canada’s benign neglect through early August (1998) and the
apparent
indifference expressed by the government." Some would also argue
that tied
along with this deterioration in competitiveness, is the influence
the Asian
currency crisis had on the Canadian dollar. The depreciation of the
dollar was
one of the most visible impacts that crisis in Asia had on
Canada’s economy.
The crisis over there demonstrated a lower demand and
prices for commodities,
not to mention the perception of Canada being able to
compete in the global
market. It also caused other countries to question its
other policy and
structural issues that take away from the country’s
attractiveness to
investors. Conclusion To conclude, the depreciation of the
Canadian dollar had
many influences hinging upon it. Some of the key economic
indicators were
unfazed by the devaluation, while others were heavily
affected. These and the
outside factors of the Canadian government’s
ignorance of the problem and the
Asian currency crisis all added to the
already confusing mix of speculations. A
quote in the article by Janet
Matthews ties it altogether best, "...if we have
learned anything from the
last 18 months, it is that only the longest of
perspectives is likely to be
of any use when looking a Canada’s economy. This
period since May 1998 has
been characterized by so many ups and downs that it is
easy to jump to
conclusions when looking at economic performance statistics."
Many
economists did. They believed that this depreciation would cause a long
term
economic slowdown for Canada but as current facts indicate, the dollar
has
regained some of its strength and contrary to predictions, the economy is
again
growing and improving at a steady rate.