? The Canadian dollar has declined by over thirty percent versus the United States dollar,since it was at its highest in 1970. The reason for this is mainly the following factors: theQuebec factor, the inflation factor, the productivity factor, the growth in government and taxesfactor, and the commodity price factor. These all come together to bring us to what theCanadian dollar is worth compared to the U. S.
dollar today. The Quebec factor is partly responsible for the decline. ?It is no coincidence that theCanadian dollar began its descent to 69 cents in November 1976. ?? That was the month in whichthe Parti Quebecois shocked political observers by winning the Quebec provincial election.
Itwas the first, and still only, party explicitly committed to separation to assume the reins of powerin Quebec City. ?While it is generally agreed that there is a risk premium built into the Canadiandollar because of the threat of separation, no one believes that threat is responsible for thewhole, or even the bulk, of the currency’s decline. ?? The Canadian dollar is much lower because of separation because of what happenedduring the 1980 Quebec referendum. At the beginning of the campaign, in March 1980, pollsshowed the Yes side leading. In response, the Canadian dollar very quickly dropped from 87cents to 83 cents. But in May, when the No side won a resounding 60-40 per cent victory overthe separatists, the Canadian dollar leaped back up.
It was at 87 cents again in June. Thecurrency’s movement in that period suggests a minimum 4 cent risk premium because ofseparation. This is roughly consistent with what happened in the subsequent October 1995referendum. On the night of the referendum, the television networks were showing the Yes sidewith a substantial lead. The Canadian dollar immediately dropped a cent.
Then, however, thevotes from Montreal were counted and the momentum began to swing strongly towards the Noside. Over the next several days, the Canadian leaped 3 cents to 75 cents. Inflation means that the same amount of money purchases fewer goods and services thanbefore. It follows that if, in a given time frame, currency A undergoes more inflation thancurrency B, then A will end up purchasing relatively less goods than B. Obviously, this meanscurrency A is going to be less valuable than before.
People will be more likely to sell thecurrency or to buy less of it in favor of currency B. The result is that currency A declines relativeto currency B. This is an application of the Purchasing Power Parity Theorom, which holds thatexchange rates, in the long run, reflect relative national inflation performances. ?While Canada’s inflation rate has been lower than the U.
S. rate of late, this has not beenthe case over the last twenty five years. The United States has done better than Canada incontaining inflation during that twenty five year period. ?? Part of the Canadian dollar’s decline,according to the Royal Bank’s John McCallum, can be attributed to this. During the summer of 1998, when the Canadian dollar was hitting all time lows, the Globe and Mail’s editorial page opined that Canada’s lagging productivity is behind the currency’s doldrums.
Productivity refers to the returns generated from employing a unit of capital or labour. Rising productivity means firms are getting more value from each unit of capital and labour in which they invest. For example, you hire someone to mow you lawn for the summer at $10 an hour. At thebeginning of the summer, this individual takes one and a half hours to mow your lawn. So youpay him $15.
By the end of the summer, he is mowing the lawn in an hour. Now you only haveto pay him $10. Notice that the productivity of the labour you have employed has increased: youare getting more grass cut per hour. Notice, too, that your costs have come down as a result. Thatis what rising productivity does: it allows us to produce goods and services at a lower cost.
How does that affect the currency? For an exporting country like Canada, productivity’s mainimpact is in international competitiveness. Higher productivity, involves lower costs, means thata country’s exports become more competitive than the goods produced by other countries. Thattranslates into higher exports, which is supportive of the currency. The opposite takes place inthe case of lagging productivity. Then a country’s costs of production become higher and itsexports cannot be sold at competitive prices. Exports go down and the currency suffers.
Unfortunately, Canada’s productivity has declined relative to the United States in thecrucial area of manufacturing. Between 1979 and 1997, Canadian manufacturing productivityhas grown by 36%. That pales by comparison to the United States. In the same period, U. S.
manufacturing productivity grew by seventy one percent. The Growth in Government and Taxes factor is a major reason for the drop in value. ?Led by the Fraser Institute, neoconservative commentators like to blame the fall of theCanadian dollar on the growth of the public sector and increases in taxation. With governmentmore mettlesome in its regulations and the tax take substantially higher than it was at thebeginning of the 1980’s, people just do not want to invest in Canada. ? Investors take theirmoney elsewhere. So they sell their Canadian dollar assets or do not buy them at all.
Either way,capital flows run against the currency. The Commodity Price Factor is the most prevalent explanation of the Canadian dollar’spoor performance. The argument here is that Canada is still a large exporter of natural resources;not as large as it used to be in the 1950’s, but still about forty percent of its exports are naturalresource based. As such, Canada’s export revenues are very sensitive to commodity pricemovements.
When those prices rise, export revenues go up, helping the Canadian dollar. Butwhen commodity prices decline, the Canadian dollar suffers. And that is what has beenhappening for most of the last twenty five years. Believing that the devaluation of the Canadian dollar has indeed had this effect on theCanadian economy, some economists have proposed that something be done to avoid it fromfurther decreasing in value.
The most noteworthy proposal, along these lines, is North Americancurrency union. ?Just as the European Union has opted for one currency, the Euro, so thesignatories to NAFTA (the North American Free Trade Agreement) – namely, Mexico, Canada,and the United States – should adopt one currency for the continent. ? No longer would we haveto worry about our dollar declining against the U. S. dollar, since we would share the samecurrency. In conclusion, the Canadian dollar has declined by over thirty percent versus the UnitedStates dollar, since 1970 mainly because of inflation and the fact that government taxes havegone up.
This is why the Canadian dollar is worth what it is today. Endnotes? Boreham, Gordon F. & Bodkin, Ronald, Money, Banking, and Finance: The CanadianContext (Holt, Rinehart, &Winston of Canada, 1993), p. 36? Ibid.
p. 43? McCallum, John Drivers of the Canadian dollar and policy implications Royal Bank ofCanada Current Analysis, August 1998, p. 12Ibid. Cooper, Sherry S, Why we’re getting poorer The Financial Post, Mar.
5/99, p. 3Board of Economists, Do we want one North American currency? The Financial Post, Jan. 30/99, p. 9BibliographyBibliographyBoreham, Gordon F.
; Bodkin, Ronald. Money, Banking, and Finance: The Canadian Context. Holt, Rinehart, ;Winston of Canada, 1993. Board of Economists. Do we want one North American currency? The Financial Post, Jan.
30/99. Cooper, Sherry S. Why we’re getting poorer The Financial Post, Mar. 5/99.McCallum, John Drivers of the Canadian dollar and policy implications Royal Bank of CanadaCurrent Analysis, August 1998.Economics