Letter from... Canada

Alison Arnot writes on the growing strength of the Canadian dollar

In May this year, the Canadian dollar passed the US 90 cents mark for the first time in almost 30 years, bringing on speculation that parity with the US dollar could not be too far away.

The Canadian dollar, which is affectionately referred to as the “loonie” after the image of the loon carved on the coin, has steadily risen from a low of around US 63 cents in January 2002, until it reached a 28-year high of more than US 91 cents on 31 May.

In a world where strength is good and high numbers are usually desired, it is easy to get caught up in nationalistic pride and say: “Our dollar is just as strong as theirs.”

But is a strong Canadian dollar really a good thing? Many manufacturers and exporters, who do business with the US, and have watched their profits decrease with each penny increase, do not think so. Exports to the US represent 80% of Canada’s total exports, or 30% of the GDP, says Clément Gignac, chief economist with National Bank Financial.

The strength of the Canadian dollar had by far the biggest impact on the paper and wood product producer Abitibi-Consolidated’s bottom line, said the President and CEO, John Weaver, in an address to shareholders in May. “With 76% of our Canadian production sold in US dollars, the impact of the relative change in exchange rate has been enormous… When compared to 2001, the strengthening Canadian dollar resulted in a negative EBITDA [earnings before interest, taxes, depreciation and amortisation] impact of C$598m for 2005 alone, and a cumulative negative impact of over C$1bn.”

Parity with the greenback would only increase these losses. “A 10% rise in the Canadian dollar would clip C$3bn-C$4bn per month from export revenues,” says Stephen Poloz, chief economist at Export Development Canada (EDC).

Still, the strong dollar benefits Canadian retailers and other importers, who are paying less for merchandise, machinery and equipment. In fact, imports were growing at three times the pace of exports in March, Statistics Canada reported.

So why is the Canadian dollar so strong? “Part of it is a gradual weakening of the US dollar against all major currencies,” says Avery Shenfeld, senior economist with CIBC World Markets. “But Canada has also benefited uniquely from its position as a resource exporter, particularly an energy exporter.” With high oil and gas prices, and the development of the Alberta oil sands and natural gas projects, this sector of the Canadian economy is reaping huge profits.

According to EDC, a C$10 rise in oil prices translates into a currency appreciation of three cents. “Given the current conditions, a rise in the price of oil to the C$100-C$110 range would take the Canadian dollar to parity,” says Poloz. However, Poloz sees this as cyclical. “The global economy would slow significantly, prices of other commodities would retreat, oil prices would probably retreat as well, monetary policy would ease, and the Canadian dollar would reverse some of its gains.”

The current geopolitical climate has been good for Canada, says Gignac. “The Canadian dollar has [recently] gained strength against the US dollar, but not necessarily against the euro, so it was more a US dollar decline than just a made-in-Canada commodities story.” Gignac cites Canada’s geographical position, abundant natural resources, low interest rates and debt-to-GDP ratio, and low unemployment rate as additional reasons for the dollar’s strength. In addition, with productivity estimated at about 3% of GDP, inflation has been contained.

With all this working in Canada’s favour, Gignac says it would be naïve to think there would not be parity with the US dollar, something we have not seen since the 1970s, with the Canadian dollar reaching a high of US$1.04 in 1974. “Assuming the world economy doesn’t fall apart”, the economist predicts the loonie will equal the greenback by autumn of 2007.

Shenfeld is not as certain. “Many things can happen that can change the world’s economic picture,” he says. “The high dollar is a reflection of the strength of the Canadian economy, but in and of itself represents a drag on economic growth.”

But one thing is certain: it’s been a long time since Canadians had this much spending power abroad. Many will be taking advantage of the loonie’s strength by travelling to foreign destinations this summer.

Alison Arnot is a freelance writer and editor based in Ottawa.