The truth about where the Canadian dollar is headed

Nobody really knows anything

Brent Lewin/Bloomberg via Getty Images

Brent Lewin/Bloomberg via Getty Images

The Canadian dollar fell from 97 cents US to below 89 cents US in the weeks following the Bank of Canada’s decision to shift its monetary policy stance away from a tightening bias. (It has recently rebounded to hold steady at around 91 cents as I write.) These developments have provided additional fodder for those pundits who are in the habit of offering their views about where the dollar should go and/or where it will go (the two are separate issues). These views fill up media space, but they shouldn’t be taken too seriously. The foreign exchange market is one where the “semi-strong” form of the Efficient Market Hypothesis holds: movements in exchange rates cannot be predicted using publicly-available information.

If everyone really believed that the Canadian dollar will end up at (say) 85 US cents, then everyone would sell CAD at its current price to buy USD, wait for the price of USD to increase – which is the same thing as waiting for the CAD to depreciate – and then sell at the higher price. But if everyone does that, the CAD would be bid down to the point where it is no longer profitable: 85 cents. This is why you should take predictions about foreign exchange movements with a grain of salt: if you could actually predict them, the last thing you’d do is tell anyone.

This doesn’t mean that exchange rate movements are completely random: some of the fluctuations can be ascribed to variations in the ‘fundamentals’. But what really drives these movements are the unexpected changes in the fundamentals. And unexpected changes are, by definition, unpredictable. The most reliable forecasting model is a random walk: the exchange rate next period is the current exchange rate plus a white noise error term. The best prediction for where the exchange rate is going is where it is now.

While we’re on the subject, here are why a couple of popular theories are wrong (see also Mike Moffatt’s recent post):

Purchasing Power Parity (PPP): According to this theory, the CAD will – or should – return to its PPP value. Roughly speaking, if the CAD-USD exchange rate is equal to its PPP, then both currencies have the same purchasing power in both countries. For example, if 85 USD has the same purchasing power in the US that 100 CAD has in Canada, then the CAD-USD PPP is 0.85. The problem with this story is that it is entirely based on activity in the goods market, and that is not the only market that matters. In addition to purchasing Canadian-provided goods and services, the demand for CAD is also driven by the demand for CAD-denominated assets. If foreigners wish to increase their holdings, then there will be upward pressure on the Canadian dollar. There is no reason to think that these capital flows will or should cancel out exactly.

The current account deficit: The idea here is that the current account deficit is due to an insufficient demand for Canadian goods, and a depreciation will close the gap by making Canadian goods more competitive on world markets. But running a current account deficit is the same thing as running a capital account surplus: a positive new flow of foreign investment into Canada. An increase in foreign demand for Canadian assets will put upward pressure on the CAD and show up as a surplus in the capital account – which is the same thing as a current account deficit. It’s possible to tell a story in which a current account deficit is associated with a depreciation or an appreciation of the CAD, depending on which side of the national accounts you’re looking at.

In any case, there is no significant relationship between the current account balance and future movements in the exchange rate. This shouldn’t be surprising, because if there were, it would have been arbitraged away. (You get similar-looking results regardless of the length of the forecast horizon):

Canadian dollar chart
No-one knows where the Canadian dollar is going.

Filed under:

The truth about where the Canadian dollar is headed

  1. the same direction as resources, especially oil, down.

    • No one really knows which way oil is going. In 2008 people predicted $300 oil just before it dropped to under $30.

      • with fracking etc there is an abundance of hydrocarbons in NA and without exports the price will fall, soon

        • As the price falls, so does the profitability of getting harder-to-reach deposits, thus making them less likely to be pulled from the ground.

      • If you are betting, I bet we see $300/barrel before we see $30/barrel, with only one exception, if money if revalued say 4 to 1, that is the only hope of seeing $30/barrel or less.

        But revaluation of currency aside, I would take a $10,000 bet we get $300 a barrel before $30 a barrel.

        Big Mac Meal Deal was $0.89 in 1967, its near $8.90 today, it will someday for many people alive today be $89.

        Imagine if you bought $35,000 of gold in 1971, today it would be worth $1,465,000 CAD…..but gold is gold, its value in gold would be the same. Its that money lost value.

        Sort of like lending money to Ontario government for 3%, and 1% goes to taxes for a net 2% yield. But wait, the value of CAD dropped 10 cents….so in fact after taxes and tax as inflation of devalued money, you lost over 8% in value.

        Its why TFSA are better than RRSP, as TFSA come without inflation taxes and do even better if taxes go up. But better than TFSA and RRSP is foreign investments in stable currencies…..

        My dividends in terms of CAD are 11% more with a 10 cent off par.

  2. On the current account deficit, one cannot generalize. One has to look at the reason the current account changed from surplus to deficit.

    In Canada’s case, the current account deficit changed from surplus to deficit, because of
    1) the collapse of natural gas and oil prices (because of shale oil and shale gas in the US and the lack of pipeline capacity)
    2) the high cost of energy in Eastern Canada, because they import expensive oil from the rest of the world, rather than use cheap oil from Alberta, and the high cost of electricity in Ontario relative to its competitors in the States, which has led to
    3) the collapse of manufacturing in Ontario

    Those three local reasons are magnified by global macroeconomic factors:
    1) QE tapering, or tightening in the US, and tightening credit in China, which has led to a decline/collapse of emerging market and commodity currencies.

    And problems with the exchanges.
    1) All trading is dominated by front-running high frequency algorithmic trading, where preferential access is sold to these traders by the exchanges via colocation of their supercomputers with the exchanges, which means they get the information first because of shorter transit times.
    2) HFT due in weeks or days what used to take months and years, because they are able to find softness and weakness in the markets much quicker because of their abilities to overwhelm the trading systems with bids and asks.
    3) This is where all the easy central bank money has gone. Not into improving the real economy, but into aggressive trading all markets for the benefit of the banksters and the 1%.

    • where has the price of oil collapsed?

      • No pipelines. Shale oil boom in the United States, leading to a mid-continent glut. The discount differential between Western Canadian oil and WTI oil priced at Cushing Oil has been over $20 at times over the last two years, and WTI has been trading at a further discount to the now world price Brent, priced in London.

        This is why oil by rail is now expanding exponentially. The price differentials are huge.

      • And it will not collapse. And here is why. Unlike prior depressions, we have new auto/consumers of oil in Asia and in India. Asia now produces more cars for domestic use than Canda, USA and Mexico combined. Tata Motors in India is growing too in auto production.

        Its no longer driven by USA/Europe only demand. For this reason alone, $30 oil is a myopic stupid idea that should be quickly discarded. As while we bash China, we bailout banks and dysfunctional auto, they built the Yangtze dam for 3.5% renewable and clean hydro-electric power. Its why we can’t compete, they are far more efficient in governance, less waste, less money for nothing bailouts and more and more people are joining the middle class.

        But we waste too much in our governance to be successful. They will be the economic prosperity center and that includes automobiles. Oil is needed in Asia, not USA. Its why FN chiefs get political moneys from USA to stop fair market access in western Canada to the Asian markets. Its why Redford was parachuted in… lock western Canada into NA markets and lower prices.

        • The price of oil has on occassion seen reductions generally every ten years only to rebound to a higher sustained price over the long term. Howevet you are correct in your observation of price differentials Canada sees for its oil WTI and the much higher Brent pricing. Your assumption that first nation chiefs are paid for pundates as well as paid for environmental activists are tools used by American interests to control the free markets of Canada and maintain a reserve of mineral wealth here is as much of the story as preventing Asia mostly China from access the oil. One of the reasons for the needs of America to control our distribution is they make a lot of money on the differential price. With the Chinese already heavily invested in Canadian oil pipeline or rail the oil will get out one way or another.

    • Canada is a failing economy. Tax inflated economy of ponzi fraud debt.

      QE is unsustainable and fraud. Be like all of us living off of photocopied money we print and lend to ourselves. It would be called fraud but only legal as governemtn does it. But doesn’t make it ethical or moral to devlaue money like this.

      The above chart shows the ugly truth. The depression started right after Bernanke and others diluted the currencies with fraud money creation to buy government debt that no savvy lender would buy. I have zero debt in the portfolio as I refuse to lend money at rates below inflation+taxes for a negative value return.

      Which is the real issue, fraud low interest rates have a cost, devalued money and less affordable exchange of goods and services for less jobs.

      Its the governemtn debt fraud that caused this. They refuse to live inside their means. Debt is never free, cheap and easy, its only a mater of who and how its paid for. And its being paid in inflation tax and they lie about real inflation.

      • get a life, nothing in your rant will ever happen!

    • What really causes the economy to fail for Ontario manufacturing is that Canada is a tax inflated economy of debt fraud.

      Follow this, our hidden plus realized taxation from all levels of government are huge. We pay more for a dental hygenist because 50% of what you pay them goes to taxes. You pay more for cheese as mozarella has a 283% tariff and protectionism going on, and why it $6/kg in Detroit and $15/kg in Windsor…..Beeef too, Alberta cow looking at Montana cow is $11/kg for rib-eye in Montanta, $20++ in Canada as it has a 234% tariff and protectionism…..all told, $45 billion a year does CBSA collect in hidden taxes from toilets, copper wire, moe goods, food and cloths for getting the poor….

      All this inflates costs and the need for excessively high wages. Wages that well, can be lower in less taxed USA or less taxed China, Asia, India et al.

      Sure, you could raise protectionism, just means fewer can afford the luxuries. Tariff, tax and bilk me more with devalued money and inflation, you can bet we will have less to spend on each others jobs.

  3. Our economy as a giant Casino…and just as many wide-eyed Bubbas wandering in with their shekels, insisting only they understand it

    • ….insisting only they understand it.
      One commenter in particular is fond of reminding the rest of us that only she can understand the economy, since “it’s my field.” Her name escapes me right now.

      • Probably because she never said that.

      • Funny, I recall something similar. There was a commenter on a similar article last week about predicting where the economy was going. This remarkable woman, who’s name escapes me, stated repeatedly that her powers of intellect and unbiased observation skills allowed her to predict with certainty where the economy was going. Although she was challenged by many other commenters, she dismissed them all out of hand and called them stupid (this, incidentally, gave me even more respect for her mental acuity). I believe she declined to make any new predictions, or point to any previous accurate predictions – but this was probably in order to safeguard her technique, which has doubtless made her a very wealthy woman who has lots of time to hang out on comment boards.
        If only I could remember her name…

        • You neglected to mention her vastly superior education to the average plumber or serf.

        • a) First Cons ‘read-in’ what isn’t there

          b) Then they spend huge amounts of time fighting their own strawmen

          c) Then they win the argument against themselves

          d) Which is why they get dismissed.

          • Good news – I have located the actual quotes! Here are the actual pearls of wisdom from the great soothsayer herself:
            “Sorry, I tend to think of things on a global scale….and there you can see the future.”

            “No, you’re part of the class clown crowd. I’ve told you about the economic future on here dozens of times….if you are incapable of handling it, that’s fine with me.”

          • Mmmm and your problem in understanding that would be……?

            Half hour later on edit……Mike2 seems to have disappeared….embarrassed at having misunderstool plain English no doubt.

            Well 42% of Canadians are functionally illiterate…..

          • “Mmmm and your problem in understanding that would be……?”

            The absolute lack of substantive evidence?

          • Evidence for what??

            Apparently neither of you understood what was said in the first place!

            It’s why the dungeon exists….I have no patience for this nonsense.

          • You have no patience for logic.
            Or memory, it seems. Just bash what you cannot grasp as “Con.”

          • Evidence to support any of your claims. You say you have expertise, but all you ever do is make sweeping statements, and then claim intellectual (and class) superiority when anyone challenges you.

            Pretty thin and vacuous. But tons of ego.

      • The best economists don’t work for government, they work for themselves. If a univercity or government economist was so good, they would not need a wage income.

        The best ones I know retired in their 50s to manage their own money and make money doing it. We discuss in our groups stuff that government would not want disclosed, would not want the public to know, a real assessment of what is really going on.

        But media like CBC and other governemtn media puppets will never use real effective economists as the truth would scare the heck out of people.

        • why don`t you share the stuff you discuss, I need a good laugh.

  4. Gets worse when you factor in USD/CAD lost value to other major economies of the world, namely Asia.

    Most Canadians are ignorant of the fact that the CAD didn’t rise to the USD, the USD fell faster than the CAD. USD and CAD are devaluing currencies form excessive debt and ponzi fiat money creation for debt no legitimate lender buys.

    No one is legitimately lending money to governments, they create it devaluing money.

    People with less value money and more taxes will spend less on each others jobs.

    Tax me for bailouts, corporate and provincial welfare; governemtn bloat, I will buy less goods and services. And GDP doesn’t drive jobs, affordable exchange of goods and services drives jobs. But when you get governemtn taking too much and devaluing money, it isn’t a surprise there are fewer jobs and the ones there are are lower paying.

    Its why governments can’t solve the jobs and economic issues, they are the problem. But they love to propel the illusions and myth for PR of it. Deceive the people and brainwash people in believing big government is good. Tax me more for buying a job, I will spend less on someone else’s job and why job programs are a farce.

    The reality is the western economies have passed their zenith, now are in decline from lack of morals, lack of ethics, just replaced with failing governments tax greed and corruption.

  5. Our dollar tied to the USA economy, just look at our trade numbers with the USA,someday our water will be traded higher than our oil

    • If our politicians were not so appeasing to USA interests, it need not be so dependent on USA. But NSA/CIA will assure DC has the advantage. The real reason to spy on people is to get information to control them.

      Yes, I just said Ottawa is the under USA control.

  6. Breaking ! … Local area economist says ” Hey, don’t look
    at me !” ..

  7. Devaluation of currency can be somewhat predicted in general terms. If government/BoC creates money, it dilutes the money already in existence.

    Money is like stock int he economy. You can create no value money for governemtn waste, say 10% ore money then each existing share of money has 10% less value for 11% inflation. 11% as 1.00 / 0.90 = 1.11 to buy $1.00 USD of goods.

    Gets worse as USD has been devlauing for the excessive QE fraud against the now worlds #1 trading region, Asia. Asia GDP is now larger than NAFTAs GDP and more wealth now exists in Yuan and not USD.

    Will not be long before China replaces USA as the #1 country economy.

    Hazards of devalued money. Get lower value money, pay more for tax inflation just means we have less to spend on each others jobs. Employers getting 11% inflation on tomatoes and sugars (Heinz), 11% more for aircraft materials, engines, parts, tire et all (Bombardier) and others will lay off before raises come through as their customers cannot pass on the costs.

    Hey, if it costs me $2250 for a new refrigerator that used to be $2000 a few months ago, its $250 I don’t have tos pend on someone else’s job. Just like the falacy government can create jobs, taxing me more to buy a job, I just spend less on someone else’s job and no new jobs are really created. Governemtn can only reallocate and cnsume wealth, it cannot create it.

    But we love our myths to put government bloat in a good light, when in fact the economic problems we have are from excessive governemtn non-valued added consumption, waste and buddy bailouts….

    Ask yourselves why this economic depressions started in 2006/7 why after 7+ years government has made no progress in making it better? Hint, they can’t solve the issues as they are the cause of the issues. Government tself is in denial as they refuse to right-size.

  8. The Loonie is a resource currency. There’s much more to it than that, but resource dollars will point the way. As the global economy slows, so does the demand and price for resources drops and the Loonie follows. There isn’t the demand by foreiners to buy the Loonie. As the global economy rises so does the demand and price for resources and the demand to buy Loonies by foreigners. There is a lag in the system between the state of the global economy as stockpiles are depleted and orders placed and filled for new. The lag also includes the payment cycle.

    Then there is the lag in the manufactured goods cycle. Just because the currency makes Canadian gods cheaper or more expensive doesn’t create or cancel orders immediately. I takes three years from the time a part is created in the engineering office until it appears on the assembly line.

    Interest rates have an immediate effect. Capital will move to where it can earn a better return. Raise Canadian rates and capital pours in, lower the rate and capital flees. It happens quickly until the capital depreciation appreciation equals the change in return.

  9. Oil is down just not on taxes here in Canada we’ve already sold are oil refineries to the USA I guess the games will still continue

    • How when oil is trading at $103?

  10. I can say that this is really a serious issue.

  11. Well that just proves it, we need to either fire our financial experts or outsource the lot of them.

    • there’s talk in the Canadian government of eliminating its deficit by 2015. No politicians in the U.S. or anywhere else for that matter, are talking about doing that any time soon.