Parity party

Even if the Canadian dollar were to mirror the U.S. in value, Andrew Coyne says that’s no reason for celebration

The loonie requires urgent inactionOnce again the dollar is flirting with parity, and once again everyone is very excited about it. Why? Objectively, there is no more significance to the dollar being worth US100 cents than any other value, except that 100 is a nice, round number.

Yes, it means the Canadian dollar is worth as much as a U.S. dollar. But so what? The only reason anyone pays attention to this is because they have the same name. If we were to call our currency something else—I have long favoured “the pelt”—then the mere fact that on any given day, between one currency being worth more than the other and the reverse, their values happened momentarily to coincide would attract little notice. But because they are both called the dollar, it gives rise to the entirely occult belief that the two ought naturally to be at par, the approach of which is celebrated as if it were some kind of cosmic convergence.

That is among those who are not busy complaining that the dollar is “too high.” Indeed, if there is one belief more fixed in popular consciousness than the parity myth, it is that the dollar is always at the wrong level. When it is low it should be higher. When it is high it should be lower. Of course, that doesn’t mean anyone wants to see a rising dollar—why, the only thing worse than that is a falling dollar. In short, while clearly the dollar should never be where it is, on no account should it ever be somewhere else.

Ask AndrewJust now the concern is over the high dollar, mainly among the manufacturing industries. Not every manufacturer, mind you. For while a high dollar drives up the price of Canadian exports to the U.S, it also drives down the price of imports from the U.S. In our highly integrated economies, many manufacturers operate on both sides of the border, importing intermediate goods from one country for assembly in the other. So what they lose on the swings they gain on the roundabouts.

Still, it’s the ones who are hurting we always hear from, their cries taken up by the ever-vigilant Do Something lobby. A bank economist argues in a recent paper that “speculative foreign exchange market forces” are “hollowing out” the Canadian economy. “We may be sacrificing business plant and equipment,” writes CIBC’s Avery Shenfeld, “on the altar of a strong currency.”

The last time we heard the “hollowing out” alarm, it was because the low value of the dollar (as it then was) made Canadian assets a steal for foreign investors. Now the high value of the dollar is making them worthless. Okay: either the dollar’s current lofty value is of some permanence, based on fundamental economic factors—oil prices, the weakness of the American economy, Canada’s relative strength—or it is an illusion, driven by “speculative” forces.

But if it’s the latter, then manufacturers should be able to look past any short-term fluctuations, as should their lenders. And if it’s the former, well, what then? Shenfeld wants the Bank of Canada to step in to drive the dollar down. But, in fact, the bank’s ability to do this is quite limited. Merely selling dollars into foreign exchange markets will not work over the long run, if the overall supply of dollars is unchanged, that is absent a loosening of monetary policy.

But if the bank starts setting monetary policy to hit some target exchange rate, it cannot also hit its target for inflation. Perhaps this seems like an acceptable trade-off to you. But, in fact, it’s not even a trade-off—any reduction in export prices from devaluing the currency will be cancelled out by the rise in domestic prices.

That only emboldens a more radical Do Something faction. Short-term fixes for the dollar are no use, they agree. The answer, rather, is to fix its value, once and for all. Of course, exactly what value to fix it at is an interesting question. The last time we heard from the fixed exchange rate crowd it was sold as a cure for the low dollar.

But, in fact, fixed exchange rates are never truly fixed: in time, imbalances build up that can only be relieved by revaluing. So what might have been a gradual process of adjustment to changing economic conditions under flexible rates is compressed into a single, shuddering jolt. You get all of the uncertainty of a floating rate, and none of the benefits.

If rates really were fixed, there would be no reason to maintain separate currencies. Put another way, the only truly fixed-rate regime would be a single North American currency, which in practice means adopting the American dollar. Maybe this would make sense if we were Argentina, and had proven we were incapable of running our own monetary policy. But as it is this strikes me as a solution in search of a problem.

A floating dollar may be unsettling, but it is also useful, particularly in a commodity-driven economy such as ours. When the dollar falls, in response to a decline in, say, the price of oil, the effect is equivalent to a national pay cut, restoring competitiveness much more quickly and easily than would be possible if wages had actually to be reduced directly. The same applies in reverse—a higher dollar spreads the wealth when oil is riding high, making imported goods more affordable.

This is a situation, in other words, that cries out for urgent inaction. For God’s sake, do nothing. M




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Parity party

  1. Plus, we all remember what happened in the 80's under Mulroney when the government intervened in the value of the dollar. It was an absolute disaster.

  2. "But if the bank starts setting monetary policy to hit some target exchange rate, it cannot also hit its target for inflation. Perhaps this seems like an acceptable trade-off to you. But, in fact, it's not even a trade-off—any reduction in export prices from devaluing the currency will be cancelled out by the rise in domestic prices."

    Right, but the rising currency that causes the concern in the first place is going to be deflationary (because we are paying less for U.S. goods in Canadian dollars). So the two policies are complements, not substitutes. In other words, the BoC, if it chose to, could hit their inflation targets through a combination of changes in the target of the overnight rate and forex transactions, though pushing the dollar *up* would be difficult as the BoC risks running out of U.S. dollars.

    If you're ever in London, ON, I'd love to have you come discuss this in the International Trade course I teach at Ivey. :)

    • I note that Carney was careful to couch his comments about the rising dollar in terms of hitting his inflation target (ie not undershooting it), rather than its effects on real output — rightly so, since the former is within his power to control and the latter is not.

  3. Just now the concern is over the high dollar, mainly among the manufacturing industries. Not every manufacturer, mind you.

    Our trade surplus with the USA last year was US$70 billion.

    If . . . [the strength of the dollar] is an illusion, driven by “speculative” forces . . ., then manufacturers should be able to look past any short-term fluctuations, as should their lenders.

    Would it help if they embraced Buddhism?

    • Our trade surplus with the USA last year was US$70 billion.

      Most, perhaps even all, of that was due to energy exports though.

  4. Are you really that economically ignorant? Canada's economy, both resource & manufacturing, rely on exports, and Canada thrives when it has a trade surplus.

    Our trade surplus and export business thrive when our dollar is below 70 cents US.

    Are you starting to get the picture?

    Parity with the US dollar will mean sluggish growth, high unemployment, and eventually, inflationary prices.

    But Andrew, you are not alone, more than 90% of the people I meet everyday have no clue how our economy works.

    • You make it all sound so simple.

    • As a lowly worker in an export oriented company, I can tell you that it really is not as simple as you seem to think. While selling our goods in the States with a low dollar get us a better top-line return, our costs of doing business in the States simply go up by a countervailing amount, as do the costs of many of our components.

      The trick is to manage exposure to exchange rate fluctuations, which are inevitable, rather than bleat about government inaction in keeping the rate where you want it.

      As for the "trade surplus", this is not a measure to rely on, since it is as heavily affected by the transfer of intangibles as it is by resource and manufacturing trade.

      • It really is that simple. If your components come from the US, then US exchange is a wash, so not relevant. So, your increased operating costs are more than offset by the exchange rate loss.

        I worked for many years for a manufacturer relying on export business. Most of our components were purchased in US dollars and most of our contracts were set in US dollars. The Canadian portion of our export price could vary from as little as 10% to as much as 75%. It was the only determinant of our compettitiveness. With a weak dollar we could bid lower and make more profit. If the dollar rose high enough, we could neither win bids or make a profit. simple as that.

        Managing exposure to exchange rate fluctuations is a short term solution to a volatile market. It is no help when you have a high dollar for a sustained period of time like we are experiencing now.

        The only viable solution for manufacturing is to increase productivity in Canada beyond that in the US or elsewhere. Unfortunately Canadian productivity is usually lower, so we need a favourable exchange rate to be competitive.

        No single measure is perfect, but Canada's trade surplus and prosperity seem to go hand in hand.

  5. There is a good case for an explicitly temporary intervention: inflation is below target, and an inflationary intervention will help us get back up to target. Ordinarily, we'd just cut interest rates when inflation goes below target, but that's not possible now.

    But there are a lot of bad cases for intervention, and that's mainly what we're hearing.

  6. I think a missing element here is that many people, particularly those less conversant with economics, equate the value of the dollar with nationalistic sentiment. So if our dollar is worth 70 cents against the US, there's a feeling of inferiority. It's the quintessential Canadian insecurity – we want our dollar to be at par so we can feel 'as good as' the US. I see that driving the media's celebrationary tone when par is achieved.

  7. Best article I've read so far on the dollar situation. Artificially deflating our currency is not only unsustainable, it doesn't have that great of a benefit for the country as a whole – some win, some lose, but the whole point of a free market is that the central powers don't pick winners and losers, the market does.

    That said, I was glad to see Carney "talk down" the dollar recently, even if the effect was relatively small and temporary. The recent rise in the dollar has been a little to fast for comfort – industries can and should adapt to changing market conditions, but extraordinarily fast changes are that much harder to adapt to, even for strong, flexible businesses. Carney managed to somewhat blunt the rise, all by simply reminding people of the economic realities our country is facing – the market still set the value of the dollar, as it should, but just with the added awareness of what a rapidly rising dollar can do.

  8. I like the idea of renaming the Canadian dollar to something less ambiguous. "Pelts" is good.

    • I thought it was already the Looney?

  9. High dollar bad for the manufacturing / export. Yet its good for most Canadians that want to purchase the same product thats in the US, without a nasty markup because of the exchange.

    Its for the greater good that we find equal ground.

  10. We are in recession now, need more jobs and exports.
    Where is our invisible hand ? The BOC should do more for us.

  11. See Fred and frank above: Alas, so many just do NOT get it. The Chretien Liberals rode the wave of devalued Canadian currency to produce the illusion of faux-prosperity. Sure, the economy was humming, everyone was working… for peanuts.

    The loonie's value is what it is because that is what the sum of all known and anticipated factors about the Canadian (and other) economies and central bank policies should place it. Artificially doubling it is as stupid as artificially devaluing it. Just be smart, make sure you don't trip up your own economy, and let the chips fall where they may. Any other "intervention" is like over-steering when skidding on ice.

  12. Canada should adopt the USD. The two economies are too inter-twined to have this much exchange rate fluctuation. This phenomenon akes it impossible to provide a stable economic environment which in turn is essential for the effective functioning of business.

    One trip to the US makes it easy to see that the C$ is way overvalued.

    And Canada pays the price for this through the devastation of businesses established on the premise of a lower exchange rate. Witness the devastation of th auto, forest products and rlated industries and the related dislocations and economic fall-ou. Companies like Abitibi Consolidated bankrupt.

    Mr. Carney is saying this implicitly when he tries to talk down the dollar to reduce the carnage.

    Lest you think this sacrilege, publications no less prestigious than The Economst have called for a World Curreny (The Phoenix) for the same reasons.

    Continued wild fluctuation harms the weakest nation the most.

    The fluctuating C$ does not hurt the US – it has a devastating impact on Canada and dollar sensitive sectors of the Canadian economy.

  13. A related problem is the unhealthy obsession Canadians have with comparing to the US dollar and only the US dollar. If we're lucky, some in the television news media post the C$ value against other currencies (euro, pound, yen) but often they don't show us the change.

    Here's where some CRTC intervention could be handy. No one can report on TV what the C$ does against the US$ until they have first reported what it did against the Euro, Pound and Yen. Then maybe when people see it going one way against those three but a different way against the US$ they'll start to wonder what's going on.

    The sorry truth of the matter is that the C$ largely tracks the US$ against other currencies. Movements against the US$ pale in comparison to movements against all other currencies. Does it make anyone feel better to know that the C$ slips against other currencies but rises against the US$? In other words, we're not falling as fast as the US$! Everyone start celebrating now!

  14. It would be of great benefit to both Canada and the US if the two countries were to us use the same currency.

    • The US is at present devaluing their currency long-term through insane and unsustainable debt. Please explain how a country one tenth its size would protect itself from such fiscal insanity.

  15. Well said, Mr. Coyne.

    Besides, a strong loonie is not without its benefits. For instance, should the loonie exceed the value of the US dollar, Canada ought to purchase US assets and then trade with nations whose currency is actually stonger than ours.

    Granted, this does not solve the manufacturing problem in Ontario. However, tinkering with our currency may not save manufacturing either, since it will not improve auto sales. At the very least, a strong loonie will preserve value as the manufacturing infrastructure goes to auction.

    Grimly hopeful,
    CB

  16. Either way we go, wether we are below or above parity, US/Canada trade will still see Canadians bending over and just ignoring the fact we are getting stiffed.

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