In February, 2009, about twenty-six months ago, the Canadian dollar was worth only about 79.4 American cents. To put it the other way around, it cost us $1.26 to buy an American dollar. Today you can buy a greenback for only 95 of our cents. That’s an appreciation of 32.7% in our currency. What is going on?
The U.S. federal government is struggling with a budget deficit of record proportions. In the current year it will spend $1.3 trillion more than it takes in. By coincidence, that is the size of the entire Canadian economy. At the moment, the accumulated U.S. public debt is about $9.6 trillion. Owners of U.S. debt are concerned that the only way the American government can possibly pay them back is by printing more and more currency. This leads to inflation, and makes each dollar worth less. Unwilling to suffer the death of a thousand currency cuts, investors are selling U.S. dollars and buying other currencies, including the Canadian dollar. Our government is seen to be prudent and virtuous in the debt department, at least compared to its American counterpart. As more investors buy Canadian dollars, the increased demand forces the price higher.
Canada is in the fortunate position of being not only energy independent, but also a significant exporter of energy in the form of oil, natural gas and coal. We also have abundant mineral and timber resources, all commodities which are viewed as good hedges against inflation and likely sources of future export earnings. The Canadian dollar is therefore viewed by the world as a commodity currency as are the Australian and New Zealand dollars. As commodities rise, so too do those dollars.
Finally, the ability to move money around the globe electronically in microseconds leads to a constant comparison of interest rates. Money seeks returns, however short term. Our central bank has raised interest rates on short term funds while the Federal Reserve Bank in the U.S. has held rates close to zero. Investors who wish to capture those higher interest rates need to buy Canadian dollars to do so. This of course again raises the demand for our currency, and thus its price.
In the long run, economists believe in “the law of one price”. This principal states that identical goods (absent taxes and transportation costs) should cost the same wherever they are purchased. Thus a Toyota Camry that costs $25,000 in Buffalo should cost about $25,000 in Toronto if the two currencies are at par (right now it should really cost $23,800 in Toronto as we above par). A paperback book that is $9.95 in Detroit should cost $9.50 in Windsor. But all Canadians know that this is not the case. The law of one price is not working, and we are still paying more than Americans for the same goods. In other words, our dollar does not have purchasing power equal to its face value. On a purchase power basis, it is probably worth more like 90 American cents. Will it go back to that level?
No one knows. History shows that forecasting currency values over the long term is impossible. Our view is that our dollar was too low at 79 cents two years ago and might be too high at 105 cents right now. We do believe that the law of one price will assert itself in the long run, but we don’t know how long that might be. In the meantime we are using the strong Canadian dollar to purchase attractively priced foreign securities. Naturally, we are paying attention to currency risk in our investing and keeping the percentage of non-Canadian assets in our accounts at reasonably low levels.
