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At Issue
Who Knew? Loonie\'s Fall Keeps Us Guessing
Tuesday, May 17, 2005
Oh, how the mighty have fallen. This past winter, I had the opportunity to speak across Ontario to different agricultural groups and often the topic was that burgeoning loonie. It put a dent into farm country revenues as well as the Ontario auto industry. Adjusting to the big rise in the loonie's value was sending everybody to bed in 2004.
It was almost like a herd mentality. Once a currency starts moving, sometimes it's hard for people to realize it can go the other way. Canadians have a fixation with our currency, partly because we live so close to the US border. It's a thinly traded commodity at the best of times.
A funny thing happened on the way to 90 cents US. I'll get to the political stuff last. Our old friend Alan Greenspan, chairman of the US Federal Reserve had a lot to do with it. Raising US interest rates this past winter was the first rock solid signal that the Canadian loonie's value was on borrowed time.
The U.S. Federal Reserve has raised interest rates by a quarter point eight times since last June, taking its crucial short-term rate to three per cent. On the other hand, David Dodge and the Bank of Canada has kept its key rate at 2.5 per cent as the economy adjusted to the sharp rise in the loonie during 2003 and 2004.
The spread in the interest rates between the US and Canada is a natural magnet for capital. This has helped get the US dollar off its winter lows. It's also had the effect of taking the juice out of the Canadian dollar as capital flocked to US markets. This turnaround, which started last March, has changed the short term dynamic in the relationship between the US greenback and Canadian loonie.
I think this US stance on their interest rates is the major factor in our loonie's weakness. Remember, in November 2004, the loonie hit 85.32 cents US. 7 cents is nothing to sneeze at in five or six months. However, there are other economic factors, which are weighing in on the loonie.
Demand for our currency has also waned because of reports this past week that show retail sales dropped and foreigners slowed their purchases of Canadian securities in March. Factory shipments declined and the trade surplus remained at the smallest level since December 2002 according to Bloomberg News. It seems to me that's a picture of fluid capital taking flight to other more attractive places.
That's a bit hard to imagine with spring breaking out all over Canada. I mean, isn't this spectacular place an attractive place for capital at the best of times? Could you think of a place any better? Oh wait, I've yet to mention that little bit of political discord going on in Ottawa.
Currency traders hate political instability. That's one reason that the US dollar is such a magnet of stability throughout the world. Love them or hate them, our American friends elect a stable government every four years. Not so here in Canada. Our current
minority situation in parliament may end this week. However, with the Liberals writing fiscal and economic policy on the fly to keep from losing power, currency traders are voting with their money.
The vote on the budget this Thursday might serve as a flashpoint for the loonie. I'm expecting the government to be defeated, with Canadians going to the polls soon after. I just don't think the Liberals have the numbers to get over the hump. The next election will surely produce another minority. That will add to our currency instability.
Some of you might be saying that's a good thing. I know what you mean. With 80% of our trade going to the US, it only stands to reason that lower unstable loonie helps our economic growth. Renewed job growth follows and our economic engine only hums smoother. So maybe, this is a good thing.
We'll see. The lower dollar will free the Bank of Canada to raise interest rates in order to control inflation. They won't be so worried about the loonie going up now, so I'm expecting it. That'll make everybody's new washer and dryer just a little bit more expensive.
But of course, who knew? You say 85.32 cents US in November versus 78.76 cents US last week. It should serve as an example. Whatever goes up, will eventually come back down.
Philip Shaw, farms 830 acres near Dresden, Ontario. He holds a Masters of Agricultural Economics and Business Degree from the University of Guelph and is a well-known commentator on agricultural issues in print, on radio and over satellite in Canada and the United States. In the Chatham-Kent Times, Phil will use his frank and forthright writing style to address political and economic issues from the local to the international stage. He is a keen observer of political life at all levels, reads widely and has travelled the world to gather fodder for his column. See what's At Issue this week.
