Currency Manipulators…Seriously?

We should be well beyond this by now. Just before Christmas, I heard an eminent American, who knows Canada well, counsel us that we need to drop competitive devaluation as a trade tactic. I was dumbfounded. Our closest global friends, at high levels of influence, still seem to think we are trying to pull fast ones on them. If that’s the case, we can only imagine how the average American feels. What does the evidence say?

Plot world oil prices against the loonie, and the correlation is unmistakable. There have been some pretty radical oil price swings in the last decade, and each time, the Canadian dollar has swung in tandem. It makes sense, then, that if you want to get a forecast of the Canadian dollar right, tie it closely to the oil price forecast – get crude oil right, and the currency forecast literally falls into place. In our model, every $10 movement in West Texas Intermediate crude oil prices moves our buck by roughly three US cents. Under that rule, the $45 plunge in oil prices in 2015 should have knocked 13.5 cents off the loonie. The Canadian dollar actually dropped 12 cents, and at exactly the same time as the oil price moved – not bad at all.

Wait – there’s more. Oil prices are not the only mover. We produce and export a lot of other commodities, and they also affect the currency. Bundle all the rest together, and a 10 per cent movement in their average price level shifts the loonie by about two US cents. Given the concurrent movement of the non-energy commodity price index, we would have expected a further 9-10 cent drop in the USD value of our currency. Clearly, it doesn’t appear to have happened.

We’ve only just begun. The third element in our Canadian dollar model is interest rates – that is, the difference between US and Canadian 90-day Treasury bill rates. Open up the difference in these by, say, 100 basis points, and the Canadian dollar makes a three-cent shift in the same direction. Here, things are more tricky, as central bank forward guidance – both by the Fed and the Bank of Canada – gets factored in to currency values ahead of time. Even so, the recent change in these relative levels doesn’t seem to have pushed the currency around much. When the Bank of Canada surprised markets with a 25 basis-point cut in early 2015, on an average basis, it didn’t ultimately seem to exert any additional influence on the loonie. Same for the second rate move, made in mid-2015.

That’s not all. Given that the US dollar is the front-runner reserve currency by a very long shot, it can and does move against all currencies in unique ways. We’re just one of many currencies on the flipside of the US dollar doing its thing against everyone. Since 2014, the trade-weighted value of the US dollar against all trading partners increased by 24 per cent – the exact pace of its appreciation against our loonie. Clearly, other currencies actually depreciated against the greenback by much more than the CAD, suggesting that the other core drivers of our currency had even less influence than usual. It’s hard to accuse Canada of intentional bilateral devaluation when just about everyone else moved at the same time, by the same magnitude.

We can go on to talk about the extraordinary reasons behind Canada’s brief fling as a parity currency, and why that persisted for awhile. The market distortions brought about by quantitative easing are partly to blame. But recall also that in the aftermath of the recession, everyone loved Canada. Our banks were hailed as shining examples of prudent management. Discipline in the oversight of our public finances gave us a far superior starting point to most OECD nations. We had ample natural resources that the world was willing to pay premium prices for. And, unlike most others, we had a reasonably solid domestic economy. This brought capital inflows when most others were trying to stem outflows. With the weakening of our domestic economy, the shine of this halo has dimmed more recently, while improving conditions elsewhere have attracted greater capital inflows – yet another fundamental driver of the loonie’s more recent weakening.

The bottom line?

It’s so easy to toss ill-considered accusations around that initially seem to make sense, but in fact are dead wrong. Crafting policy on these misperceptions can be devastating. There’s a lot riding on the hope that the actual facts govern all discussions of our currency’s current and future path.

Categories Weekly Commentary

Comments are closed.

Related Posts