Understanding the impact of dollar fluctuations on Canadian businesses, June 2008
The Canadian dollar / U.S. dollar exchange rate is an enormously important factor in the performance of the Canadian economy. Any organisation wishing to trade within this country is likely to feel the effects of currency shifts so it is critical to understand the key driving factors.
The centrality of the United States as a market for Canadian exporters amplifies the impact of CAD appreciation. Canada exported over $350 billion of merchandise to the United States in 2007. As the CAD appreciates, Canadian exports become more expensive for American buyers and thus less competitive in the gigantic U.S. market.
It is not only the appreciation of the dollar that affects Canadian companies, but also the rate of its ascent. At USD1.00, Canada’s currency has appreciated in value by 60% against its American counterpart since January 2002. The CAD’s rapid ascent has given Canadian companies little time to prepare for the resultant impact on exports to the United States.
Factors Driving CAD Appreciation
The Canadian dollar’s appreciation stems from four interrelated factors:
- Increased global demand and higher prices for Canadian commodities and energy exports
- Strong economic growth in western Canada, which has boosted inflation and kept Canadian interest rates relatively high
- Weakening demand in U.S. housing and consumer markets
- The depreciation of the American dollar against major freely floating currencies, which has been aggravated by the problems and uncertainty in U.S. credit markets
Industry Effects
Some Canadian industries are benefiting from CAD appreciation. The “loonie” (named for the Canadian bird depicted on the one-dollar coin) began to take off in late 2002, just as global commodity prices started their historic climb. The commodity price boom has generated a large windfall for key Canadian industries: Between 2003 and 2007, prices of petroleum, coal, and primary metals have soared, boosting revenues of Canadian suppliers of those products.
The overall gain in Canadian exports in 2007 was driven by commodities (notably industrial goods, agriculture and energy), which accounted for half of exports that year. Prices for these goods remain buoyant on world markets, as rising demand from emerging nations more than offsets economic weakness in the United States. Canadian exporters have responded by shifting away from the slumping U.S. market; while exports to the United States fell 2% in each of the last two years, overseas shipments rose 13% in 2006 and 16% in 2007.
However, CAD appreciation has exacted a serious toll on Canadian manufacturers. According to CIBC (Canadian Imperial Bank of Commerce), over 300,000 jobs have been lost in the manufacturing sector during the past five years. CIBC is forecasting another 200,000 job losses in the industry by the end of the decade - most of which will be concentrated in Canada’s most populous province of Ontario.
Canadian auto parts manufacturers are particularly hard hit, as the ‘big three’ North American car companies represent their largest customers. The ‘big three’ are themselves dealing with decreased sales, plant closures and layoffs. The woes of the U.S. auto sector immediately trickle down to their Canadian suppliers. Many Canadian auto parts manufacturers signed contracts with U.S. customers when the CAD was trading under 90 cents USD. With the two currencies now trading near parity, those Canadian vendors find themselves in a precarious position.
Canada’s pulp and paper industry is also reeling under the dual impact of CAD appreciation and the U.S. housing crisis.
The Artificial Price Advantage
Canadian exporters generally prefer a weak CAD. But a sagging currency can lull undisciplined companies into a false sense of capability and competitiveness. Nothing makes an uncompetitive export business look better than a currency trading well below its proper value for an extended period of time. The many years that the CAD was in the 62 –70 cent range created a sense of complacency that left many Canadian export manufacturers ill-equipped to compete with a Looney trading over 75 cents U.S.
Countering CAD Appreciation
Natural hedging is an effective means of countering the effects of the rising Canadian dollar. By aligning their USD sales with USD purchases of raw materials and inputs, Canadian companies can reduce their exposure to currency shifts. However, a survey of the audit partners at RSM Richter reveals that very few mid-sized clients are changing their suppliers or customers to create natural currency hedges.
Another remedy to shifts in the CAD/USD exchange rate is reducing trade dependence on the United States. In 2000, the U.S. captured 83.6% of Canadian exports. By 2007, the U.S. export share had fallen to 76.4%.
Meanwhile, Canada’s exports to the rest of the world are growing. Between 2001 and 2006,
Canadian exports to the United Kingdom increased by 33%. During the same period, exports to other members of the European Union grew by 14%. In Asia, Japan remains Canada’s top export market. China is a close second as an export destination, and continues to be Canada’s top Asian importer.
If you would like to speak about trading within the Canadian economy contact the author of this article, Joel Cohen, Executive Partner at RSM Richter, the Canadian member firm of RSM International.